-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KYX+T6PubN0h3CLjMOn8tm5ZFg8XBC8pMT7qvX/y3kOLpa5qRjmP1JO2AFVym+Q7 RzJuYD3V0AiMYG7TUQjEiQ== 0000912057-01-538403.txt : 20020410 0000912057-01-538403.hdr.sgml : 20020410 ACCESSION NUMBER: 0000912057-01-538403 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011109 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTRUSION COM INC CENTRAL INDEX KEY: 0000736012 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER COMMUNICATIONS EQUIPMENT [3576] IRS NUMBER: 751911917 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-20191 FILM NUMBER: 1779167 BUSINESS ADDRESS: STREET 1: 1101 ARAPAHO ROAD CITY: RICHARDSON STATE: TX ZIP: 75081 BUSINESS PHONE: 9722346400 MAIL ADDRESS: STREET 1: 1101 ARAPAHO ROAD CITY: RICHARDSON STATE: TX ZIP: 75081 FORMER COMPANY: FORMER CONFORMED NAME: ODS NETWORKS INC DATE OF NAME CHANGE: 19970507 FORMER COMPANY: FORMER CONFORMED NAME: OPTICAL DATA SYSTEMS INC DATE OF NAME CHANGE: 19950517 10-Q 1 a2062587z10-q.txt 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------------- FORM 10-Q ---------------------- [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______________to______________ Commission File Number 0-20191 ---------- INTRUSION INC. ------------------------------------------------------ (Exact name of Registrant as specified in its charter) DELAWARE 75-1911917 - ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1101 EAST ARAPAHO ROAD, RICHARDSON, TEXAS 75081 ----------------------------------------------- (Address of principal executive offices) (Zip Code) (972) 234-6400 ---------------------------------------------------- (Registrant's telephone number, including area code) INTRUSION.COM, INC. ------------------------------------------- (Former name, if changed since last report) * * * * * * * * * * Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes X No --- --- The number of shares outstanding of the Registrant's Common Stock, $.01 par value, on October 31, 2001 was 10,608,801. ================================================================================ INTRUSION INC. INDEX
PAGE ---- PART I - FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Condensed Consolidated Balance Sheets as of September 30, 2001 and December 31, 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Condensed Consolidated Statements of Operations for the three months and nine months ended September 30, 2001 and September 30, 2000 . . . . 4 Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2001 and September 30, 2000 . . . . . . . . . . . . 5 Notes to Condensed Consolidated Financial Statements . . . . . . . . . . . . 6-9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . . . . 10-20 Item 3. Quantitative and Qualitative Disclosures About Market Risk. . . . . 21 PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . . 22 Signature Page . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
2 PART I - FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS. INTRUSION INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except par value amounts)
Sept 30, Dec 31, ASSETS 2001 2000 ----------- ----------- Current Assets: (Unaudited) Cash and cash equivalents $ 17,250 $ 20,345 Short-term investments 6,997 17,506 Accounts receivable, less of allowance of $1,044 in 2001 and $919 in 2000 for doubtful accounts and returns 5,657 6,887 Income taxes receivable 3,557 1,743 Inventories, net 5,617 8,359 Other assets 836 1,714 Deferred tax asset - 3,764 Net current assets - discontinued operations - 3,958 Total current assets 39,914 64,276 Property and equipment, net - continuing operations 4,379 7,134 Property and equipment, net - discontinued operations 786 1,499 Long-term investments 400 7,575 Intangible assets, net 4,189 7,634 Other assets 104 361 Net other noncurrent assets - discontinued operations - 3,935 ----------- ----------- TOTAL ASSETS $ 49,772 $ 92,414 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable and accrued expenses $ 6,819 $ 9,884 Deferred revenue 1,995 1,878 Net current liabilities - discontinued operations 614 - ----------- ----------- Total current liabilities 9,428 11,762 Deferred tax liability - noncurrent - 1,841 Capital lease obligation 22 24 Stockholders' Equity: Preferred stock, $.01 par value, authorized Shares - 5,000, no shares issued and outstanding - - Common stock, $.01 par value, authorized shares - 80,000 Issued shares - 20,649 in 2001 and 20,525 in 2000 Outstanding shares - 20,609 in 2001 and 20,485 in 2000 206 205 Common stock held in treasury, at cost - 40 shares (362) (362) Additional paid-in capital 47,320 46,916 Retained (deficit) earnings (6,461) 32,453 Foreign currency translation adjustment (381) (425) Total stockholders' equity 40,322 78,787 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 49,772 $ 92,414 =========== ===========
See accompanying notes. 3 INTRUSION INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts) (Unaudited)
Three Months Ended Nine Months Ended ---------------------- ---------------------- Sept 30, Sept 30, Sept 30, Sept 30, 2001 2000 2001 2000 --------- --------- --------- --------- Net Sales $ 3,612 $ 6,456 $ 13,381 $ 18,575 Cost of sales 2,354 5,046 11,249 14,428 --------- --------- --------- --------- Gross profit 1,258 1,410 2,132 4,147 Operating expenses: Sales and marketing 4,597 7,571 19,123 20,033 Research and development 2,933 3,488 10,472 9,892 General and administrative 894 1,421 3,704 4,217 Amortization of intangibles 182 334 852 640 Restructuring costs and other special charges - - 3,973 - --------- --------- --------- --------- Operating loss (7,348) (11,404) (35,992) (30,635) Interest income, net 334 885 1,436 2,513 Other income 51 8 112 66,361 --------- --------- --------- --------- Income (loss) before income taxes (6,963) (10,511) (34,444) 38,239 Income tax (benefit) expense (74) (3,445) (1,694) 5,952 --------- --------- --------- --------- Income (loss) from continuing operations (6,889) (7,066) (32,750) 32,287 Income (loss) from discontinued operations, net of tax - (486) (6,164) (571) --------- --------- --------- --------- Net income (loss) $ (6,889) $ (7,552) $(38,914) $ 31,716 ========= ========= ========= ========= Basic earnings (loss) per share, continuing operations $ (0.33) $ (0.36) $ (1.59) $ 1.67 ========= ========= ========= ========= Diluted earnings (loss) per share, continuing operations $ (0.33) $ (0.36) $ (1.59) $ 1.58 ========= ========= ========= ========= Basic earnings (loss) per share $ (0.33) $ (0.38) $ (1.89) $ 1.64 ========= ========= ========= ========= Diluted earnings (loss) per share $ (0.33) $ (0.38) $ (1.89) $ 1.56 ========= ========= ========= ========= Weighted average common shares outstanding 20,592 19,778 20,550 19,339 ========= ========= ========= ========= Weighted average shares outstanding assuming dilution 20,592 19,778 20,550 20,374 ========= ========= ========= =========
