Factors That May Affect Future Results of Operations
We are providing the following information
regarding changes that have occurred to previously disclosed risk factors from our Annual Report on Form 10-K for the year ended
December 31, 2019. In addition to the other information set forth below and elsewhere in this report, you should consider the factors
discussed under the heading “Risk Factors” in our Form 10-K for the year ended December 31, 2019 filed on March 27,
2020 and in our Form 10-Q for the quarters ended March 31, 2020 filed on May 15, 2020 and June 30, 2020 filed on August 13, 2020.
The risks described in our Annual Report on Form 10-K and our Quarterly Reports on Form 10-Q are not the only risks facing our
Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially
adversely affect our business, financial condition and/or operating results.
We had a net loss of $1.4 million for the quarter ended
September 30, 2020, and we have an accumulated deficit of $57.4 million as of September 30, 2020. To continue current financial
performance, we must increase revenue levels.
For the quarter ended September 30, 2020,
we had a net loss of $1.4 million and had an accumulated deficit of approximately $57.4 million as of September 30, 2020, compared
to a net income of $1.5 million for the quarter ended September 30, 2019 and an accumulated deficit of approximately $54.8 million
at December 31, 2019. We need to increase current revenue levels from the sales of our solutions if we are to regain profitability.
If we are unable to achieve these revenue levels, losses could continue for the near term and possibly longer, and we may not regain
profitability or generate positive cash flow from operations in the future.
We do not anticipate significant changes in net revenue
for the fourth quarter of fiscal year 2020 as compared with the third quarter, which was lower than previous quarters. Lack of
increased revenue could adversely affect our results of operation, our liquidity position, and result in a decline in the price
of our common stock.
The Company anticipates that we will not
see significant changes in our net revenue for the quarterly period ending on December 31, 2020 as compared with the third quarter,
which was lower than previous quarters. While it is premature to determine whether this depressed revenue is a trend or merely
a reflection of our customers’ varying ordering patterns, our inability to increase our net revenue could result in lower
operating results for the fiscal year 2020, have a negative effect on our cash flow and our overall liquidity position, and potentially
affect the perception of the Company’s value in the marketplace and result in a decline in the price of our common stock.
Further, our expense levels are based, in
part, upon our expectations as to future revenues and are largely fixed in the short term. Therefore, we may not be able to timely
adjust our expenditures in order to compensate for an unanticipated shortfall in revenue in any given quarter. Any significant,
unanticipated shortfall in revenues could have an immediate and significant effect on our operating results for that quarter and
might lead to a reduced market price for our stock.
We may be unable to successfully market, promote, and
sell our new commercial solution, INTRUSION Shield, and market it through new sales channels to a new set of prospective
customers.
We anticipate significant resources will
be required in order to succeed in launching our new INTRUSION Shield solution, including the time, attention, and
focus of our senior management and our research and development team, coordination of new marketing strategies highlighting this
new offering and promoting it through new and expanded sales channels to a wider audience of prospective customers than we have
historically marketed and sold our solutions and services. In addition, significant financial resources will be required to successfully
manage the implementation of this new solution. This could result in diversion of those resources from critical areas of our company
operations and a potential strain on our liquidity and ability to meet our current and these anticipated increases in our cash-flow
needs.
We could experience damage to our reputation in the cybersecurity
industry in the event that our INTRUSION Shield solution fails to perform as expected, to meet our customers’ needs,
or to achieve market acceptance.
Our reputation in the industry as a leading
provider of entity identification, data mining, and advanced persistent threat detection solutions may be harmed, perhaps significantly,
in the event that our new INTRUSION Shield fails to perform as we expect it to. If Shield does not
perform as we expect, if we experience delivery delays, or if our customers do not perceive the benefits of purchasing and using
Shield as part of their comprehensive cybersecurity solution, our position as a leader in this technology space may
be damaged and could affect the willingness of our customers, as well as potential customers, to purchase our other solutions that
function separately from our INTRUSION Shield. Any reputational damage could result in a decrease in orders for all
of our solutions, the loss of current customers, and a decrease in our overall revenues which could in turn have a material adverse
effect on our results of operation.
Uncertainties surrounding the effects of the coronavirus,
particularly potential diversion of time and resources of the federal, state, and local governmental entities which make up a significant
concentration of our customer base, could cause a material adverse effect on our results of operations and financial results.
