Edgar Filing: INTRUSION INC

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549
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FORM 10-K

(MARK ONE)

/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
OR

/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

FOR THE TRANSITION PERIOD FROM ______________ TO ______________

COMMISSION FILE NUMBER 0-20191
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INTRUSION INC.

(Exact name of registrant as specified in its charter)

DELAWARE 75-1911917
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1101 EAST ARAPAHO ROAD 75081
RICHARDSON, TEXAS (Zip Code)
(Address of principal executive
offices)

Registrant's telephone number, including area code: (972) 234-6400

Securities registered pursuant to Section 12(b) of the Act:
None

Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.01 PAR VALUE
(Title of class)
------------------------

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 / /

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. /X/

As of February 26, 2002, the aggregate market value of the Registrant's
voting stock held by non-affiliates of the Registrant was approximately
$19,309,282 (affiliates being, for these purposes only, directors, executive
officers and holders of more than 5% of Registrant's Common Stock). As of
February 26, 2002, 20,643,425 shares of the Registrant's Common Stock were
outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's definitive Proxy Statement filed in connection
with the Registrant's 2002 Annual Meeting of Stockholders are incorporated by
reference into Part III of this Form 10-K.

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INTRUSION INC.
INDEX

PAGE
----

PART I
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 15
Item 3. Legal Proceedings........................................... 15
Item 4. Submission of Matters to a Vote of Security Holders......... 15

PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 15
Item 6. Selected Financial Data..................................... 16
Item 7. Management's Discussion and Analysis of Financial Condition
And Results of Operations................................... 17
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 25
Item 8. Financial Statements and Supplementary Data................. 25
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 25

PART III
Item 10. Directors and Executive Officers of the Registrant.......... 26
Item 11. Executive Compensation...................................... 26
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 26
Item 13. Certain Relationships and Related Transactions.............. 26

PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 26

Signatures.......................................................................... II-1

PART I

ITEM 1. BUSINESS.

In addition to the historical information contained herein, the discussion
in this Form 10-K contains certain 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 anticipated operating results, developments in
Intrusion Inc.'s markets and strategic focus; new products and product
enhancements; potential acquisitions and the integration of acquired businesses,
products and technologies; strategic relationships and future economic and
business conditions. The cautionary statements made in this Form 10-K should be
read as being applicable to all related forward-looking statements whenever they
appear in this Form 10-K. Intrusion Inc.'s actual results could differ
materially from the results discussed in the forward-looking statements. Factors
that could cause or contribute to such differences include, but are not limited
to, those discussed under the section captioned "Factors That May Affect Future
Results of Operations" in Item 1 of this Form 10-K as well as those cautionary
statements and other factors set forth elsewhere herein.

GENERAL

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 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 Inc." refer to Intrusion Inc. and its
subsidiaries.

RECENT DEVELOPMENTS

In March 2002 we sold our last remaining discontinued operation, Essential
Communications division, for $1 million generating a gain of $0.4 million. Terms
of the sale included transferring $0.7 million in net property, plant and
equipment, $0.1 million in current liabilities and product maintenance
obligations for which $0.4 million is recorded in deferred revenue.

INDUSTRY BACKGROUND

In the last decade, network computing has evolved from local-area networks
to global systems communicating through open Internet connections. The
widespread adoption of open computing environments, such as the Internet,
enables organizations to increase revenue and reduce costs with electronic
business-to-business and business-to-consumer transactions, business process
re-engineering and secure messaging for telecommuters and widely distributed
workforces.

Although open computing environments such as the Internet have many business
advantages, their openness and accessibility make these systems, and the
integrity of the information that is stored on them, vulnerable to internal and
external security threats. These systems can be breached by computer hackers,
curious or disgruntled employees, contractors and competitors who may compromise
or destroy sensitive information within the system or otherwise disrupt the
normal operation of the system. In addition, open computing environments such as
the Internet are complex and typically involve a variety of hardware, operating
systems and applications provided by numerous vendors. Each addition or change
to the hardware, operating system or application may introduce new
vulnerabilities and security risks to the system.

Enterprises are therefore adopting a variety of security solutions to meet
the challenge posed by malicious intruders, curious hackers and disgruntled
employees. To be effective, an organization requires an enterprise-wide
information risk management process that can be managed centrally and
implemented on a distributed basis. Organizations seek a set of individual,
best-of-breed solutions designed to work standalone and in concert with one
another to provide an integrated view of their security status. These solutions
often include:

- firewalls to control the flow of data between an internal network and
outside networks or the Internet;

- virtual private network ("VPN") systems to protect information during
transmission and provide authentication of users;

- security assessment systems to identify potential security risks by
comparing security policy with actual system configuration;

- intrusion detection systems to monitor the packet traffic on network
segments to identify and respond to security breaches; and

- a comprehensive reporting system to automate the analysis and correlation
of data generated by multiple security applications.

As e-business and open computing environments continue to expand, we
anticipate that security management will become an essential system on
organizations' networks. We believe we are poised to take advantage of this
requirement for robust security technologies.

We focus on two areas of security, network intrusion detection systems and
security appliances to deliver security applications to end users.

NETWORK INTRUSION DETECTION SYSTEMS

Network intrusion detection systems analyze network traffic for attacks.
They examine individual packets within the data stream to identify threats from
authorized users, back-door attacks and hackers who have thwarted the control
systems to exploit network connections and access valuable data. Network
intrusion detection systems add a new level of visibility into the nature and
characteristics of the network. They provide information about the use and usage
of the network that can be used to:

- increase the value and efficacy of the control systems like firewalls and
routers;

- produce hard evidence for the altering of the enterprise security policy;
and

- provide decision support for network management.

SECURITY APPLIANCES

As the need for network security expands, we believe there is a need to
simplify security software installation and reduce the total cost of deployment
of network security systems.

Security appliances simplify the deployment of security systems with
preinstalled and preconfigured operating systems and application software.
Available in desktop or rack-mountable versions, these integrated appliances
extend the reach of security administrators to remote and branch offices.

- Desktop appliances are small, low profile, task-specific devices built to
be deployed within the workplace, and managed remotely by the enterprise
or a managed service provider (MSP).

- Rack-mountable appliances offer expanded input/output and
keyboard/video/mouse capabilities. These appliances are highly accessible,
expandable and upgradeable.

INTRUSION INC. SOLUTION AND PRODUCTS

Intrusion's approach to the challenges of information security is to
develop, market and support a family of intrusion detection and security
appliances for deployment by enterprises, to include remote and branch offices
of enterprises, and use by security service providers. We seek to protect
information assets from attack and misuse and to safeguard data integrity.
Implementing adequate perimeter defense, monitoring network traffic, profiling
user behavior and responding rapidly to network intrusions are critical elements
for the protection of information integrity.

SECURENET PRO FAMILY OF INTRUSION DETECTION PRODUCTS

Intrusion's SecureNet Pro-TM-, introduced in July 2000, is a network
intrusion detection system software that allows security administrators to
automatically monitor high speed network traffic, detect and respond to
suspicious activity, and respond to internal and external network abuse. The
SecureNet Pro architecture enables the recognition and response to a large
number of attack patterns on high-speed networks. Additionally, SecureNet Pro
provides for comprehensive packet analysis, resulting in fewer false positives.
When a SecureNet Pro sensor detects an attack or misuse, it transmits an alarm
to the SecureNet Pro console for administrative review. In addition, SecureNet
Pro can respond immediately to an attack or misuse by terminating a connection,
sending e-mail or pager alerts, recording the session or taking other
user-definable actions. We believe SecureNet Pro's interface, monitoring and
reporting capabilities increase the effectiveness of security professionals and
enable them to secure their networks more efficiently.

The SecureNet Pro family of intrusion detection products includes the
following:

- SecureNet Provider-TM- is a three-tier, Windows-based network intrusion
detection monitoring and reporting system for enterprises and managed
service providers. Coupled with the SecureNet Series of intrusion
detection security appliances, SecureNet Provider enables the centralized
monitoring and reporting for all SecureNet Pro intrusion detection system
sensors to increase the value and accessibility of intrusion detection
information.

- SecureNet 5000 series of network intrusion detection security appliances
are rack-mountable security appliance solutions featuring SecureNet Pro
network intrusion detection software. Enterprises can configure these
appliances as an intrusion detection security sensor, a standalone
intrusion detection security appliance that is both sensor and console, or
as a console to manage up to 20 SecureNet Pro sensors.

- SecureNet 2000 series of desktop network intrusion detection security
appliances simplify network intrusion detection deployment and increase
network intelligence to extend the reach of intrusion detection to remote
and branch offices by combining pre-installed SecureNet Pro network
intrusion software with open Intel architecture, a hardened operating
system based on Red Hat Linux and interfaces for either remote management
or command line access.

- SecureNet 7145-F is an integrated intrusion detection solution designed
for gigabit networks. Featuring SecureNet Pro software pre-installed on a
1U-high, rack-mountable appliance and a fiber optic gigabit interface,
SecureNet 7145-F extends network intelligence from the enterprise border
to gigabit backbones and data centers.

PDS FAMILY OF SECURITY APPLIANCES

Effective deployment of a security strategy involves installation,
configuration, validation, and implementation of all systems. We believe the
optimal solution is a combined software and appliance solution that enables
increased performance, effectively leverages personnel and reduces the total
cost of ownership to the enterprise.

As organizations expand their operations to include remote offices, regional
divisions, branch locations and telecommuters, securing the enterprise becomes
more complex. We offer cost-effective integrated security software and appliance
solutions that enable centralized management and allow businesses to more easily
secure their networks by enabling a variety of complementary security
technologies.

The PDS Series of security appliances are Linux-based platforms with open
Intel architecture that enable a variety of security software such as intrusion
detection and virtual private network and firewall applications. These perimeter
defense systems deliver security software solutions for a networks' perimeter to
the managed service provider, large enterprise, small business, or enterprise
remote offices.

While many security platforms can be difficult or costly to manage, a PDS
appliance delivers Web-based setup and administration with centralized policy
management by enabling the deployment of complementary technologies such as
firewall, virtual private network and network intrusion detection systems.

We have partnered with Check Point Software Technologies to offer their
market-leading virtual private network and firewall security software integrated
on our family of Perimeter Defense System ("PDS") security appliances. These
appliances enable security administrators to more easily and cost-effectively
deploy virtual private network and firewall technology throughout the network,
into the subnets, and in branch and remote offices.