See accompanying notes. 4 INTRUSION INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands), (Unaudited)
Nine Months Ended ----------------------- Sept 30, Sept 30, 2001 2000 --------- -------- Operating Activities: Income (loss) from continuing operations $(32,750) $32,287 Adjustments to reconcile income (loss) from continuing operations to net cash used in operating activities of continuing operations: Gain on sale of available for sale security - (66,355) Depreciation and amortization 3,442 3,433 Impairment of intangible assets 3,109 - Deferred income tax (benefit) expense 1,923 (2,608) Changes in operating assets and liabilities: Accounts receivable 1,230 (2,275) Income taxes receivable (1,814) - Inventories 2,742 (2,172) Other assets 683 (275) Accounts payable and accrued expenses (3,065) (2,576) Income taxes payable - 973 Deferred revenue 117 980 --------- -------- Net cash used in operating activities of continuing Operations (24,383) (38,588) --------- -------- Investing Activities: Proceeds from sale of available for sale security - 67,055 Purchase of MimeStar, Inc. - (4,000) Purchases of available for sale investments (10,629) (50,979) Maturities of available for sale investments 28,313 26,403 Net purchases of property and equipment (247) (5,209) --------- -------- Net cash provided by investing activities of continuing operations 17,437 33,270 --------- -------- Financing Activities: Exercise of warrants and employee stock options 405 15,876 Payments on stockholder loan - 1,177 Net repayment of capital leases (2) (3) --------- -------- Net cash provided by financing activities of continuing operations 403 17,050 --------- -------- Net cash provided by (used in) discontinued operations 3,404 (571) Effect of foreign currency translation adjustments on cash and cash equivalents 44 (78) --------- -------- Net (decrease) increase in cash and cash equivalents (3,095) 11,083 Cash and cash equivalents at beginning of period 20,345 12,602 --------- -------- Cash and cash equivalents at end of period $ 17,250 $23,685 ========= ========
See accompanying notes. 5 INTRUSION INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. Description of Business We develop, market and support a family of security software and appliances that address vital security issues facing organizations deploying business applications over the Internet or internally via Intranets. We currently provide information security solutions including intrusion detection systems, security assessment systems, virtual private network appliances and firewall appliances. We market and distribute our products through a direct sales force to end-users, distributors and by numerous domestic and international system integrators, service providers and value-added resellers. Our end-user customers include high-technology, manufacturing, telecommunications, retail, transportation, health care, insurance, entertainment, utilities and energy companies, government agencies, financial institutions, and academic institutions. Our company was organized in Texas in September 1983 and reincorporated in Delaware in October 1995. For more than 15 years, we provided local area networking equipment and were known as Optical Data Systems or ODS Networks. On April 17, 2000, we announced plans to sell, or otherwise dispose of, our networking divisions which include our Essential Communications division ("Essential") and our local area networking assets. In accordance with these plans, we have accounted for these businesses as discontinued operations. On June 1, 2000, we changed our name from ODS Networks, Inc. to Intrusion.com, Inc. and our NASDAQ ticker symbol from ODSI to INTZ to reflect our focus on e-security solutions. On November 1, 2001 we changed our name from Intrusion.com, Inc. to Intrusion Inc. Our principal executive offices are located at 1101 E. Arapaho Road, Richardson, Texas 75081, and our telephone number is (972) 234-6400. References to "we", "us", "our" or "Intrusion" refer to Intrusion Inc. and its subsidiaries. 2. Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The December 31, 2000 balance sheet was derived from audited financial statements, but does not include all the disclosures required by generally accepted accounting principles. However, we believe that the disclosures are adequate to make the information presented not misleading. In our opinion, all the adjustments (consisting of normal recurring adjustments) considered necessary for fair presentation have been included. The results of operations for the three and nine month periods ending September 30, 2001 are not necessarily indicative of the results that may be achieved for the full fiscal year or for any future period. The condensed consolidated financial statements included herein should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2000. Certain prior year information has been reclassified to conform with current year presentation. 6 In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests in accordance with the statements. Other intangible assets will continue to be amortized over their useful lives. The company is currently reviewing the impact of SFAS No. 142 and will be performing a fair-value analysis at a later date in connection with the adoption of SFAS No. 142 on January 1, 2002. 3. Inventories (In thousands)
Inventories consist of: Sept 30, December 31, 2000 2000 ----------- ------------ (Unaudited) Raw materials $537 $1,550 Work in progress - 1,350 Finished goods 4,635 4,231 Demonstration systems 445 1,228 ----------- ------------ Net inventory - continuing operations $ 5,617 $8,359 =========== ============ Net inventory - discontinued operations $ - $3,958 =========== ============
4. Income Taxes Our effective tax rate for the quarter ended September 30, 2001 was 1.1%, compared to 32.8% for the quarter ended September 30, 2000. Our effective tax rate for the nine months ended September 30, 2001 was 4.9%, compared to 15.6% for the nine months ended September 30, 2000. The effective tax rate for the nine months ended September 30, 2001 varied from the U.S. statutory rate primarily due to the increase in the valuation allowance for deferred tax assets which recognizes that tax benefits associated with a significant portion of our operating losses may not be realized. Without such changes to the valuation allowance, the Company's effective tax rate for the quarter and nine months ended September 30, 2001 would have been 38%. 5. Restructuring Charges In June 2001, we recorded a charge of $4.0 million for restructuring costs and other special charges consisting primarily of a $3.1 million charge to recognize the impairment of intangible assets (primarily developed technology) related to our SecurityAnalyst and SecureEnterprise product lines and $0.8 million for severance as a result of reductions in force. Demand has shifted to our new intrusion detection and security appliance product lines. As such, we streamlined operations and activities that are not aligned with these core markets and strategies. 7 6. Earnings per Share (In thousands, except per share amounts)(Unaudited)