We have a concentration of customers that
are federal, state, and local governmental entities. Such entities have had to allocate resources and adjust budgets to accommodate
real and potential contingencies related to the effects of the coronavirus and measures required to be put in place to prevent
and contain contamination of the virus. These uncertainties have resulted in decreased demand by some of our customers for our
current solutions. A continued decrease in orders for our solutions by government customers could cause a material adverse effect
on our operations and financial results. While we anticipate that widening the scope of our customer base through the introduction
of our INTRUSION Shield solution will minimize the effect of this decrease in demand by our government customers,
we can offer no assurances as to the effects the Coronavirus may continue to have on our current or future customers.
Our common stock may experience volatility in trading
or loss in value as a result of the effects of the coronavirus on the US and global economies.
Uncertainties surrounding the effects of
the coronavirus on the US and global economies has resulted in an increase in volatility and violent drops in the value of publicly
traded securities. While the price of our common stock has not experienced such volatility or loss in value, we can offer no assurances
that the long-term effects on the overall US economy will not negatively affect us in the future.
We must expend time and resources addressing potential
cybersecurity risk, and any breach of our information security safeguards could have a material adverse effect on the Company.
The threat of cyber-attacks requires additional
time and money to be expended in efforts to prevent any breaches of our information security protocols. However, we can provide
no assurances that we can prevent all such attempts from being successful, which could result in expenses to address and remediate
such breaches as well as potentially losing the confidence of our customers who depend upon our services to prevent and mitigate
such attacks on their respective business. Should a material breach of our information security systems occur, it would likely
have a material adverse impact on our business operations, our customer relations, and our current and future sales prospects,
resulting in a significant loss of revenue.
Fluctuations in our quarterly revenues may cause the price
of our common stock to decline.
Our operating results have varied significantly
from quarter to quarter in the past, and we expect our operating results to vary from quarter to quarter in the future due to a
variety of factors, many of which are outside of our control. Therefore, if revenues are below our expectations, this shortfall
is likely to adversely and disproportionately affect our operating results. Accordingly, we may not attain positive operating margins
in future quarters. Any of these factors could cause our operating results to be below the expectations of securities analysts
and investors, which likely would negatively affect the price of our common stock.
A large percentage of our current revenues are received
from U.S. government entities, and the loss of these customers or our failure to widen the scope of our customer base to include
general commercial enterprises could negatively affect our revenues.
A large percentage of our current revenues
result from sales to U.S. government entities. If we were to lose one or more of these customers, our revenues could decline and
our business and prospects may be materially harmed. Further, sales to the government present risks in addition to those involved
in sales to commercial customers, including potential disruption due to appropriation and spending patterns, delays in approving
a federal budget and the government’s right to cancel contracts and purchase orders for its convenience. While we expect
that developing relationships with non-governmental customers will mitigate or eliminate this dependence on, and risk from, serving
governmental entities, we can offer no assurances that we will be able to sufficiently diversify our customer portfolio in a time
and manner to adequately mitigate this risk.
Almost all of our revenues are currently from one family
of solutions with a limited number of customers, and the decrease of revenue from sales of this family of solutions could materially
harm our business and prospects. Timeliness of orders from customers may cause volatility in growth.
Almost all of our revenues result from sales
of one cybersecurity solution. TraceCop revenues were $1.5 million for the quarter ended September 30, 2020, compared to $3.9 million
for the third quarter 2019. While we anticipate the introduction of our new INTRUSION Shield solution will minimize
our dependence on this single solution, we can offer no assurances as such, and in the absence of a shift in solution mix, we may
continue to face risks in the event that sales of this key solution to these limited customers were to decrease.
We are highly dependent on sales of our current solutions
through indirect channels, the loss of which would materially adversely affect our operations.
We derived 53.8% of revenue in the third
quarter of 2020 through indirect channels of mainly government resellers, compared to 90.9% of our revenues in the quarter ended
September 30, 2019. We must expand sales of our current solutions as well as any new solutions, such as the INTRUSION Shield,
through these indirect channels in order to increase our revenues. We cannot assure you that our current solutions or future solutions
will gain market acceptance in these indirect sales channels or that sales through these indirect sales channels will increase
our revenues. Further, many of our competitors are also trying to sell their products and solutions through these indirect sales
channels, which could result in lower prices and reduced profit margins for sales of our solutions.
You will experience substantial dilution upon the exercise
of certain stock options currently outstanding.
On November 1, 2020, we had 17,394,279 shares
of common stock outstanding. Upon the exercising of current options exercisable at or below the exercise price of $4.25, we would
have approximately 18,015,782 shares of common stock outstanding, a 3.6% increase in the number of shares of our common stock outstanding.