The PDS family of security appliance products includes the following:

- The PDS 1000 and PDS 2000 series are designed for remote and branch
offices, and enterprise network subnet deployment. The appliances reduce
the threat of unauthorized local access because they do not require a
keyboard, video or mouse. Both the PDS 1000 and PDS 2000 series of
products offer virtual private network and firewall deployment with the
PDS Pilot appliance management software and Check Point VPN-1/FireWall-1
SmallOffice together in an integrated appliance package. The PDS 2000
series can also deliver Check Point's VPN-1/FireWall-1 enterprise
software.

- The PDS 5000 series series is designed for server room, data center or
managed service provider deployments where network expansion may be
required and may be configured as standalone gateways or for local/remote
management. These appliances deliver high-end VPN/firewall security with
hardened Red Hat Linux in a rack-mountable case.

THIRD-PARTY PRODUCTS

We believe that it is beneficial to work with third parties with
complementary technologies to provide integrated solutions to our customers. As
we also compete with these technology partners in certain segments of the
market, there can be no assurance that we will have access to all of the third-
party products which may be desirable in order to offer fully integrated
solutions to our customers.

CUSTOMER SERVICES

In addition to offering our network security products, we also offer a wide
range of services, including design and configuration, project planning and
management, training, security analysis and installation and maintenance.

PRODUCT DEVELOPMENT

The data security industry is characterized by rapidly changing technology,
standards and customer demands. We believe that our future success depends in
large part upon the timely enhancement of existing products as well as the
development of technologically advanced new products that meet industry
standards, perform successfully and achieve market acceptance. We are currently
developing and marketing next-generation data security products. We are also
investing in the development of products that comply with emerging industry
standards and are continuously engaged in testing to ensure that our products
interoperate with other manufacturers' products which comply with industry
standards.

During 2001, 2000 and 1999, our research and development expenditures were
$12.5 million, $13.1 million and $8.2 million, respectively. All of our
expenditures for hardware and software research and development costs have been
expensed as incurred. At December 31, 2001, we had 32 employees engaged in
research and product development.

MANUFACTURING AND SUPPLIES

Our operational strategy relies on the outsourcing of manufacturing
components, assembly and certain other operations to reduce fixed costs and to
provide flexibility in meeting market demand.

Our internal manufacturing operations consist primarily of replication of
software on CDs, packaging, final assembly, testing and quality control of
subassemblies and finished units. Materials used in our manufacturing processes
include semiconductors such as microprocessors, memory chips and application
specific integrated circuits ("ASICs"), printed circuit boards, power supplies
and enclosures.

INTELLECTUAL PROPERTY AND LICENSES

Our success and our ability to compete is dependent, in part, upon our
proprietary technology. We hold one U.S. patent relating to network event
detection and using event signatures. While we have applied for certain other
patents, we currently rely on a combination of contractual rights, trade secrets
and copyright laws to establish and protect our proprietary rights in our
products. We have also entered into confidentiality agreements with our
employees and enter into non-disclosure agreements with our suppliers, resellers
and certain customers to limit access to and disclosure of proprietary
information. There can be no assurance that the steps taken by us to protect our
intellectual property will be adequate to prevent misappropriation of our
technology or that our competitors will not independently develop technologies
that are substantially equivalent or superior to our technology.

We have entered into several software and product license agreements. These
license agreements provide us with additional software and hardware components
that add value to our security products. These license agreements do not provide
proprietary rights that are unique or exclusive to us and are generally
available to other parties on the same or similar terms and conditions, subject
to payment of applicable license fees and royalties.

SALES, MARKETING AND CUSTOMERS

We market and distribute our products primarily through a direct sales force
to end users supplemented by numerous domestic and international distributors,
system integrators and value added resellers. At December 31, 2001, our sales
and marketing organization consisted of 58 individuals, including managers,
sales representatives, marketing personnel and technical support personnel.

FIELD SALES FORCE. Our direct sales organization focuses on major account
sales; channel partners including distributors, Value Added Resellers ("VARs")
and integrators; promotes our products to current and potential customers; and
monitors evolving customer requirements. The field sales and technical support
force provides training and technical support to our resellers and end users and
assists our customers to design secure data networking solutions.

We currently conduct sales and marketing efforts from our principal office
in Richardson (Dallas), Texas; Washington, D.C.; and through foreign sales
offices located in the following countries: Canada, England, France, Germany,
Japan, Malaysia, and South Korea.

DISTRIBUTORS. We have signed distribution agreements with distributors in
the United States, Europe and Asia. In general, these relationships are
non-exclusive. Distributors typically maintain an inventory of our products.
Under these agreements, we provide certain protection to the distributors for
their inventory of our products for price reductions as well as products that
are slow-moving or have been discontinued. Recognition of sales to distributors
and related gross profits are deferred until the merchandise is resold by the
distributors. However, since we have legally sold the inventory to the
distributor and we no longer have care, custody or control over the inventory,
we recognize the trade accounts receivable and reduce inventory related to the
sale at the time of shipment to the distributor.

RESELLERS. Domestic and international system integrators and value added
resellers (collectively, "resellers") sell our products as stand-alone solutions
to end users and integrate our products with products sold by other vendors into
data security systems that are sold to end users. Our field sales force and
technical support organization provide support to these resellers. Our
agreements with resellers are non-exclusive, and our resellers generally sell
other products that may compete with our products. Resellers may place higher
priority on products of other suppliers who are larger than and have more name
recognition than us, and there can be no assurance that resellers will continue
to sell and support our products.

FOREIGN SALES. We believe that rapidly evolving international markets are
important sources of future net sales. Our export sales are currently being made
through a direct sales force supplemented by international resellers in Europe,
Asia, Latin America and Canada. Export sales accounted for approximately 36.4%,
19.2% and 14.0% of net sales in 2001, 2000 and 1999, respectively. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in this report for a geographic breakdown of our product
revenue in 2001, 2000 and 1999. Sales to foreign customers and resellers
generally have been made in United States dollars.

MARKETING. We have implemented several methods to market our products,
including regular participation in trade shows and seminars, advertisement in
trade journals, telemarketing, distribution of sales literature and product
specifications and ongoing communication with our resellers and installed base
of end-user customers.

CUSTOMERS. Our end-user customers include manufacturing, high-technology,
telecommunications, retail, transportation, health care, insurance,
entertainment, utilities and energy companies, government agencies, financial
institutions and academic institutions. Sales to certain customers and groups of

customers can be impacted by seasonal capital expenditure approval cycles, and
sales to customers within certain geographic regions can be subject to seasonal
fluctuations in demand.

Although we sell our products to many customers, direct sales to five such
resellers and end-user customers, iGov.com, TRW Systems & Information Technology
("TRW"), AT&T Corp. ("AT&T"), Federal Data Corporation ("Federal Data") and
Comstor, Inc. ("Comstor") have each accounted for 10% or more of our net sales
in at least one of the past three fiscal years as indicated in the following
schedule.

PERCENTAGE OF
NET SALES
------------------------------
CUSTOMER 2001 2000 1999
-------- -------- -------- --------

iGov.com.................................................. 5.4% 14.2% 21.3%
TRW....................................................... 7.9 24.1 7.4
AT&T...................................................... 0.6 0.2 10.9
Federal Data.............................................. 0.8 1.9 16.0
Comstor................................................... 0.0 0.0 12.1

A large portion of the products sold to iGov.com, TRW and Federal Data
during the periods shown were integrated with other products or services and
sold to U.S. government customers by those system integrators. No other customer
accounted for 10% or more of our net sales in 2001, 2000 or 1999, respectively.
The loss of any of these customers could have a material adverse effect our
business and our operating results if not replaced.

BACKLOG. We believe that only a small portion of our order backlog is
non-cancelable and that the dollar amount associated with the non-cancelable
portion is immaterial. We purchase inventory based upon our forecast of customer
demand and maintain inventories of sub-assemblies and finished products in
advance of receiving firm orders from customers. Orders are generally fulfilled
within two to eight weeks following receipt of an order. Due to the generally
short cycle between order and shipment and occasional customer-initiated changes
in delivery schedules or cancellation of orders that are made without
significant penalty, we do not believe that our backlog as of any particular
date is indicative of future net sales.

CUSTOMER SUPPORT, SERVICE AND WARRANTY. We service, repair and provide
technical support for our products. Our field sales and technical support force
work closely with resellers and end-user customers on-site and by telephone to
assist with pre- and post-sales support services such as network security
design, system installation and technical consulting. By working closely with
our customers, our employees increase their understanding of end-user
requirements and provide input to the product development process.

We warrant all of our products against defects in materials and workmanship
for periods ranging from 90 days to 12 months. Before and after expiration of
the product warranty period, we offer both on-site and factory-based support,
parts replacement and repair services. Extended warranty services are separately
invoiced on a time and materials basis or under an annual maintenance contract.

COMPETITION

The market for data security solutions is intensely competitive and subject
to frequent product introductions with improved price and performance
characteristics. Industry suppliers compete in areas such as conformity to
existing and emerging industry standards, interoperability with networking and
other security products, management and security capabilities, performance,
price, ease of use, scalability, reliability, flexibility, product features and
technical support. We believe that our approach

of combining security network design services, our products and third-party
products provides us with a competitive advantage with large organizations with
complex security requirements.

There are numerous companies competing in various segments of the data
security markets. Our principle competitors in the network intrusion detection
market include Internet Security Systems, Inc. ("ISS"), Cisco Systems, Inc.
("Cisco"), Enterasys Networks, Inc. ("Enterasys") and NFR Security, Inc.
("NFR"). Our principle competitors in the Check Point Software
Technologies Ltd. firewall / VPN appliance market include Nokia Corporation
("Nokia"), Celestix Networks, Inc. ("Celestix"), International Business Machines
Corp. ("IBM") and Compaq Computer Corp. ("Compaq"). Several of our competitors
have substantially greater financial, technical, sales and marketing resources,
better name recognition and a larger customer base than we do. In addition, many
of our competitors offer customers a broader product line which may provide a
more comprehensive networking and security solution than we currently offer.
Even if we do introduce advanced products which meet evolving customer
requirements in a timely manner, there can be no assurance that our new products
will gain market acceptance.