Three Months Ended Nine Months Ended -------------------- --------------------- Sept 30, Sept 30, Sept 30, Sept 30, 2001 2000 2001 2000 -------- -------- -------- -------- Numerator: Net income (loss) and numerator for basic and diluted earnings per share $(6,889) $(7,552) $(38,914) $ 31,716 -------- -------- -------- -------- Income (loss) from continuing operations and numerator for basic and diluted earnings per share, continuing operations $(6,889) $(7,066) $(32,750) $ 32,287 -------- -------- -------- -------- Denominator: Denominator for basic earnings per share - weighted average common shares outstanding 20,592 19,778 20,550 19,339 Effect of dilutive securities: Stock options and warrants - - - 1,035 -------- -------- -------- -------- Denominator for diluted earnings per share - adjusted weighted average common shares outstanding 20,592 19,778 20,550 20,374 ======== ======== ======== ======== Basic earnings (loss) per share, continuing operations $ (0.33) $ (0.36) $ (1.59) $ 1.67 ======== ======== ======== ======== Diluted earnings (loss) per share, continuing operations $ (0.33) $ (0.36) $ (1.59) $ 1.58 ======== ======== ======== ======== Basic earnings (loss) per share $ (0.33) $ (0.38) $ (1.89) $ 1.64 ======== ======== ======== ======== Diluted earnings (loss) per share $ (0.33) $ (0.38) $ (1.89) $ 1.56 ======== ======== ======== ========
Total stock options outstanding at September 30, 2001 and September 30, 2000 that are not included in the diluted earnings per share computation due to the antidilutive effect are 2.1 million and 1.6 million for the three months ended September 30, 2001 and September 30, 2000, respectively, and 2.1 million and 0.4 million for the nine months ended September 30, 2001 and September 30, 2000, respectively. Such options are excluded due to either a net loss per share or due to exercise prices exceeding the average market value of our common stock in the applicable period. 7. Comprehensive Income Comprehensive loss for the nine months ended September 30, 2001 and 2000 was $(38.9) million and $(12.4) million, respectively. The difference between net income of $31.7 million for the nine months ended September 30, 2000 relates to the realization of an unrealized gain on available for sale securities of $44.1 million. 8. Discontinued Operations In the second quarter of 2000, we discontinued our networking operations and accordingly have shown the networking operations as discontinued in the accompanying financial statements. Certain prior year information has been reclassified to conform with the current presentation. 8 During the first quarter of 2001, we closed the sale of our legacy local area networking division generating a gain of $2.1 million which was used to reduce the estimated net realizable value of the net assets of our remaining discontinued operations, Essential. During the second quarter of 2001, in response to unfavorable market conditions and efforts to sell Essential, we recorded additional charges to write down the net assets of Essential to reflect its current estimated net realizable value of $0.8 million. The $5.0 million second quarter charge included $0.8 million for operating losses expected to be incurred between July and the end of 2001 by which time we expect to have exited, disposed of or otherwise transitioned a majority of our ownership in Essential. The following represents a summary of assets and liabilities classified as discontinued operations (In thousands):
Sept 30, December 31, 2001 2000 -------- ------------ (Unaudited) Inventories, net $ - $ 3,958 Property and equipment, net 786 1,499 Intangible assets, net - 3,935 ----- ------- Discontinued assets $ 786 $ 9,392 ===== ======= Discontinued liabilities consist of: Accrued expenses $ 614 $ - ----- ------- Discontinued liabilities $ 614 $ - ===== =======
The following represents a summary of losses from discontinued operations (In thousands)(Unaudited):
Three Months Ended Nine Months Ended --------------------- --------------------- Sept 30, Sept 30, Sept 30, Sept 30, 2001 2000 2001 2000 -------- -------- -------- -------- Net sales $1,077 $3,777 $ 3,606 $15,075 Cost of sales 529 2,668 2,635 9,650 -------- -------- -------- -------- Gross profit 548 1,109 971 5,425 Operating expenses 925 1,651 3,877 6,101 -------- -------- -------- -------- Operating loss (377) (542) (2,906) (676) Other, net 377 0 (3,644) - -------- -------- -------- -------- Loss before income taxes - (542) (6,550) (676) Income tax benefit - (56) (386) (105) -------- -------- -------- -------- Loss from discontinued operations $ - $ (486) $(6,164) $ (571) ======== ======== ======== ========
9 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This report contains forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, that involve risks and uncertainties, such as statements concerning: growth and future operating results; developments in the company's markets and strategic focus; new products and product enhancements; potential acquisitions and the integration of acquired businesses, products and technologies; strategic relationships; the effect of military actions on government or corporate spending on information security products, the effect of restructuring plans and cost reductions; and future economic, business and regulatory conditions. Such forward-looking statements are generally accompanied by words such as "plan," "estimate," "expect," "believe," "should," "would," "could," "anticipate," "may" or other words that convey uncertainty of future events or outcomes. These forward-looking statements and other statements made elsewhere in this report are made in reliance on the Private Securities Litigation Reform Act of 1995. The section below entitled "Factors That May Affect Future Results of Operations" sets forth and incorporates by reference certain factors that could cause actual future results of the company to differ materially from these statements. OVERVIEW We develop, market and support a family of security software and appliances that address vital security issues facing organizations deploying business applications over the Internet or internally via Intranets. We currently provide information security solutions including intrusion detection systems, security assessment systems, virtual private network appliances and firewall appliances. On June 1, 2000, we changed our name from ODS Networks, Inc. to Intrusion.com, Inc. and our NASDAQ ticker symbol from ODSI to INTZ to reflect our focus on information security solutions. On November 1, 2001 we changed our name from Intrusion.com, Inc. to Intrusion Inc. During the second quarter of 2000, we announced our plan to sell, or otherwise dispose of, our networking divisions which includes our Essential Communications division and our local area networking assets and began accounting for these networking divisions as discontinued operations. Given our change in strategy, our results of operations prior to 2001 do not necessarily reflect our current business. The following management's discussion and analysis of financial condition and results of operations pertains only to our continuing operations unless otherwise disclosed. Certain prior year information has been reclassified to conform with the current presentation. 