We resemble a developmental stage company and our business
strategy may not be successful.
We depend exclusively on revenues generated
from the sale of our current network security/advanced persistent threat detection solution (Savant), which has received limited
market acceptance, and our entity identification, data mining and analytic solution (TraceCop). We can provide no assurances that
these solutions or our newly developed INTRUSION Shield solution will ever achieve widespread market acceptance or
that an adequate market for these solutions will ever emerge. Consequently, we resemble a developmental stage company and will
face the following inherent risks and uncertainties:
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the need for our current and in-development solutions to achieve market acceptance and produce a sustainable revenue stream;
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our ability to manage costs and expenses;
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our dependence on key personnel;
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our ability to obtain financing on acceptable terms; and
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our ability to offer greater value than our competitors.
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Our business strategy may not successfully
address these risks. If we fail to recognize significant revenues from the sales of our current and in-development solutions, our
business, financial condition and operating results would be materially adversely affected.
If we fail to respond to rapid technological changes in
the network security industry, we may lose customers or our solutions may become obsolete.
The network security industry is characterized
by frequent product and service introductions, rapidly changing technology and continued evolution of new industry standards. We
have and must continue to introduce upgrades to our current solutions rapidly in response to customer needs such as new computer
viruses or other novel external attacks on computer networks. Further, our new INTRUSION Shield solution represents
our efforts to continue to provide state-of-the art first-in-time innovation for our customer’s cybersecurity solutions.
As a result, our success depends upon our ability to develop and introduce in a timely manner such upgrades, enhancements, and
new solutions to meet evolving customer requirements and industry standards. The development of technologically advanced network
security products and solutions is a complex and uncertain process requiring high levels of innovation, rapid response, and accurate
anticipation of technological and market trends. We cannot assure you that we will be able to identify, develop, manufacture, market
or support new or enhanced solutions successfully in a timely manner. Further, we or our competitors may introduce new solutions
or enhancements that shorten the life cycle of our existing solutions or cause our existing solutions to become obsolete.
We face intense competition from both start-up and established
companies that may have significant advantages over us and our solutions.
The market for our solutions is intensely
competitive. There are numerous companies competing with us in various segments of the data security markets, and their products
or solutions may have advantages over our solutions in areas such as conformity to existing and emerging industry standards, interoperability
with networking and other cybersecurity products, management and security capabilities, performance, price, ease of use, scalability,
reliability, flexibility, features, and technical support.
Our principal competitors in the data mining
and advanced persistent threat market include Niksun, NetScout, Fireeye, and Darktrace. Our current and potential competitors may
have one or more of the following significant advantages over us:
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greater financial, technical and marketing resources;
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better name recognition;
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more comprehensive security solutions;
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better or more extensive cooperative relationships; and
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larger customer base.
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We cannot assure you that we will be able
to compete successfully with our existing or new competitors. Some of our competitors may have, in relation to us, one or more
of the following:
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longer operating histories;
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longer-standing relationships with OEM and end-user customers; and
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greater customer service, public relations and other resources.
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As a result, these competitors may be able
to more quickly develop or adapt to new or emerging technologies and changes in customer requirements, or devote greater resources
to the development, promotion and sale of their products or solutions. Additionally, it is likely that new competitors or alliances
among existing competitors could emerge and rapidly acquire significant market share.
Our management and larger stockholders currently exercise
significant control over our Company and will continue to have influence over our Company after the offering has concluded, and
such influence may be in conflict to your interests.
As of November 1, 2020, our executive officers
and directors beneficially own approximately 20.7% of our voting power. In addition, other related non-affiliate parties control
approximately 25.6% of voting power. As a result, these stockholders have been able to exercise significant control over all matters
requiring stockholder approval, including the election of directors and approval of significant corporate transactions, including
the details of this offering. Although we follow our policies regarding related party transactions and have, in fact, created a
special committee of our Board to negotiate, arrange, and complete this offering, including determining the extent of the participation
of these stockholders in the offering, we cannot entirely eliminate the influence of these stockholders as long as they hold such
a concentration of the voting power of our common stock.
Our solutions are highly technical and if they contain
undetected errors, our business could be adversely affected and we might have to defend lawsuits or pay damages in connection with
any alleged or actual failure of our solutions and services.
Our solutions are highly technical and complex,
are critical to the operation of many networks and, in the case of ours, provide and monitor network security and may protect valuable
information. Our solutions have contained and may contain one or more undetected errors, defects or security vulnerabilities. Some
errors in our solutions may only be discovered after a solution has been installed and used by end customers. Any errors or security
vulnerabilities discovered in our solutions after commercial release could result in loss of revenues or delay in revenue recognition,
loss of customers and increased service and warranty cost, any of which could adversely affect our business and results of operations.