Certain companies in the data security industry have expanded their product
lines or technologies in recent years as a result of acquisitions. Further, more
companies have developed products which conform to existing and emerging
industry standards and have sought to compete on the basis of price. We
anticipate increased competition from large networking equipment vendors which
are expanding their capabilities in the data security market. In addition, we
anticipate increased competition from private "start-up" companies that have
developed or are developing advanced security products. Increased competition in
the security industry could result in significant price competition, reduced
profit margins or loss of market share, any of which could have a material
adverse effect on our business, operating results and financial condition. There
can be no assurance that we will be able to compete successfully in the future
with current or new competitors.

EMPLOYEES

As of December 31, 2001, we employed a total of 149 persons, including 58 in
sales, marketing and technical support, 9 in manufacturing and operations, 32 in
research and product development, 15 in administration and finance, and 35 in
our discontinued networking operations.

None of our employees are represented by a labor organization, and we are
not a party to any collective bargaining agreement. We have not experienced any
work stoppages and consider our relations with our employees to be good.

Competition in the recruiting of personnel in the networking and data
security industry is intense. We believe that our future success will depend in
part on our continued ability to hire, motivate and retain qualified management,
sales and marketing, and technical personnel. To date, we have not experienced
significant difficulties in attracting or retaining qualified employees.

FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS

In addition to the other information in this Form 10-K, the following
factors should be considered in evaluating Intrusion Inc. and our business.

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 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.

ACQUISITIONS. ISS, Cisco, Enterasys, NFR, Nokia, Celestix, IBM, Compaq and
other competitors have recently 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.

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 in 2002 that 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 that 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 our company 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.

SUFFICIENCY OF CASH FLOW. As of December 31, 2001, we had cash, cash
equivalents and investments in the amount of approximately $20.4 million, down
from approximately $45.4 million as of December 31, 2000. Although we believe we
have sufficient cash resources to finance our operations and expected capital
expenditures for the next twelve months, the sufficiency of our cash resources
may depend to a certain extent on general economic, financial, competitive or
other factors beyond our

control. Moreover, despite actions to reduce our costs and improve our
profitability, we expect our operating losses and net operating cash outflows to
continue during 2002. As a result, we may not be able to achieve the revenue and
gross margin objectives necessary to achieve positive cash flow or profitability
without obtaining additional financing. We do not currently have any
arrangements for financing, and we may not be able to secure additional debt or
equity financing on terms acceptable to us, or at all, at the time when we need
such funding. If our business does not generate sufficient cash flow from
operations and sufficient future financings are not available, we may not be
able to operate or grow our business, pay our expenses when due or fund our
other liquidity needs.

DEPENDENCE ON CHECK POINT TECHNOLOGIES. A large percentage of our sales are
represented by our PDS family of security appliances which are integrated with
Check Point Software Technologies' market-leading virtual private network and
firewall security software. We expect the percentage of sales represented by
these products to increase in the future. Although we are a certified appliance
partner of Check Point and our PDS products have received certification from
Check Point, we have no long term agreement or exclusive relationship with Check
Point. As a result, the loss or significant change in our relationship with
Check Point, the failure of future PDS products to receive Check Point
certification, the business failure of Check Point or its acquisition by or of
one of our competitors, and the loss of market share of Check Point or market
acceptance of its products could each have a material adverse effect on our
business, financial condition and results of operations.

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 alliances allow us to provide integrated solutions to our
customers by combining our developed technology with third-party products. As we
also compete with these technology partners in certain segments of the market,
there can be no assurance that we will have access to all of the third-party
products that 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, Enterasys, NFR, Nokia, Celestix, IBM, Compaq 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. In 2001, 23.7% of our revenue was derived
from sales to the U.S. government, either directly by us 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.

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.

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 the remaining
discontinued operations of our Essential Communications division. 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 the first
quarter of 2002 by which time we expect to have exited, disposed of or otherwise
transitioned a majority of our ownership in Essential.

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.

RESTRUCTURING AND COST REDUCTIONS. We implemented a restructuring plan in
2001. The objective of our restructuring plan was 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. 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.

ITEM 2. PROPERTIES.

Our headquarters is located in a modern, two-story building in Richardson,
Texas, with an aggregate of approximately 95,000 square feet of floor space.
This facility includes our corporate administration, operations, marketing,
research and development, sales and technical support personnel. We occupy this
facility under a lease, the base term of which expires in February 2005, with
two seven-year options to extend the lease term, subject to compliance with
certain conditions. We also lease a separate warehouse facility consisting of
approximately 8,000 square feet, adjacent to our headquarters, under a lease
that expires in June 2002.

Personnel of the Essential division (part of the our discontinued
operations) are located in a 15,120 square foot leased property in Albuquerque,
New Mexico. The lease is scheduled to expire in February 2009. In March 2002, we
sold the assets of Essential Communications (see Recent Developments). A
condition of the sale was to give Essential personnel 60 days to exit the
facility. Included in the gain on the sale of Essential is a $0.3 million
reserve to terminate the lease which is the equivalent of 2 years' lease and
maintenance of the facility. Successful termination for less than $0.3 million
will result in a greater gain on disposition of Essential. Termination for more
than $0.3 million will reduce the gain on disposition of Essential.

Much of our security software research and development staff is located in
an 11,400 square foot leased property in San Diego, California. The lease will
expire in August 2002. Research and development, sales and administrative
personnel occupy this facility.

The lease on the sales office located in Vienna, Virginia, which occupied
9,747 square feet and had an original expiration date of April 2004, was
terminated early in November 2001 for $0.2 million.

In addition, we lease small amounts of office space for sales and technical
support personnel domestically internationally in Canada, England, France,
Germany, Malaysia, Japan and South Korea. We believe that the existing
facilities at December 31, 2001 will be adequate to meet our requirements
through 2002. See Note 5 of Notes to Consolidated Financial Statements for
additional information regarding our obligations under leases.

ITEM 3. LEGAL PROCEEDINGS.

We are not a party to any material litigation and are not aware of any
threatened litigation which would have a material adverse effect on our
business, operating results or financial position.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

There were no matters submitted to a vote of our security holders during the
fourth quarter of 2001.

PART II

ITEM 5. MARKET FOR INTRUSION'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

Our common stock is traded on The Nasdaq Stock Market (National Market
System) under the symbol "INTZ". As of February 26, 2002 there were
approximately 220 registered holders of record of the common stock. The
following table sets forth, for the periods indicated, the high and low per
share intra-day sales prices for the common stock, as reported by The Nasdaq
Stock Market.

2001 2000
------------------- -------------------
HIGH LOW HIGH LOW
-------- -------- -------- --------

First Quarter.................................. $8.50 $3.25 $31.50 $8.69
Second Quarter................................. 4.90 2.75 24.00 7.56
Third Quarter.................................. 4.14 0.90 17.25 9.00
Fourth Quarter................................. 2.15 0.62 12.25 2.88

We have not declared or paid cash dividends on our capital stock since 1995.
We currently retain any earnings for use in our business and do not anticipate
paying any cash dividends in the foreseeable future. Future dividends, if any,
will be determined by our Board of Directors.

ITEM 6. SELECTED FINANCIAL DATA.

The following selected consolidated financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" in Item 7 of this Form 10-K and the consolidated
financial statements and notes thereto included in Item 14 of this Form 10-K.
Continuing operations consisted of our information security business which began
operations in 1998. Discontinued operations are composed of our local area
networking divisions which were discontinued in April 2000.

YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
2001 2000 1999 1998 1997
STATEMENT OF OPERATIONS DATA: ------------ ------------ -------- ------------ --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)

Revenue.......................... $ 16,685 $ 23,210 $ 7,963 $ 1,920 $ --
Cost of Sales.................... 13,490 19,009 3,877 968 --
--------- --------- -------- --------- --------
Gross profit..................... 3,195 4,201 4,086 952 --
Operating expenses:
Sales and marketing............ 23,550 27,740 12,236 17,806 --
Research and development....... 12,549 13,073 8,171 2,847 --
In-process research and
development.................. -- -- -- 1,047 (1) --
General and administrative..... 4,481 5,865 2,466 731 --
Amortization of intangibles.... 1,233 975 547 272 --
Restructuring costs............ 4,673 (3) -- -- -- --
--------- --------- -------- --------- --------
Operating loss................... (43,291) (43,452) (19,334) (21,751) --
Interest income, net............. 1,687 3,301 1,104 1,398 --
Other income (expense)........... 112 66,335 (2) -- (1,122) --
--------- --------- -------- --------- --------
Income (loss) before income
taxes.......................... (41,492) 26,184 (18,230) (21,475) --
Income taxes provision
(benefit)...................... (1,877) 1,999 -- (3,104) --
--------- --------- -------- --------- --------
Income (loss) from continuing
operations..................... (39,615) 24,185 (18,230) (18,371) --
Income (loss) from discontinued
operations, net of tax......... (6,165) (974) 6,190 (7,379) (4,937)
--------- --------- -------- --------- --------
Net income (loss)................ $ (45,780) $ 23,211 $(12,040) $ (25,750) $ (4,937)
========= ========= ======== ========= ========
Basic earnings (loss) per share,
continuing operations.......... $ (1.93) $ 1.23 $ (0.98) $ (1.07) $ 0.00
========= ========= ======== ========= ========
Diluted earnings (loss) per
share, continuing operations... $ (1.93) $ 1.18 $ (0.98) $ (1.07) $ 0.00
========= ========= ======== ========= ========
Basic earnings (loss) per
share.......................... $ (2.23) $ 1.18 $ (0.65) $ (1.50) $ (0.30)
========= ========= ======== ========= ========
Dilutive earnings (loss) per
share.......................... $ (2.23) $ 1.13 $ (0.65) $ (1.50) $ (0.30)
========= ========= ======== ========= ========
Weighted average shares
outstanding
--Basic........................ 20,565 19,624 18,565 17,190 16,437
========= ========= ======== ========= ========
--Diluted...................... 20,565 20,478 18,565 17,190 16,437
========= ========= ======== ========= ========

BALANCE SHEET DATA:

2001 2000 1999 1998 1997
-------- -------- -------- -------- --------

Working capital............................... $25,240 $52,514 $ 66,578 $31,763 $51,847
Total assets.................................. 42,295 92,414 120,502 61,710 77,178
Total liabilities............................. 8,797 13,627 38,925 12,204 10,799
Total stockholders' equity.................... 33,498 78,787 81,577 49,506 66,379

------------------------

(1) The write-off of acquired in-process research and development in the year
ending December 31, 1998, is comprised of approximately $1.0 million
resulting from the acquisition of Computer Misuse and Detection System
assets from Science Applications International Corporation.