10 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain financial data as a percentage of net sales. The period to period comparison of financial results is not necessarily indicative of future results.
Three Months Ended Nine Months Ended ------------------------ ------------------------ Sept 30, Sept 30, Sept 30, Sept 30, 2001 2000 2001 2000 ---------- ---------- --------- ---------- Net sales 100.0% 100.0% 100.0% 100.0% Cost of sales 65.2 78.2 84.1 77.7 ---------- ---------- --------- ---------- Gross profit 34.8 21.8 15.9 22.3 Operating expenses: Sales and marketing 127.3 117.3 142.9 107.8 Research and development 81.2 54.0 78.3 53.3 General and administrative 24.8 22.0 27.7 22.7 Amortization of intangibles 5.0 5.2 6.4 3.4 Restructuring costs and other special charges - - 29.7 - ---------- ---------- --------- ---------- Operating loss (203.4) (176.7) (269.0) (164.9) Interest income, net 9.2 13.7 10.7 13.5 Other income 1.4 0.1 0.8 357.3 ---------- ---------- --------- ---------- Income (loss) before income taxes (192.8) (162.9) (257.4) 205.9 Income tax (benefit) expense (2.0) (53.4) (12.7) 32.0 ---------- ---------- --------- ---------- Income (loss) from continuing operations (190.7) (109.5) (244.8) 173.9 Loss from discontinued operations, net of tax - (7.5) (46.1) (3.1) ---------- ---------- --------- ---------- Net income (loss) (190.7) (117.0) (290.8) 170.8 ========== ========== ========= ==========
Three Months Ended Nine Months Ended ------------------------ ----------------------- Sept 30, Sept 30, Sept 30, Sept 30, 2001 2000 2001 2000 ---------- ---------- --------- ---------- Domestic sales 49.2% 73.2% 65.0% 81.5% Export sales to: Europe 40.8 8.1 23.6 6.0 Canada 5.4 0.6 3.9 3.0 Asia 4.0 14.0 6.7 7.8 Latin America 0.6 4.1 0.8 1.7 ---------- ---------- --------- ---------- Net sales 100.0% 100.0% 100.0% 100.0% ========== ========== ========= ==========
11 NET SALES. Net sales decreased to $3.6 million and $13.4, respectively, compared to $6.5 million and $18.6 million, respectively, for the same periods of 2000 as sales from our newest product lines, the SecureNet Pro intrusion detection and PDS security appliance family of products, did not increase as fast as our SecureCom and other security product lines declined. EXPORT SALES. Export sales for the quarter and nine months ended September 30, 2001 increased to $1.8 million and $4.7 million, respectively, compared to $1.7 million and $3.4 million, respectively, for the same periods of 2000, as the security market continued to grow internationally. Though we expect increased sales from export sales going forward, such export sales may vary as a percentage of net sales in the future. CONCENTRATION OF SALES. Sales to TRW Systems & Information Technology ("TRW") were 0.2% and 8.6% for the quarter and nine months ended September 30, 2001, respectively, compared to 10.6% and 27.0% for the same periods of 2000. Sales to Lockheed Martin Federal Systems ("Lockheed Martin") were 0.5% and 5.0% for the quarter and nine months ended September 30, 2001, respectively, compared to 12.8% and 4.5% for the same periods of 2000. Sales to iGov.com were 7.7% and 3.7% for the quarter and nine months ended September 30, 2001, respectively, compared to 17.5% and 15.5% for the same periods in 2000. Sales to SecureGate Limited ("SecureGate") were 0.0% and 0.2% for the quarter and nine months ended September 30, 2001, respectively, compared to 11.5% and 4.0% for the same periods of 2000. In addition, a portion of our sales to TRW, Lockheed Martin, iGov.com and other corporations were for products resold by those organizations to various agencies of the U.S. Government. GROSS PROFIT. Gross profit decreased to $1.3 million or 34.8% of net sales for the quarter ended September 30, 2001, compared to $1.4 million or 21.8% of net sales for the quarter ended September 30, 2000. For the nine months ended September 30, 2001, gross profit decreased to $2.1 million or 15.9% of net sales compared to $4.1 million or 22.3% of net sales for the same period in the prior year. Gross profit margins as a percentage of net sales were up for the three months ended September 30, 2001 primarily because of the change in product mix from lower margin hardware products to higher margin intrusion detection products. Gross profit margins as a percentage of net sales were negatively impacted during the nine months ended September 30, 2001, due primarily to a second quarter inventory write off of $1.3 million in our SecureCom product line as demand has shifted to our new intrusion detection and security appliance product lines. Absent this write off, gross profit would have been $3.5 million or 26.0% for the nine months ended September 30, 2001. Gross profit as a percentage of net sales is impacted by several factors, including shifts in product mix, changes in channels of distribution, sales volume, fluctuations in manufacturing costs, pricing strategies, and fluctuations in sales of integrated third-party products. SALES AND MARKETING. Sales and marketing expenses decreased to $4.6 million for the quarter ended September 30, 2001, compared to $7.6 million for the quarter ended September 30, 2000. Sales and marketing expenses decreased to $19.1 million for the nine months ended September 30, 2001, compared to $20.0 million for the nine months ended September 30, 2000. Sales and marketing expenses decreased in the three and nine month periods ended September 30, 2001, compared to the same periods of 2000, primarily due to the reorganization of our sales and marketing departments in the second and third quarters of 2001 and other cost reduction initiatives. We expect sales and marketing expenses to continue to decline in the 12 fourth quarter of 2001, in comparison to the third quarter of 2001. Sales and marketing expenses may vary as a percentage of net sales in the future. RESEARCH AND DEVELOPMENT. Research and development expenses