In addition, we could face claims for product liability, tort, or breach of warranty. Defending a lawsuit, regardless of its merit,
is costly and may divert management’s attention. In addition, if our business liability insurance coverage is inadequate
or future coverage is unavailable on acceptable terms or at all, our financial condition could be harmed.
A breach of network security could harm public perception
of our cybersecurity solutions, which could cause us to lose revenues.
If an actual or perceived breach of network
security occurs in the network of a customer of our cybersecurity solutions, regardless of whether the breach is attributable to
our solutions, the market perception of the effectiveness of our solutions could be harmed. This could cause us to lose current
and potential end customers or cause us to lose current and potential value-added resellers and distributors. Because the techniques
used by computer hackers to access or sabotage networks change frequently and generally are not recognized until launched against
a target, we may be unable to anticipate these techniques.
If our solutions do not interoperate with our customers’
networks, installations will be delayed or cancelled and could harm our business.
Our solutions are designed to interface
with our customers’ existing networks, each of which have different specifications and utilize multiple protocol standards
and products or solutions from other vendors. Many of our customers’ networks contain multiple generations of products that
have been added over time as these networks have grown and evolved. Our solutions will be required to interoperate with many products
and solutions within these networks as well as future products or solutions in order to meet our customers’ requirements.
If we find errors in the existing software or defects in the hardware used in our customers’ networks, we may have to modify
our software or hardware to fix or overcome these errors so that our solutions will interoperate and scale with the existing software
and hardware, which could be costly and negatively impact our operating results. In addition, if our solutions do not interoperate
with those of our customers’ networks, demand for our solutions could be adversely affected, orders for our solutions could
be cancelled, or our solutions could be returned. This could hurt our operating results, damage our reputation and seriously harm
our business and prospects.
We must adequately protect our intellectual property in
order to prevent loss of valuable proprietary information.
We rely primarily on a combination of patent,
copyright, trademark and trade secret laws, confidentiality procedures, and non-disclosure agreements to protect our proprietary
technology. However, unauthorized parties may attempt to copy or reverse- engineer aspects of our solutions or to obtain and use
information that we regard as proprietary. Policing unauthorized use of our solutions is difficult, and we cannot be certain that
the steps we have taken will prevent misappropriation of our intellectual property. This is particularly true in foreign countries
whose laws may not protect proprietary rights to the same extent as the laws of the United States and may not provide us with an
effective remedy against unauthorized use. If protection of our intellectual property proves to be inadequate or unenforceable,
others may be able to use our proprietary developments without compensation to us, resulting in potential cost advantages to our
competitors.
We may incur substantial expenses defending ourselves
against claims of infringement.
There are numerous patents held by many
companies relating to the design and manufacture of network security systems. Third parties may claim that our solutions infringe
on their intellectual property rights. Any claim, with or without merit, could consume our management’s time, result in costly
litigation, cause delays in sales or implementations of our solutions or require us to enter into royalty or licensing agreements.
Royalty and licensing agreements, if required and available, may be on terms unacceptable to us or detrimental to our business.
Moreover, a successful claim of product infringement against us or our failure or inability to license the infringed or similar
technology on commercially reasonable terms could seriously harm our business.
The price of our common stock has been volatile in the
past and may continue to be volatile in the future due to factors outside of our control.
The market price of our common stock has
been highly volatile in the past and may continue to be volatile in the future. During fiscal year 2019, the market price of our
common stock on the OTCQB fluctuated between $2.90 and $5.55 per share. For the nine months ended September 30, 2020, the market
price of our common stock on the OTCQB fluctuated between $2.34 and $18.18 per share. The market price of our common stock may
fluctuate significantly in the future in response to a number of factors, many of which are outside our control, including:
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variations in our quarterly operating results;
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changes in estimates of our financial performance by securities analysts;
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changes in market valuations of our competitors;
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thinly traded common stock;
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our ability to successfully produce, market, and sell our new INTRUSION Shield solution through new and broader sales channels to an expanded potential client market;
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announcements by us or our competitors of new products or solutions, significant contracts, acquisitions, strategic relationships, joint ventures or capital commitments;
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product or design flaws, product recalls or similar occurrences;
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additions or departures of key personnel;
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sales of common stock in the future; and
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fluctuations in stock market prices and volume, which are relatively typical for high technology companies.
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