(2) Other income for the year ending December 31, 2000 is comprised primarily of
a $66.4 million pre-tax gain realized on the sale of Alteon
WebSystems, Inc. common stock.

(3) Restructuring costs for the year ending December 31, 2001 include the
impairment of certain intangible assets associated with obsolete product
lines and severance and lease termination costs for restructuring
activities.

See "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the Notes to the Consolidated Financial Statements.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

"SAFE HARBOR" STATEMENT UNDER THE PRIVATE LITIGATION REFORM ACT OF 1995

This Annual Report, other than historical information, may include
forward-looking statements, including statements with respect to financial
results, product introductions, market demand, sales channels, industry trends,
sufficiency of cash resources and certain other matters. These statements are
made under the "safe harbor" provisions of the Private Securities Litigation
Reform Act of 1995 and involve risks and uncertainties which could cause actual
results to differ materially from those in the forward-looking statements,
including those discussed in the section entitled "Factors That May Affect
Future Results of Operations" in Item 1 and elsewhere in this Annual Report on
Form 10-K and other filings with the Securities and Exchange Commission.

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
e-security solutions including intrusion detection 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 e-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.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Management's discussion and analysis of financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,

revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to product returns, bad debts, inventories, intangible assets, income
taxes, warranty obligations, restructuring, maintenance contracts and
contingencies. We base our estimates on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions.

We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements.

REVENUE RECOGNITION

We generally recognize product revenue upon shipment of product. We accrue
for estimated warranty costs, sales returns and other allowances at the time of
shipment based on our experience. Revenue from maintenance contracts is deferred
and recognized over the contractual period the services are performed. To date,
warranty costs and sales returns have not been material. There is a risk that
technical issues on new products could result in unexpected warranty costs and
returns.

We recognize software revenue from the licensing of our software products in
accordance with Statement of Position ("SOP") No. 97-2 "Software Revenue
Recognition" and SOP 98-9 "Modification of 97-2, Software Revenue Recognition,
with respect to certain transactions" whereby revenue from the licensing of our
products is not recognized until all four of the following have been met:
i) execution of a written purchase order, license agreement or contract;
ii) shipment of the product has occurred; iii) the license fee is fixed and
determinable; and iv) collectibility is probable. The Company defers and
recognizes maintenance and support revenue over the term of the contract period,
which is generally one year.

We have signed distribution agreements with distributors in the United
States, Europe and Asia. In general, these relationships are non-exclusive.
Distributors typically maintain an inventory of our products. Under these
agreements, Intrusion Inc. provides certain protection to the distributors for
their inventory of Intrusion Inc. products for price reductions as well as
products that are slow-moving or have been discontinued by the Company.
Recognition of sales to distributors and related gross profits are deferred
until the merchandise is resold by the distributors. However, since we have
legally sold the inventory to the distributor and we no longer have care,
custody or control over the inventory, we recognize the trade accounts
receivable and reduce inventory related to the sale at the time of shipment to
the distributor. Revenue, offset by deferred cost of sales, is included in
deferred revenue in the accompanying financial statements.

ALLOWANCE FOR DOUBTFUL ACCOUNTS AND RETURNS

We maintain allowances for doubtful accounts for estimated losses resulting
from the inability of our customers to make required payments. If the financial
condition of our customers were to deteriorate, resulting in an impairment of
their ability to make payments, additional allowances may be required.

INVENTORY

We write down our inventory for estimated obsolescence or unmarketable
inventory equal to the difference between the cost of inventory and the
estimated market value based upon assumptions about future demand and market
conditions. If actual market conditions are less favorable than those projected
by management, additional inventory write-downs may be required.

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.

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 the first quarter of 2002 by which time we
expect to have exited, disposed of or otherwise transitioned a majority of our
ownership in Essential.

A condition of the sale was to give Essential Communications personnel
60 days to exit Essential Communications' lease facility, the obligation for
which we retained as part of the sale. Included in the gain on the sale of
Essential Communications is management's estimate of $0.3 million to terminate
this lease agreement, which is equivalent to 2 years' lease and maintenance of
the facility. Successful termination for less than $0.3 million will result in a
greater gain on sale. Termination for more than $0.3 million will reduce the
gain on sale. The contractual term of the lease runs through February 2009 and
remaining contractual lease payments total $1.2 million at December 31, 2001.

RESULTS OF OPERATIONS

The following tables set forth, for the periods indicated, certain financial
data as a percentage of net sales.

YEAR ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------

Net sales................................................... 100.0% 100.0% 100.0%
Cost of Sales............................................... 80.9 81.9 48.7
------ ------ ------
Gross profit................................................ 19.1 18.1 51.3
Operating expenses:
Sales and marketing....................................... 141.1 119.5 153.7
Research and development.................................. 75.2 56.3 102.6
General and administrative................................ 26.9 25.3 31.0
Amortization of intangibles............................... 7.4 4.2 6.9
Restructuring and Other Charges........................... 28.0 -- --
------ ------ ------
Operating loss.............................................. (259.5) (187.2) (242.9)
Interest income, net........................................ 10.1 14.2 13.9
Other income (expense)...................................... 0.7 285.8 0.0
------ ------ ------
Income (loss) before income taxes........................... (248.7) 112.8 (229.0)
Income taxes provision (benefit)............................ (11.2) 8.6 0.0
------ ------ ------
Income (loss) from continuing operations.................... (237.4) 104.2 (229.0)
Income (loss) from discontinued operations, net of tax...... (36.9) (4.2) 77.7
------ ------ ------
Net income (loss)........................................... (274.4) 100.0 (151.3)
====== ====== ======

2001 2000 1999
-------- -------- --------

Domestic sales.............................................. 63.6% 80.8% 86.0%
Export sales to:
Europe.................................................... 25.4 7.6 8.3
Canada.................................................... 4.0 2.7 0.1
Asia...................................................... 6.3 7.4 5.6
Latin America............................................. 0.7 1.5 0.0
------ ------ ------
Net sales................................................... 100.0% 100.0% 100.0%
====== ====== ======

2001 COMPARED WITH 2000

NET SALES

Net sales decreased 28.1% to $16.7 million in 2001 from $23.2 million in
2000. The decrease in net sales is primarily due to the fact that the decline in
our maturing SecureCom product line was greater than the growth in our more
recently introduced product lines, SecureNet Pro and our PDS appliances. In
addition, the economic decline in technology spending for large enterprise and
federal customers during 2001 contributed to the decrease in our net sales for
the period.

Export sales in 2001 increased to $6.1 million, or 36.4% of net sales,
compared to $4.5 million, or 19.2% of net sales in 2000 primarily due to greater
international acceptance of our security products.

Sales to iGov.com in 2001 and 2000 were 5.4% and 14.2%, respectively of net
sales. Sales to TRW in 2001 and 2000 were 7.9% and 24.1%, respectively of net
sales. In addition, a portion of our sales to iGov.com, TRW and other
corporations were resold by those organizations to various agencies of the U.S.
government.

GROSS PROFIT

Gross profit decreased 23.9% to $3.2 million in 2001 from $4.2 million in
2000. As a percentage of net sales, gross profit increased to 19.1% for 2001
from 18.1% in 2000. This increase is primarily associated to a decrease in our
operations infrastructure spending, which includes operations management, supply
chain management, purchasing, quality, order entry, planning and other related
functions.

Cost of Sales in 2001 includes a $1.3 million second quarter write-off of
SecureCom inventory as demand has shifted to our new intrusion detection and
security appliance product lines. Absent this write-off, gross profit would have
been $4.5 million or 27.2% as a percentage of net sales.

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 15.1% to $23.6 million in 2001 from
$27.7 million in 2000 as we restructured our sales force, including headcount
reductions, to accommodate the decline in information technology spending. As a
percentage of net sales, sales and marketing expenses increased to 141.1% in
2001 from 119.5% in 2000. We expect sales and marketing expenses to decrease in
2002 compared to 2001 as we recognize the full benefit from restructuring
actions taken throughout 2001. We also expect sales and marketing expenses, as a
percentage of net sales, to decrease in 2002 compared to 2001.

RESEARCH AND DEVELOPMENT

Research and development expenses decreased 4.0% to $12.5 million, or 75.2%
of net sales, in 2001 compared to $13.1 million, or 56.3% of net sales, in 2000
as we reduced headcount in our engineering department to accommodate the decline
in information technology spending and eliminated engineering efforts with
regards to our SecureCom product family. Our research and development costs are
expensed in the period in which they are incurred. We expect research and
development expenses to decrease in 2002 compared to 2001 as we recognize the
full benefit from restructuring actions taken throughout 2001. The Company
expects research and development, as a percentage of net sales, to decrease in
2002 compared to 2001.

GENERAL AND ADMINISTRATIVE

General and administrative expenses, excluding amortization expenses,
decreased 23.6% to $4.5 million in 2001 from $5.9 million in 2000 as we reduced
headcount in our support functions to reduce costs. As a percentage of net
sales, general and administrative expenses increased to 26.9% in 2001 from 25.3%
in 2000. We expect general and administration expenses to decrease in 2002
compared to 2001 as we recognize the full benefit of restructuring actions taken
throughout 2001.

AMORTIZATION OF INTANGIBLES

Amortization of intangibles increased 26.5% to $1.2 million in 2001 from
approximately $1.0 million in 2000, due to the acquisition of MimeStar in
June 2000. Amortization expense in 2001 reflects a full year amortization of
MimeStar intangibles. Absent any acquisitions or impairment of MimeStar
intangibles, we expect amortization of intangibles to be $0.8 million in 2002.

RESTRUCTURING CHARGES

Demand continued to shift to our new intrusion detection and security
appliance product lines during 2001, and as such, we streamlined operations and
activities that are not aligned with these core markets and strategies. This
shift in demand resulted in a charge of $3.1 million to recognize the impairment
of intangible assets (primarily developed technology) related to our
SecurityAnalyst and SecureEnterprise product lines. We also recorded
restructuring charges of $1.3 million for severance as a result of reductions in
force affecting 150 employees and $0.2 million for early termination of excess
lease space. Substantially all severance obligations and the lease termination
payment were paid prior to December 31, 2001.