decreased to $2.9 million for the quarter ended September 30, 2001, compared to $3.5 million for the quarter ended September 30, 2000. Research and development expenses increased to $10.5 million for the nine months ended September 30, 2001, compared to $9.9 million for the nine months ended September 30, 2001. Research and development costs are expensed in the period incurred. Research and development expenses decreased in the three months ended September 30, 2001, compared to the same period in 2000 as we focused more of our development efforts on our core security products, SecureNet Pro and PDS security appliances, while reducing efforts on our other security products. It is expected that research and development expenses will continue to decrease in the fourth quarter of 2001, in comparison to the third quarter of 2001. Research and development expenses may vary as a percentage of net sales in the future. GENERAL AND ADMINISTRATIVE. General and administrative expenses decreased to $0.9 million for the quarter ended September 30, 2001, compared to $1.4 million for the quarter ended September 30, 2000. General and administrative expenses decreased to $3.7 million for the nine months ended September 30, 2001, compared to $4.2 million for the same period last year. General and administrative expenses decreased in the three and nine month periods ending September 30, 2001 compared to the same periods of 2000, primarily due to the restructuring done in the second and third quarters of 2001 and other cost reduction initiatives. It is expected that general and administrative expenses will continue to decrease in the fourth quarter of 2001, in comparison to the third quarter of 2001. General and administrative expense may vary as a percentage of net sales in the future. AMORTIZATION. Amortization expenses decreased to $0.2 million for the quarter ended September 30, 2001, compared to $0.3 million for the quarter ended September 30, 2000. Amortization expenses increased to $0.9 million for the nine months ended September 30, 2001, compared to $0.6 million for the nine months ended September 30, 2000. Amortization expenses decreased in the three-month period ended September 30, 2001, compared with the same period in 2000, as a result of the June 30, 2001 write off of certain impaired assets and intellectual properties acquired from Science Applications International Corporate ("SAIC") in 1998. Therefore, all amortization for the quarter ended September 30, 2001 was associated with the acquisition of MimeStar, Inc. ("Mimestar") on June 30, 2000. The increase in amortization for the nine-month period ended September 30, 2001, as compared with the prior year, is the result of the Mimestar acquisition occurring on June 30, 2000. Absent subsequent acquisitions, all future amortization will continue to be associated only with Mimestar intangibles and will be approximately $0.2 million per quarter. RESTRUCTURING CHARGES. In June 2001, we recorded a charge of approximately $4.0 million for restructuring costs and other special charges consisting primarily of a $3.1 million impairment charge related to intangible assets of our SecurityAnalyst and SecureEnterprise product lines and $0.8 million for severance as a result of reductions in force. Demand has shifted to our new intrusion detection and security appliance product lines. As such, we streamlined operations and activities that are not aligned with these core markets and strategies. 13 INTEREST. Net interest income decreased to $0.3 million and $1.4 million, respectively, for the quarter and nine months ended September 30, 2001, compared to $0.9 million and $2.5 million, respectively, for the same periods in 2000. The net interest income decreases were primarily due to the reduced overall cash balances resulting from operating losses. We expect net interest income to decrease in the fourth quarter of 2001, due to further operating losses and declining interest rates. Net interest income may vary in the future based on our cash flow and rate of return on investments. INCOME TAXES. Our effective tax rate for the quarter ended September 30, 2001 was 1.1%, compared to 32.8% for the quarter ended September 30, 2000. Our effective tax rate for the nine months ended September 30, 2001 was 4.9%, compared to 15.6% for the nine months ended September 30, 2000. The effective tax rate for the three months and nine months ended September 30, 2001 varied from the U.S. statutory rate primarily due to the increase in the valuation allowance for deferred tax assets which recognizes that tax benefits associated with a significant portion of our operating losses may not be realized. Without such changes to the valuation allowance, the Company's effective tax rate for the quarter and nine months ended September 30, 2001 would have been 38%. 14 LIQUIDITY AND CAPITAL RESOURCES Our principal source of liquidity at September 30, 2001 is $17.2 million of cash and cash equivalents, $7.0 million of short-term investments and $0.4 million of investments with a stated maturity beyond one year. As of September 30, 2001, excluding discontinued operations, working capital was $30.5 million compared to $48.6 million as of December 31, 2000. Cash used in continuing operations for the nine months ended September 30, 2001 was $24.4 million, primarily due to an operating loss from continuing operations of $32.8 million, offset by a decrease in accounts receivable, inventories, and other assets. Future fluctuations in inventory balances, accounts receivable and accounts payable will be dependent upon several factors, including, but not limited to, quarterly sales, our strategy in building inventory in advance of receiving orders from customers, and the accuracy of our forecasts of product demand and component requirements. Cash provided by investing activities of continuing operations in the nine months ended September 30, 2001 was $17.4 million, which consisted of the net proceeds of $17.7 million from the maturities and purchases of available for sale securities and the purchase of property and equipment of $0.2 million. Cash provided by financing activities of continuing operations in the nine months ended September 30, 2001 was $0.4 million, which was entirely the result of the issuance of common stock upon the exercise of employee stock options. Cash provided by discontinued operations in the nine months ended September 30, 2001 was $3.4 million, which consisted primarily of the net proceeds of the sale of our legacy local area networking business partially offset by losses incurred in the discontinued operations. At September 30, 2001, the Company did not have any material commitments for capital expenditures. During the nine months ended September 30, 2001, the Company funded its operations through the