Pursuant to these restructuring actions, we reduced operating expenses,
excluding restructuring charges and amortization, 48.4% from $14.1 million in
the first quarter of 2001 to $7.3 million in the fourth quarter of 2001.
Comparing first quarter 2001 to fourth quarter 2001 operating expense
categories, sales and marketing reduced 44.7% from $8.0 million to
$4.4 million, research and development reduced 51.5% from $4.3 million to
$2.1 million and general and administrative reduced 57% from $1.8 million to
$0.8 million, respectively. We expect operating expenses, excluding amortization
and any additional restructuring charges, to be less than $7.0 million in the
first quarter of 2002.

INTEREST INCOME, NET

Net interest income decreased 48.9% to $1.7 million in 2001 from
$3.3 million in 2000 primarily due to a decrease in average cash and
interest-bearing investment balances. As a percentage of net sales, net interest
income was 10.1% and 14.2% in 2001 and 2000, respectively. We expect net
interest income to decrease in 2002 compared to 2001 as we expect our average
cash and interest-bearing investment balances to decline for 2002 when compared
to 2001. Net interest income will vary in the future based on our cash flow and
rate of return on investments.

INCOME TAXES

Our effective income tax rate was a benefit of 4.8% in 2001 compared to an
income tax rate of 7.6% in 2000. We were able to carryback our 2001 net
operating loss to 2000 and expect to recover $2.8 million of income taxes, which
we expect to receive by June 30, 2002. We also incurred a $475 thousand foreign
tax expense related to the sale of the LAN business. These two items were the
primary contributors to a $1.8 million tax benefit for 2001. See Note 8 of the
Notes to Consolidated Financial Statements.

2000 COMPARED WITH 1999

NET SALES

Net sales increased 191.5% to $23.2 million in 2000 from $8.0 million in
1999. Our increased revenue was attributed to several factors including:
increased sales in our SecureCom product line, SecurityAnalyst availability for
all of 2000 compared to only the fourth quarter of 1999, and new product
introductions of SecureNet Pro and PDS 2100.

Export sales in 2000 increased to $4.5 million, or 19.2% of net sales,
compared to $1.1 million, or 14.0% of net sales in 1999 primarily due to greater
international acceptance of our security products.

Sales to iGov.com in 2000 and 1999 were 14.2% and 21.3%, respectively of net
sales. Sales to TRW in 2000 and 1999 were 24.1% and 7.4%, respectively of net
sales. Sales to AT&T in 2000 and 1999 were 0.2% and 10.9%, respectively of net
sales. Sales to Federal Data in 2000 and 1999 were 1.9% and 16.0%, respectively
of net sales. Sales to Comstor in 2000 and 1999 were 0.0% and 12.1%,
respectively of net sales. In addition, a portion of our sales to iGov.com, TRW,
Federal Data and other corporations were resold by those organizations to
various agencies of the U.S. government.

GROSS PROFIT

Gross profit increased 2.8% to $4.2 million in 2000 from $4.1 million in
1999. As a percentage of net sales, gross profit decreased to 18.1% for 2000
from 51.3% in 1999. This decrease is primarily associated to an increase in our
operations infrastructure, which includes operations management, supply chain
management, purchasing, quality, order entry, planning and other related
functions as well as certain period costs associated with starting up new
products and processes.

SALES AND MARKETING

Sales and marketing expenses increased 126.7% to $27.7 million in 2000 from
$12.2 million in 1999 as we expanded our sales and marketing programs and staff
to support more products and new channels. As a percentage of net sales, sales
and marketing expenses decreased to 119.5% in 2000 from 153.7% in 1999.

RESEARCH AND DEVELOPMENT

Research and development expenses increased 60.0% to $13.1 million, or 56.3%
of net sales, in 2000 compared to $8.2 million, or 102.6% of net sales, in 1999.
Much of this increase was to support product development of new products
including SecureNet Pro, SecurityAnalyst and the PDS 2100. Our research and
development costs are expensed in the period in which they are incurred.

GENERAL AND ADMINISTRATIVE

General and administrative expenses, excluding amortization expenses,
increased 137.8% to $5.9 million in 2000 from $2.5 million in 1999 primarily due
to the shift of general and administrative personnel from our discontinued
operations to our continuing operations. As a percentage of net sales, general
and administrative expenses decreased to 25.3% in 2000 from 31.0% in 1999.

AMORTIZATION OF INTANGIBLES

Amortization of intangibles increased 78.2% to approximately $1.0 million in
2000 from approximately $0.5 million in 1999, due to the acquisition of MimeStar
in June 2000.

INTEREST INCOME, NET

Net interest income increased 199.0% to $3.3 million in 2000 from
$1.1 million in 1999 primarily due to an increase in average cash and
interest-bearing investment balances related to our sale of Alteon WebSystems'
common stock, generating gross proceeds of $67.1 million in the first quarter of
2000. As a percentage of net sales, net interest income was 14.2% and 13.9% in
2000 and 1999, respectively.

INCOME TAXES

Our effective income tax rate was 7.6% in 2000 compared to an income tax
rate of 0% in 1999. We fully utilized our net operating loss carryback in 1998.
We did not record an income tax benefit in 1999 related to the net operating
losses that can be carried forward to offset taxable income in future years. Due
to our sale of Alteon WebSystems' common stock in 2000, we recognized the tax
benefit of the 1999 net operating loss carryforward in 2000. See Note 8 of the
Notes to Consolidated Financial Statements.

LIQUIDITY AND CAPITAL RESOURCES

Our principal sources of liquidity at December 31, 2001 were $15.8 million
of cash and cash equivalents and $4.7 million of short-term investments. As of
December 31, 2001, we do not hold investments with a stated maturity beyond one
year. Working capital at December 31, 2001 was $25.2 million compared to
$52.5 million as of December 31, 2000.

Net cash used in continuing operations in 2001 was $28.9 million, primarily
due to an operating loss for the year, an increase in income taxes receivable
and a decrease in accounts payable and accrued expenses, partially offset by
depreciation and amortization, and a decrease in accounts receivable and
inventories. Future fluctuations in accounts receivable, inventory balances and
accounts payable will be dependent upon several factors, including but not
limited to quarterly sales, timely collection of accounts receivable, and the
accuracy of our forecasts of product demand and component requirements.

During 2001, our cash, cash equivalents and investments declined
$25.0 million from $45.4 million on December 31, 2000 to $20.4 million on
December 31, 2001. During 2001 we implemented various cost reduction programs
reducing operating expenses, excluding these restructuring and cost reductions,
from $14.4 million in the first quarter of 2001 to $7.7 million in the fourth
quarter of 2001. Based on our current expectations, the Company will incur
operating losses and further usage of cash resources during 2002, although at a
reduced rate when compared to 2001.

Net cash provided by investing activities of continuing operations in 2001
was $19.7 million, which consisted of the net proceeds of $20.4 million from
maturities and purchases of available for sale securities and the purchase of
property and equipment of $0.7 million.

Net cash provided by financing activities of continuing operations in 2001
was $0.4 million as a result of the issuance of common stock upon the exercise
of employee stock options.

Net cash provided by discontinued operations in 2001 was $4.1 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 December 31, 2001, we did not have any material commitments for capital
expenditures. During 2001, we funded our operations through the use of available
cash, cash equivalents and investments.

Although we believe we have sufficient cash resources to finance our
operations and expected capital expenditures for the next twelve months, the
sufficiency of our cash resources may depend to a certain extent on general
economic, financial, competitive or other factors beyond our control. Moreover,
despite actions to reduce our costs and improve our profitability, we expect our
operating losses and net operating cash outflows to continue during 2002. As a
result, we may not be able to achieve the revenue and gross margin objectives
necessary to achieve positive cash flow or profitability without obtaining
additional financing. We do not currently have any arrangements for financing,
and we may not be able to secure additional debt or equity financing on terms
acceptable to us, or at all, at the time when we need such funding. If our
business does not generate sufficient cash flow from operations and sufficient
future financings are not available, we may not be able to operate or grow our
business, pay our expenses when due or fund our other liquidity needs.

We intend to 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.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Foreign Exchange. Our revenue originating outside the U.S. in 2001, 2000 and
1999 was 36.4%, 19.2% and 14.0% of total revenues, respectively. Revenues
generated from the European region in 2001, 2000 and 1999 were 25.4%, 7.6% and
8.3% of total revenues, respectively. Revenues generated from the Asia region in
2001, 2000 and 1999 were 6.3% 7.4% and 5.6% of total revenues, respectively.
International sales are generated primarily 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, import and export regulations,
other regulations and restrictions, and foreign exchange rate volatility.
Accordingly, our results could be materially adversely impacted by changes in
these or other factors. The effect of foreign exchange rate fluctuations on our
business 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.

Interest income on our investments is carried in "Interest income, net". We
account for our investment instruments in accordance with Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" ("SFAS 115"). All of the cash equivalents and short-term
investments are treated as available-for-sale under SFAS 115.

Investments in fixed rate interest earning instruments carry a degree of
interest rate risk. Fixed rate securities may have their fair market value
adversely impacted 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 in 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. The
weighted-average interest rate on investment securities at December 31, 2001 was
5.4%. The fair value of investments held at December 31, 2001 approximated
amortized cost.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The information required by this item is included in Part IV Item 14(a)(1
and 2).

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

Not applicable.

PART III

Certain information required by Part III is omitted from this Form 10-K
because we will file a definitive Proxy Statement for our 2002 annual meeting of
stockholders pursuant to Regulation 14A (the "Proxy Statement") no later than
120 days after the end of the fiscal year covered by this Form 10-K, and certain
information to be included therein is incorporated herein by reference.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF INTRUSION INC..

The information regarding Directors and Executive Officers of
Intrusion Inc. appearing under the captions "Election of Directors", "Compliance
with Section 16 Reporting Requirements" and "Executive Officers" contained in
the Proxy Statement is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION.

The information set forth under the caption "Executive Compensation"
contained in the Proxy Statement is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The information set forth under the caption "Security Ownership of Certain
Beneficial Owners and Management" contained in the Proxy Statement is
incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

The information set forth under "Certain Transactions with Management"
contained in the Proxy Statement is incorporated herein by reference.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

(a) 1. CONSOLIDATED FINANCIAL STATEMENTS.