use of cash and cash equivalents. We believe that our cash, cash equivalents and investment balances will provide sufficient cash resources to finance our operations and currently projected capital expenditures through 2002. However, there can be no assurance that our cash resources will be sufficient for the year 2002 and beyond. We may explore the possible acquisitions of businesses, products and technologies that are complementary to our existing business. We are continuing to identify and prioritize additional security technologies which we may wish to develop, either internally or through the licensing or acquisition of products from third parties. While we engage from time to time in discussions with respect to potential acquisitions, there can be no assurances that any such acquisitions will be made or that we will be able to successfully integrate any acquired business. In order to finance such acquisitions, it may be necessary for us to raise additional funds through public or private financings. Any equity or debt financings, if available at all, may be on terms which are not favorable to us and, in the case of equity financings, may result in dilution to our stockholders. 15 FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS Numerous factors may affect our business and future results of operations. These factors include, but are not limited to, current economic and market conditions, the effect of military actions on government and corporate spending on information security products, technological changes, competition and market acceptance, acquisitions, product transitions, timing of orders, manufacturing and suppliers, reliance on outsourcing vendors and other partners, intellectual property and licenses, third-party products, dependence on key customers, international operations, intellectual property issues and effects of restructuring plans and cost reductions. The discussion below addresses some of these and other factors. For a more thorough discussion of these and other factors that may affect our business and future results, see the discussion under the caption "Factors That May Affect Future Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2000. TECHNOLOGICAL CHANGES. The market for our products is characterized by frequent product introductions, rapidly changing technology and continued evolution of new industry standards. The market for security products requires our products to be compatible and interoperable with products and architectures offered by various vendors, including other security products, networking products, workstation and personal computer architectures and computer and network operating systems. Our success will depend to a substantial degree upon our ability to develop and introduce in a timely manner new products and enhancements to our existing products that meet changing customer requirements and evolving industry standards. The development of technologically advanced products is a complex and uncertain process requiring high levels of innovation as well as the accurate anticipation of technological and market trends. There can be no assurance that we will be able to identify, develop, manufacture, market and support new or enhanced products successfully in a timely manner. Further, we or our competitors may introduce new products or product enhancements that shorten the life cycle of or make obsolete our existing product lines, any of which could have a material adverse effect on our business, operating results and financial condition. MARKET ACCEPTANCE. We are pursuing a strategy to increase the percentage of our revenue generated through indirect sales channels including distributors, value added resellers, system integrators, original equipment manufacturers and managed service providers. There can be no assurance that our products will gain market acceptance in these indirect sales channels. Further, competition among security companies to sell products through these indirect sales channels could result in significant price competition and reduced profit margins. We are also pursuing a strategy to further differentiate our product line by introducing complementary security products and incorporating new technologies into our existing product line. There can be no assurance that we will successfully introduce these products or that such products will gain market acceptance. We anticipate competition from networking companies, network security companies and others in each of our product lines. We anticipate that profit margins will vary among our product lines and that product mix fluctuations could have an adverse effect on our overall profit margins. 16 DISPOSITION OF DISCONTINUED OPERATIONS. On April 17, 2000, we announced plans to sell, or otherwise dispose of, the assets in our networking divisions which include our Essential Communications division and our local area networking assets. The disposition of our local area networking assets was completed in the quarter ended March 31, 2001 generating a gain of $2.1 million which was used to reduce the estimated net realizable value of the net assets of our remaining discontinued operations, Essential. During the second quarter of 2001, in response to unfavorable market conditions and efforts to sell Essential, we recorded additional charges to write down the net assets of Essential to reflect its current estimated net realizable value of $0.8 million. The $5.0 million second quarter charge includes $0.8 million for operating losses expected to be incurred between July and the end of 2001 by which time we expect to have exited, disposed of or otherwise transitioned a majority of our ownership in Essential. While we took an appropriate charge to exit, dispose of or otherwise transition a majority of our ownership in Essential, there can be no assurance that this charge will be sufficient. To the extent it is not, the additional financial impact will be charged to discontinued operations in future periods. ACQUISITIONS. Internet Security Systems, Inc. ("ISS"), Cisco Systems, Inc. ("Cisco"), Symantec Corp. ("Symantec"), Enterasys Networks ("Enterasys"), Nokia Corporation ("Nokia"), Nortel Networks ("Nortel") and other competitors have acquired several security companies with complementary technologies, and we anticipate that such acquisitions will continue in the future. These acquisitions may permit such competitors to accelerate the development and commercialization of broader product lines and more comprehensive solutions than we currently offer. In the past, we have relied upon a combination of internal product development and partnerships with other security vendors to provide competitive solutions to customers. Certain of the recent and future acquisitions by our competitors may have the effect of