The following consolidated financial statements of Intrusion Inc. and
subsidiaries, are submitted as a separate section of this report (See F-pages,
and are incorporated by reference in Item 8:

PAGE NO.
--------

Report of Independent Auditors.............................. F-1
Consolidated Balance Sheets at December 31, 2001 and 2000... F-2
Consolidated Statements of Operations for the years ended
December 31, 2001, 2000 and 1999.......................... F-3
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 2001, 2000 and 1999.............. F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999.......................... F-5
Notes to Consolidated Financial Statements.................. F-6

2. FINANCIAL STATEMENT SCHEDULES.

PAGE NO.
--------

Schedule II--Valuation and Qualifying Accounts.............. S-1

All other schedules are omitted because they are either not required or not
applicable or the required information is shown in the Consolidated Financial
Statements or Notes thereto.

(b) REPORTS ON FORM 8-K.

On November 5, 2001 we filed a Current Report on Form 8-K (Item 5) dated
November 1, 2001 in order to report the Company's name change from
Intrusion.com, Inc. to Intrusion Inc. effective November 1, 2001.

The following Exhibits are filed herewith pursuant to Item 601 of
Regulation S-K or incorporated herein by reference to previous filings as noted:

EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
--------------------- ------------------------------------------------------------

2.1 (6) Certificate of Ownership and Merger Merging Intrusion.com,
Inc. into Intrusion Inc.
3.1 (6) Amended and Restated Certificate of Incorporation of the
Registrant.
3.2 (5) Bylaws of the Registrant.
4.1 (5) Specimen Common Stock Certificate.
10.1 (1) Lease Agreement, dated September 12, 1989, between G.D.A.F.
Associates and the Registrant for the Registrant's
headquarters.
10.2 (1) 1983 Incentive Stock Option Plan of the Registrant, as
amended.
10.3 (1) 1987 Incentive Stock Option Plan of the Registrant, as
amended.
10.4 (1) Form of Indemnification Agreement.
10.5 (6) 1995 Stock Option Plan of the Registrant as amended April
26, 2001.
10.6 (2) 1995 Non-Employee Directors Stock Option Plan of the
Registrant.
10.7 (3) Supplemental Lease Agreement, dated March 7, 1995, between
G.D.A.F. Assoc., subsequently assigned to CIIF Assoc. II
Limited Partnership, Landlord, and the Registrant, as
Tenant, relative to the Registrant's headquarters.
10.8 (4) Registration Rights Agreement, dated as of September 25,
1998, by and between the Registrant and Science Applications
International Corporation.
10.9 (4) Stockholder and Voting Agreement, dated as of September 25,
1998, by and among Science Applications International
Corporation, the Registrant and certain stockholders of the
Registrant.
10.10 (4) Strategic Alliance Agreement, dated as of September 25,
1998, by and between Science Applications International
Corporation and the Registrant.
10.11 (4) Software Royalty, Grant Back and Improvements License
Agreement, dated as of September 25, 1998, by and between
Science Applications International Corporation and the
Registrant.
10.12 (4) PartnersPlus Agreement, dated September 25, 1998, by and
between the Registrant and Science Applications
International Corporation.
10.13 (5) Amended and Restated 401(k) Savings Plan of the Registrant.
10.14 (5) 1997 Employee Stock Purchase Plan of the Registrant, as
amended January 17, 2001.
10.15 (6) Resignation Agreement and General Release dated November 28,
2001 with Timothy W. Kinnear.
21 (6) List of Subsidiaries of the Registrant.
23 (6) Consent of Independent Auditors.

------------------------

(1) Filed as an Exhibit in the Registrant's Registration Statement on Form S-1,
as amended (File No. 33-6899) which was declared effective on May 21, 1992,
by the Securities and Exchange Commission, which Exhibit is incorporated
herein by reference.

(2) Filed as an Exhibit to the Registrant's Definitive Proxy Statement on
Schedule 14A in connection with the solicitation of proxies for its 1995
Annual Meeting of Stockholders, which Exhibit is incorporated herein by
reference.

(3) Filed as an Exhibit in the Registrant's Annual Report on Form 10-K, for the
fiscal year ended December 31, 1995, which Exhibit is incorporated herein by
reference.

(4) Filed as an Exhibit in the Registrant's Current Report on Form 8-K (Item 5),
dated October 13, 1998, which Exhibit is incorporated herein by reference.

(5) Filed as an Exhibit in the Registrants' Annual Report on Form 10-K, for the
fiscal year ended December 31, 2000, which Exhibit is incorporated herein by
reference.

(6) Filed herewith.

ANNUAL REPORT ON FORM 10-K
ITEM 14(A)(1)
FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 2001
INTRUSION INC.
RICHARDSON, TEXAS

REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Stockholders,

Intrusion Inc.

We have audited the accompanying consolidated balance sheets of
Intrusion Inc., and subsidiaries (the "Company") as of December 31, 2001 and
2000, and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the three years in the period ended
December 31, 2001. Our audits also included the financial statement schedule
included in the Index at Item 14(a). These financial statements and schedule are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free from material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of
Intrusion Inc., and its subsidiaries at December 31, 2001 and 2000, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.

[LOGO]

Dallas, Texas
January 17, 2002

F-1

INTRUSION INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT PAR VALUE AMOUNTS)

DECEMBER 31,
-------------------
2001 2000
-------- --------

ASSETS
Current Assets:
Cash and cash equivalents................................. $ 15,783 $20,345
Short-term investments.................................... 4,652 17,506
Accounts receivable, net of allowance for doubtful
accounts And returns of $797 in 2001 and $919 in 2000... 5,206 6,887
Income taxes receivable................................... 2,779 1,743
Inventories............................................... 5,016 8,359
Deferred taxes--current................................... -- 3,764
Other current assets...................................... 601 1,714
Net current assets of discontinued operations............. -- 3,958
-------- -------
Total current assets........................................ 34,037 64,276
Property and Equipment
Machinery and equipment................................... 11,484 13,223
Furniture and fixtures.................................... 1,433 1,573
Leasehold improvements.................................... 962 1,125
-------- -------
13,879 15,921
Accumulated depreciation.................................. (10,276) (8,787)
-------- -------
3,603 7,134
Long-term investments....................................... -- 7,575
Goodwill and intangible assets, net......................... 3,807 7,634
Other assets................................................ 107 361
Net non-current assets from discontinued operations......... 741 5,434
-------- -------
TOTAL ASSETS................................................ $ 42,295 $92,414
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable and accrued expenses..................... $ 6,000 $ 9,908
Deferred revenue.......................................... 1,658 1,316
Current liabilities--discontinued operations.............. 1,139 562
-------- -------
Total current liabilities................................... 8,797 11,786
Deferred taxes--noncurrent.................................. -- 1,841
-------- -------
TOTAL LIABILITIES........................................... $ 8,797 $13,627
======== =======
Commitments and contingencies............................... -- --
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
Additional paid-in-capital................................ 47,320 46,916
Common stock held in Treasury, at cost--40 shares......... (362) (362)
Retained earnings (accumulated deficit)................... (13,327) 32,453
Accumulated other comprehensive loss...................... (339) (425)
-------- -------
Total stockholders' equity.................................. 33,498 78,787
-------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................. $ 42,295 $92,414
======== =======

See accompanying notes.

F-2

INTRUSION INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

YEAR ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------

Net sales................................................... $ 16,685 $23,210 $ 7,963
Cost of sales............................................... 13,490 19,009 3,877
-------- ------- --------
Gross profit................................................ 3,195 4,201 4,086
Operating expenses:
Sales and marketing....................................... 23,550 27,740 12,236
Research and development.................................. 12,549 13,073 8,171
General and administrative................................ 4,481 5,865 2,466
Amortization of intangibles............................... 1,233 975 547
Restructuring costs....................................... 4,673 -- --
-------- ------- --------
Operating loss.............................................. (43,291) (43,452) (19,334)
Interest income, net........................................ 1,687 3,301 1,104
Other income (expense)...................................... 112 66,335 --
-------- ------- --------
Income (loss) from continuing operations before income
Taxes..................................................... (41,492) 26,184 (18,230)
Income taxes provision (benefit)............................ (1,877) 1,999 --
-------- ------- --------
Income (loss) from continuing operations.................... (39,615) 24,185 (18,230)
Income (loss) from discontinued operations, net of tax...... (6,165) (974) 6,190
-------- ------- --------
Net income (loss)........................................... $(45,780) $23,211 $(12,040)
======== ======= ========
Basic earnings (loss) per share, continuing operations...... $ (1.93) $ 1.23 $ (0.98)
======== ======= ========
Diluted earnings (loss) per share, continuing Operations.... $ (1.93) $ 1.18 $ (0.98)
======== ======= ========
Basic earnings (loss) per share............................. $ (2.23) $ 1.18 $ (0.65)
======== ======= ========
Diluted earnings (loss) per share........................... $ (2.23) $ 1.13 $ (0.65)
======== ======= ========
Weighted average shares outstanding
--Basic................................................... 20,565 19,624 18,565
======== ======= ========
--Diluted................................................. 20,565 20,478 18,565
======== ======= ========

See accompanying notes.

F-3

INTRUSION INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(IN THOUSANDS)

YEAR ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------

NUMBER OF SHARES--ISSUED
Balance, beginning of year................................ 20,525 18,623 18,513
Issuance of common stock under warrants, stock option and
purchase Plans.......................................... 124 1,902 110
-------- -------- --------
Balance, end of year...................................... 20,649 20,525 18,623
-------- -------- --------
NUMBER OF SHARES--OUTSTANDING
Balance, beginning of year................................ 20,485 18,583 18,513
Issuance of common stock under warrants, stock option and
purchase Plans.......................................... 124 1,902 110
Repurchase of common stock into treasury.................. -- -- (40)
-------- -------- --------
Balance, end of year...................................... 20,609 20,485 18,583
-------- -------- --------
COMMON STOCK
Balance, beginning of year................................ $ 205 $ 186 $ 185
Issuance of common stock under warrants, stock option and
purchase Plans.......................................... 1 19 1
-------- -------- --------
Balance, end of year...................................... $ 206 $ 205 $ 186
-------- -------- --------
ADDITIONAL PAID-IN CAPITAL
Balance, beginning of year................................ $ 46,916 $ 29,996 $ 29,551
Issuance of common stock under warrants, stock option and
purchase Plans.......................................... 396 15,312 378
Issuance of common stock for MimeStar acquisition......... -- 1,000 --
Tax benefit derived from exercise of employee stock
options................................................. 8 608 67
-------- -------- --------
Balance, end of year...................................... $ 47,320 $ 46,916 $ 29,996
-------- -------- --------
TREASURY SHARES
Balance, beginning of year................................ $ (362) $ (362) $ --
Purchase of treasury shares............................... -- -- (362)
-------- -------- --------
Balance, end of year...................................... $ (362) $ (362) $ (362)
-------- -------- --------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Balance, beginning of year................................ $ (425) $ 43,692 $ (323)
Foreign currency translation adjustment (a)............... 86 (34) (68)
Unrealized gain from securities available for sale (b).... -- (44,083) 44,083
-------- -------- --------
Balance, end of year...................................... $ (339) $ (425) $ 43,692
-------- -------- --------
NOTE RECEIVABLE FROM STOCKHOLDER
Balance, beginning of year................................ $ -- $ (1,177) $ (1,189)
Repayments on stockholder loan............................ -- 1,177 12
-------- -------- --------
Balance, end of year...................................... $ -- $ -- $ (1,177)
-------- -------- --------
RETAINED EARNINGS (ACCUMULATED DEFICIT)
Balance, beginning of year................................ $ 32,453 $ 9,242 $ 21,282
Net income (loss) (c)..................................... (45,780) 23,211 (12,040)
-------- -------- --------
Balance, end of year...................................... $(13,327) $ 32,453 $ 9,242
-------- -------- --------
TOTAL STOCKHOLDERS' EQUITY.................................. $ 33,498 $ 78,787 $ 81,577
======== ======== ========
TOTAL COMPREHENSIVE INCOME (LOSS) (A+B+C)................... $(45,694) $(20,906) $ 31,975
======== ======== ========

See accompanying notes.

F-4

INTRUSION INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

YEAR ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------

Operating Activities:
Income (loss) from continuing operations.................. $(39,615) $ 24,185 $(18,230)
Adjustments to reconcile income (loss) from continuing
operations to net cash used in operating activities:
Sale of property and equipment.......................... -- -- (7)
Gain on sale of available for sale security............. -- (66,355) --
Depreciation and amortization........................... 4,369 4,555 3,840
Impairment of intangible assets......................... 3,109 -- --
Deferred income tax (benefit) expense................... 1,923 (4,219) 763
Provision for doubtful accounts and returns............. -- -- 85
Changes in operating assets and liabilities:
Accounts receivable................................... 1,681 (1,483) 776
Income tax receivable................................. (1,036) (1,571) 4,749
Inventories........................................... 3,343 (1,625) (1,430)
Other assets.......................................... 851 2 (1,135)
Accounts payable and accrued expenses................. (3,905) (2,118) 4,201
Deferred revenue...................................... 374 (161) (1,084)
-------- -------- --------
Net cash used in operating activities of continuing
operations................................................ (28,906) (48,790) (7,472)
Investing Activities:
Purchase of MimeStar, Inc................................. -- (4,000) --
Proceeds from sale of property and equipment.............. -- -- 2,611
Proceeds from sale of available for sale security......... -- 67,055 --
Purchases of available for sale investments............... (14,369) (57,504) (16,372)
Maturities of available for sale investments.............. 34,798 41,273 12,282
Purchases of property and equipment....................... (680) (6,412) (1,446)
-------- -------- --------
Net cash provided by (used in) investing activities of
continuing operations..................................... 19,749 40,412 (2,925)
Financing Activities:
Note receivable secured by company's common stock......... -- 1,177 12
Exercise of warrants and employee stock options........... 405 15,939 445
Purchase of treasury stock................................ -- -- (362)
Other..................................................... (3) 13 (9)
-------- -------- --------
Net cash provided by financing activities of continuing
operations................................................ 402 17,129 86
-------- -------- --------
Net cash provided by (used in) discontinued operations...... 4,107 (974) 6,190
Effect of foreign currency translation adjustment on cash
and cash Equivalents...................................... 86 (34) (68)
Net increase (decrease) in cash and cash equivalents........ (4,562) 7,743 (4,189)
Cash and cash equivalents at beginning of period............ 20,345 12,602 16,791
-------- -------- --------
Cash and cash equivalents at end of period.................. $ 15,783 $ 20,345 $ 12,602
======== ======== ========

See accompanying notes.

F-5

INTRUSION INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. DESCRIPTION OF BUSINESS

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 manufacturing, high-technology, telecommunications, retail,
transportation, health care, insurance, entertainment, utilities and energy
companies, government agencies, financial institutions, and academic
institutions.

We 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 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.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of
Intrusion Inc. and its wholly-owned subsidiaries. Intercompany balances and
transactions have been eliminated in consolidation.

CASH EQUIVALENTS

Cash and all highly liquid investments purchased with an original or with a
remaining maturity of less than three months as of the balance sheet date are
considered to be cash equivalents.

SHORT-TERM INVESTMENTS

Short-term investments consist of U.S. government obligations and corporate
securities with maximum maturities of one year. Short-term investments are
classified as available for sale. These investments are valued at market value,
which approximates amortized cost. The difference between fair market value and
amortized cost is not material.

RISK CONCENTRATION

Financial instruments which potentially subject the Company to
concentrations of credit risk are primarily cash and cash-equivalents,
investments and accounts receivable. The Company places its investments in U.S.
government obligations, corporate securities and money market funds.
Substantially

F-6

INTRUSION INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
all of the Company's cash, cash equivalents and investments are maintained with
two major U.S. financial institutions.

We sell our products to customers in diversified industries worldwide,
primarily in North America, Europe, Asia and Latin America. Fluctuations in
currency exchange rates and adverse economic developments in foreign countries
could adversely effect the Company's operating results. We perform ongoing
credit evaluations of our customers' financial condition and generally require
no collateral. We maintain reserves for potential credit losses and such losses,
in the aggregate, have not exceeded management expectations.

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 are available from one or a limited number of suppliers. The
inability of any supplier or manufacturer to fulfill supply requirements of the
Company could impact future results.

INVENTORIES

Inventories are stated at the lower of cost or market. Cost is computed
using standard cost, which approximates actual cost on a first-in, first-out
basis. Management estimates the allowance required to state inventory at the
lower of cost or market. There is a risk that we will forecast demand for our
products and market conditions incorrectly and produce excess inventories.
Therefore, there can be no assurance that we will not produce excess inventory
and incur inventory lower of cost or market charges in the future.

PROPERTY AND EQUIPMENT

Property and equipment is stated at cost and depreciated on a straight-line
basis over the estimated useful lives of the assets. Such lives vary from 3 to
20 years. Leasehold improvements are amortized over the shorter of their useful
lives or the terms of the leases. Repair and maintenance costs are expensed as
incurred.

LONG-TERM INVESTMENTS

Long-term investments consist of U.S. government and corporate obligations
with maturities over one year with a maximum range of up to two years. Long-term
investments are classified as available for sale. These investments are valued
at market value, which approximates amortized cost. The difference between fair
value and amortized cost is not material.

GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill represents the excess of purchase price and related direct costs
over the value assigned to the net tangible and specifically identifiable
intangible assets of businesses acquired. Goodwill is being amortized using the
straight-line method over 7 years. Intangibles generally relate to software and
developed technology acquired in a purchase business combination or acquisition
of assets. Intangibles are being amortized over their useful lives, ranging from
3 to 7 years. Annual amortization expense related to goodwill and other
intangible assets for the years ended December 31, 2001 and 2000 was
$1.2 million and $1.0 million, respectively.

F-7

INTRUSION INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
We assess whether our goodwill and other intangible assets are impaired
based on the evaluation of undiscounted projected cash flows through the
remaining amortization period. If an impairment exists, the amount of such
impairment is calculated based on the estimated fair value of the asset.

FOREIGN CURRENCY TRANSLATION

Our international subsidiaries use their local currencies as their
functional currencies. Assets and liabilities are translated at the exchange
rate in effect at the balance sheet date, and income and expense accounts at
average exchange rates during the year. Resulting translation adjustments are
recorded directly to accumulated other comprehensive loss.

ACCOUNTING FOR STOCK OPTIONS

We have elected to continue to follow APB Opinion No. 25, ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES, (APB 25) and related interpretations in accounting
for our employee stock options. Under APB 25, if the exercise price of an
employee's stock option equals or exceeds the market price of the underlying
stock on the date of grant, no compensation expense is recognized. The Financial
Accounting Standards Board (FASB) has issued SFAS No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION, which provides for either recognition or disclosure of
a hypothetical charge for stock options. We did not recognize any charge in our
income statement, but we have provided the required disclosure in Note 9.

NET INCOME PER SHARE

We report two separate earnings per share numbers, basic EPS and diluted EPS
with additional disclosure made between continuing and discontinued operations.
Diluted EPS includes the dilutive impact of employee stock options and warrants.

REVENUE RECOGNITION

F-8

INTRUSION INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
their inventory of Intrusion Inc. products for price reductions as well as
products that are slow-moving or have been discontinued by the Company.
Recognition of sales to distributors and related gross profits are deferred
until the merchandise is resold by the distributors. However, since we have
legally sold the inventory to the distributor and we no longer have care,
custody or control over the inventory, we recognize the trade accounts
receivable and reduce inventory related to the sale at the time of shipment to
the distributor. Revenue, offset by deferred cost of sales, is included in
deferred revenue in the accompanying financial statements.

ADVERTISING COSTS

Advertising expense is charged to operations in the period in which such
costs are incurred. Total advertising included in sales and marketing expenses
was $0.5 million, $1.3 million and $0.1 million for the years ended
December 31, 2001, 2000 and 1999, respectively.

RESEARCH AND DEVELOPMENT COSTS

We incur 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 development costs
are comprised primarily of salaries and related benefits expenses, contract
labor and prototype and other related expenses.

Software development costs are included in research and development and are
expensed as incurred. Statement of Financial Accounting Standards No. 86,
ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE TO BE SOLD, LEASED OR OTHERWISE
MARKETED, requires that software development costs incurred subsequent to
reaching technological feasibility be capitalized, if material. If the process
of developing a new product or major enhancement does not include a detailed
program design, technological feasibility is determined only after completion of
a working model. To date, the period between achieving technological feasibility
and the general availability of such software has been short, and the software
development costs qualifying for capitalization have been insignificant.

RESTRUCTURING CHARGES

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles 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 doubtful

F-9

INTRUSION INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
accounts, sales discounts, sales returns, distribution revenue, warranty costs,
inventory obsolescence, depreciation and taxes. Actual results could differ from
these estimates.