limiting our access to commercially significant technologies. Further, the business combinations and acquisitions in the security industry are creating companies with larger market shares, customer bases, sales forces, product offerings and technology and marketing expertise. There can be no assurance that we will be able to compete successfully in such an environment. In September 1998, we completed an acquisition of certain assets of the Computer Misuse and Detection System ("CMDS") Division from Science Applications International Corporation ("SAIC"), a privately held company in San Diego, California. On September 30, 1999, we entered a technology licensing agreement with RSA Security Inc. ("RSA") under which we are the exclusive licensee of RSA's Kane Security products in North America and Europe. On June 30, 2000, we acquired MimeStar, Inc. ("MimeStar"), a Virginia corporation. MimeStar developed an advanced, network based intrusion detection system called SecureNet Pro-TM-. We may, in the future, acquire or invest in additional companies, business units, product lines, or technologies to accelerate the development of products and sales channels complementary to our existing products and sales channels. Acquisitions involve numerous risks, including: difficulties in assimilation of operations, technologies, and products of the acquired companies; risks of entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions; the potential loss of key employees of the acquired company; and the diversion of our attention from normal daily operation of our business. There can be no assurance that any other acquisition or investment will be consummated or that such acquisition or investment will be realized. 17 PRODUCT TRANSITIONS. Once current security products have been in the market place for a period of time and begin to be replaced by higher performance products (whether of our design or a competitor's design), we expect the net sales of such products to decrease. In order to achieve revenue growth in the future, we will be required to design, develop and successfully commercialize higher performance products in a timely manner. There can be no assurance that we will be able to introduce new products and gain market acceptance quickly enough to avoid adverse revenue transition patterns during current or future product transitions. Nor can there be any assurance that we will be able to respond effectively to technological changes or new product announcements by competitors, which could render portions of our inventory obsolete. MANUFACTURING AND SUPPLIERS. Our operational strategy relies on outsourcing of product assembly and certain other operations. There can be no assurance that we will effectively manage our third-party contractors or that these contractors will meet our future requirements for timely delivery of products of sufficient quality and quantity. Further, we intend to introduce a number of new products and product enhancements which will require that we rapidly achieve volume production of those new products by coordinating our efforts with those of our suppliers and contractors. The inability of the third-party contractors to provide us with adequate supplies of high-quality products could cause a delay in our ability to fulfill orders and could have an adverse effect on our business, operating results and financial condition. All of the materials used in our products are purchased under contracts or purchase orders with third parties. While we believe that many of the materials used in the production of our products are generally readily available from a variety of sources, certain components such as microprocessors and mother boards are available from one or a limited number of suppliers. The lead times for delivery of components vary significantly and can exceed twelve weeks for certain components. If we should fail to forecast our requirements accurately for components, we may experience excess inventory or shortages of certain components which could have an adverse effect on our business and operating results. Further, any interruption in the supply of any of these components, or the inability to procure these components from alternative sources at acceptable prices within a reasonable time, could have an adverse effect on our business and operating results. INTELLECTUAL PROPERTY AND LICENSES. There are many patents held by companies which relate to the design and manufacture of data security systems. Potential claims of infringement could be asserted by the holders of those patents. We could incur substantial costs in defending ourself and our customers against any such claim regardless of the merits of such claims. In the event of a successful claim of infringement, we may be required to obtain one or more licenses from third parties. There can be no assurance that we could obtain the necessary licenses on reasonable terms. 18 THIRD-PARTY PRODUCTS. We believe that it is beneficial to work with third parties with complementary technologies to broaden the appeal of our security products. These non-exclusive alliances allow us to provide integrated solutions to our customers by combining our developed technology with third-party products. For example, sales of our PDS security appliance are dependent upon the security applications which operate on such appliances, our relationship with the security application vendors, and competition with other security appliance vendors. Our PDS firewall and VPN appliances integrate Check Point Software Technologies Ltd. security applications. As we also compete with our technology partners in certain segments of the market and compete with other security appliance vendors who have similar alliances, there can be no assurance that we will have access to all of the third-party products which may be desirable or necessary in order to offer fully integrated solutions to our customers. DEPENDENCE ON KEY CUSTOMERS. A relatively small number of customers have accounted for a significant portion of our revenue. U.S. government agencies, large system integrators and managed service providers are expected to continue to account for a substantial portion of our net revenue. We continuously face competition from ISS, Cisco, Netscreen, Nortel, Symantec, Enterasys, Nokia, SonicWALL, WatchGuard and others for U.S. government security projects and corporate security installations. Any reduction or delay in sales of our products to these customers could have a material adverse effect on our operating results. INTERNATIONAL OPERATIONS. Our international operations may be affected by changes in demand resulting from fluctuations in currency exchange rates and local purchasing practices, including seasonal fluctuations in demand, as well as by risks such as increases in duty rates, difficulties in distribution, regulatory approvals and other constraints upon international trade. Our sales to foreign customers are subject to export regulations. In particular, certain sales of our data security products require clearance and export licenses from the U.S. Department of Commerce under these regulations. Any inability to obtain such clearances or any required foreign regulatory approvals on a timely basis could have a material adverse effect on our operating results. IMPACT OF GOVERNMENT CUSTOMERS. A significant portion of our revenue is derived from sales to the U.S. government, either directly by Intrusion or through system integrators and other resellers. Sales to the government present risks in addition to those involved in sales to commercial customers, including potential disruptions due to appropriation and spending patterns and the government's reservation of the right to cancel contracts and purchase orders for its convenience. EFFECTS OF RECENT TERRORIST ATTACKS AND MILITARY ACTIONS. Recent terrorist attacks in the United States, as well as military actions or other events occurring in response or in connection to them, including future terrorist attacks against United States targets, actual conflicts involving the United States or it allies or military or trade disruptions could impact our operations, including by: - reducing government or corporate spending on network security products; - increasing the cost and difficulty in obtaining materials or shipping products; and - affecting our ability to conduct business internationally. Should such events occur, our business, operating results and financial condition could be materially and adversely affected. 19 RESTRUCTURING AND COST REDUCTIONS. We implemented a restructuring plan in the first nine months of 2001. The objective of our restructuring plan is to reduce our cost structure to a sustainable level that is consistent with the current macroeconomic environment. We also implemented other strategic initiatives designed to strengthen our operations. These plans involve, among other things, reductions in our workforce and facilities, aligning our organization around our business objectives, realignment of our sales force and changes in our sales management. The workforce reductions could result in temporary reduced productivity of our remaining employees. Additionally, our customers and prospects may delay or forgo purchasing our products due to a perceived uncertainty caused by the restructuring and other changes. Failure to achieve the desired results of our initiatives could seriously harm our business, results of operations and financial condition. GENERAL. Sales of our products fluctuate, from time to time, based on numerous factors, including customers' capital spending levels and general economic conditions. While certain industry analysts believe that there is a significant market for data security products, there can be no assurance as to the rate or extent of the growth of such market or the potential adoption of alternative technologies. Currently, capital spending for information technology products, including security products is being adversely affected by uncertain economic conditions. Future declines in data security product sales as a result of general economic conditions, adoption of alternative technologies or any other reason could have a material adverse effect on our business, operating results and financial condition. Due to the factors noted above and in "Management's Discussion and Analysis of Financial Condition and Results of Operations", our future earnings and common stock price may be subject to significant volatility, particularly on a quarterly basis. Past financial performance should not be considered a reliable indicator of future performance and investors should not use historical trends to anticipate results or trends in future periods. Any shortfall in revenue and earnings from the levels anticipated by securities analysts could have an immediate and significant effect on the trading price of our common stock in any given period. Also, we participate in a highly dynamic industry which often results in volatility of our common stock price. 20 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK FOREIGN EXCHANGE. Revenue originating outside the U.S. in the quarters ended September 30, 2001, 2000 and 1999 were 50.8%, 26.8% and 11.3% of total revenues, respectively. Revenue originating outside the U.S. in the nine months ended September 30, 2001, 2000 and 1999 were 35.0%, 18.5% and 15.8% of total revenues, respectively. International sales are made mostly from our foreign sales subsidiaries in the local countries and are typically denominated in U.S. dollars. These subsidiaries incur most of their expenses in the local currency. Our international business is subject to risks typical of an international business, including, but not limited to: differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions and foreign exchange rate volatility. Accordingly, our future results could be materially adversely affected by changes in these or other factors. The effect of foreign exchange rate fluctuations on us in 2001, 2000 and 1999 was not material. INTEREST RATES. We invest our cash in a variety of financial instruments, including bank time deposits, fixed rate obligations of corporations, municipalities, and state and national governmental entities and agencies. These investments are denominated in U.S. dollars. Cash balances in foreign currencies overseas are operating balances and are invested in short-term time deposits of the local operating bank. Investments in fixed rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely affected due to a rise in interest rates. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses of principal if forced to sell securities which have seen a decline in market value due to changes in interest rates. Our investment securities are held for purposes other than trading. Several investment securities have a maturity in excess of one year. The weighted-average interest rate on investment securities at September 30, 2001 was 5.8%. The fair value of investments held at September 30, 2001 approximates amortized cost. 21 PART II - OTHER INFORMATION Item 6. EXHIBITS AND REPORTS ON FORM 8-K. (A.) EXHIBITS. The following exhibits are included herein: None (B.) FORM 8-K. We filed no reports on Form 8-K during the three months ended September 30, 2001. 22 S I G N A T U R E S Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. INTRUSION INC. Date: November 9, 2001 /s/ Jay R. Widdig ------------------------------- Jay R. Widdig Vice President, Chief Financial Officer, Treasurer & Secretary (Principal Financial & Accounting Officer) 23 -----END PRIVACY-ENHANCED MESSAGE-----