INCOME TAXES

The income tax provision is based on pretax financial accounting income or
loss. We account for income taxes pursuant to SFAS No. 109, ACCOUNTING FOR
INCOME TAXES, which uses the liability method to calculate deferred income
taxes. Deferred tax assets and liabilities are recognized for the expected tax
consequences of temporary differences between the tax basis of assets and
liabilities and their reported amounts. The realization of deferred tax assets
is based on historical tax positions and expectations about future taxable
income. The liability method also requires the recognition of future tax
benefits such as net operating loss carryforwards, to the extent that
realization of such benefits is more likely than not.

RECLASSIFICATION

Certain amounts in prior year financial statements have been reclassified to
conform with current year presentation.

NEW ACCOUNTING STANDARDS

In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative
Instruments and Hedging Activities". SFAS 133 requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
value. Gains or losses resulting from changes in the values of those derivatives
would be accounted for depending on the use of the derivative and whether it
qualifies for hedge accounting. SFAS 133, as amended by SFAS 138, is effective
for fiscal years beginning after June 15, 2000. The adoption of SFAS 133 as of
January 1, 2001 did not have a material impact on the financial position or
results of operations of the Company because we do not have any derivatives or
hedges.

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 during 2002. We do not expect the
adoption of SFAS No. 142 to have a material impact on our financial position or
results of operations as we have only $0.4 million of goodwill at December 31,
2001.

In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets and supersedes
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposes Of, and the account and reporting provisions of
APB Opinion No. 30, Reporting the Results of Operations, for a disposal of a
segment of a business. SFAS 144 is effective for fiscal years beginning after
December 15, 2001. We do not expect that adoption of SFAS No. 144 will have a
significant impact on our financial position or results of operations.

F-10

INTRUSION INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

3. BUSINESS COMBINATIONS AND ACQUISITION OF ASSETS

On September 25, 1998, we completed an acquisition of certain assets from
Science Applications International Corporation ("SAIC"), a privately-held
company in San Diego, California. We acquired certain assets of the Computer
Misuse and Detection System ("CMDS") Division of SAIC and certain other
information security products under development. In exchange for the CMDS
assets, the information security products under development and $1.5 million
dollars in cash, we issued to SAIC 1.6 million shares of the Company's common
stock and warrants to purchase an additional 1.5 million shares of its common
stock. Two separate warrants each grant SAIC the right to purchase 750,000
shares of Intrusion Inc. common stock. The first warrant had an exercise price
of $8.00 per share and a term of 18 months and was exercised on March 23, 2000.
The second warrant had an exercise price of $10.50 per share and a term of
24 months and was exercised on September 22, 2000. Our acquisition has been
accounted for as a purchase of software, in-process research and development and
certain other assets. The transaction value of approximately $6.9 million less
the $1.5 million cash received was allocated to the net assets acquired based on
their estimated fair market value. Assets acquired included approximately
$1.1 million of in-process research and development, $0.1 million of other
intangible assets and approximately $4.2 million of purchased software to be
amortized over seven years on a straight-line basis. In June 2001, we recorded a
restructuring charge of $2.6 million to recognize the impairment of the
remaining net book value of this intangible asset. See "Restructuring Charges"
in Note 2.

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. The Kane Security Products
include the Kane SecurityAnalyst, a security assessment tool, and the Kane
Security Monitor, a host based intrusion detection tool. We are responsible for
marketing, sales, support, maintenance and development for Kane Security
software. In June 2001, we recorded a restructuring charge of $0.4 million to
recognize the impairment of the remaining net book value of this intangible
asset. See "Restructuring Charges" in Note 2.

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-. The acquisition, accounted for using the
purchase method, was affected by the merger of a wholly owned subsidiary of the
Company ("Merger Sub") with and into MimeStar, pursuant to an Agreement and Plan
of Merger, by and among the Company, MimeStar, the Merger Sub and the sole
stockholder of MimeStar (the "Merger"). Pursuant to the Merger, the stockholder
of MimeStar received $3 million in cash with an additional $1 million in cash
and 95,969 shares of the Company's common stock (which was valued at
approximately $1 million on the date of the Merger) placed in escrow, payable to
the stockholder of MimeStar within one year subject to indemnification and other
conditions. Transaction costs for this acquisition totaled approximately
$100,000. The acquisition costs of $5.1 million were capitalized as purchased
software, goodwill and other intangibles.

F-11

INTRUSION INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

4. BALANCE SHEET DETAIL (IN THOUSANDS)

INVENTORIES

DECEMBER 31,
-------------------
2001 2000
-------- --------

Raw materials............................................... $ 661 $ 1,550
Work in process............................................. -- 1,350
Finished products........................................... 4,002 4,231
Demonstration systems....................................... 353 1,228
------- -------
Net inventory--continuing operations........................ $ 5,016 $ 8,359
======= =======
Net inventory--discontinued operations...................... $ -- $ 3,958
======= =======

INTANGIBLE ASSETS, NET

DECEMBER 31,
-------------------
2001 2000
-------- --------

CMDS purchased software..................................... $ -- $ 4,136
CMDS intangible asset....................................... -- 135
MimeStar goodwill........................................... 450 450
MimeStar purchased software................................. 3,610 3,610
MimeStar intangible asset................................... 1,040 1,040
------- -------
Gross intangibles--continuing operations.................... 5,100 9,371
Accumulated amortization.................................... (1,293) (1,737)
------- -------
Net intangibles--continuing operations...................... $ 3,807 $ 7,634
------- -------
Net intangibles--discontinued operations.................... $ -- $ 3,935
======= =======

ACCOUNTS PAYABLE AND ACCRUED EXPENSES

DECEMBER 31,
-------------------
2001 2000
-------- --------

Trade accounts payable...................................... $ 3,027 $ 5,892
Accrued sales commissions................................... 202 547
Accrued payroll............................................. 444 437
Accrued incentive bonus..................................... 25 100
Accrued vacation............................................ 580 920
Accrued property taxes...................................... 230 51
Accrued warranty expense.................................... 200 475
Other (individually less than 5% of current liabilities).... 1,292 1,486
------- -------
$ 6,000 $ 9,908
======= =======

F-12

INTRUSION INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

5. COMMITMENTS AND CONTINGENCIES

LEASES

We lease office space for our corporate headquarters in Richardson, Texas
under an operating lease, the base term of which expires in February 2005, with
two seven-year options to extend the term of the lease, subject to compliance
with certain conditions. We also lease a separate warehouse facility adjacent to
our headquarters under a lease which expires in June 2002. We lease office space
in Albuquerque, New Mexico for Essential (discontinued operations) under an
operating lease that expires in February 2009. We lease office space in San
Diego, California for a portion of our security software research and
development staff under an operating lease that expires in August 2002. In
addition, we lease office space for our U.S. and international sales and
engineering offices. Total rental expense of $1.9 million, $1.9 million and
$1.8 million was charged to operations during 2001, 2000, and 1999,
respectively.

Future minimum lease payments consisted of the following on December 31,
2001 (in thousands):

CONTINUING DISCONTINUED
OPERATIONS OPERATIONS
---------- ------------

2002........................................................ $1,251 $ 169
2003........................................................ 974 169
2004........................................................ 924 169
2005........................................................ 159 169
2006........................................................ -- 169
Thereafter.................................................. -- 360
------ ------
$3,308 $1,205
====== ======

6. 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.

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 the first quarter of 2002 by which time we
expect to have exited, disposed of or otherwise transitioned a majority of our
ownership in Essential.

F-13

INTRUSION INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

6. DISCONTINUED OPERATIONS (CONTINUED)
this lease agreement, which is equivalent to 2 years' lease and maintenance of
the facility. Successful termination for less than $0.3 million will result in a
greater gain on sale. Termination for more than $0.3 million will reduce the
gain on sale. The contractual term of the lease runs through February 2009 and
remaining contractual lease payments total $1.2 million at December 31, 2001.

The following represents a summary of assets and liabilities classified as
discontinued operations (in thousands):

DECEMBER 31,
-------------------
2001 2000
Discontinued assets and liabilities consist of: -------- --------

Inventories, net............................................ $ -- $3,958
Property and equipment, net................................. 741 1,499
Intangible assets, net...................................... -- 3,935
------ ------
Total discontinued assets................................. $ 741 $9,392
====== ======
Deferred revenue............................................ 594 $ 562
Accrued operating losses.................................... $ 545 --
------ ------
Total discontinued liabilities............................ $1,139 $ 562
====== ======

The following represents a summary of net income (loss) from discontinued
operations (in thousands):

2001 2000 1999
-------- -------- --------

Net Sales................................................... $ 4,693 $16,856 $49,988
Cost of sales............................................... 2,970 10,693 28,227
------- ------- -------
Gross profit................................................ 1,723 6,163 21,761
Operating expenses.......................................... 4,774 7,446 15,578
------- ------- -------
Operating profit (loss)..................................... (3,051) (1,283) 6,183
Net realizable value adjustment............................. (3,024) 1 7
------- ------- -------
Income (loss) before income taxes........................... (6,076) (1,282) 6,190
Income tax expense (benefit)................................ 89 (308) --
------- ------- -------
Income (loss) from discontinued operations.................. $(6,165) $ (974) $ 6,190
======= ======= =======

The net realizable value adjustment was recorded in the second quarter of
2001 and was in response to unfavorable market conditions and efforts to sell
Essential. The adjustment reduced the carrying value of Essential to
$0.8 million.

F-14

INTRUSION INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

7. EMPLOYEE BENEFIT PLANS

EMPLOYEE STOCK PURCHASE PLAN

On April 24, 1997, we adopted an Employee Stock Purchase Plan (the "Purchase
Plan") under which 0.5 million shares of common stock have been reserved for
issuance. Eligible employees may designate not more than 10% of their
compensation to be deducted each pay period for the purchase of common stock
under the Purchase Plan. The Purchase Plan was amended January 17, 2001 to
increase the maximum number of shares that can be purchased per participant from
500 shares to 1,000 shares per offering. Each participant may purchase up to
2,000 shares in any one calendar year. On January 31 and July 31 of each
calendar year, shares of common stock are purchased with the employees' payroll
deductions over the immediately preceding six months at a price per share of 85%
of the lesser of the market price of the common stock on the purchase date or
the market price on the first day of the six-month period. The Purchase Plan
will terminate no later than April 24, 2007. A total of 138,750 shares have been
issued under the Purchase Plan as of December 31, 2001. Subsequent to
December 31, 2001, 34,624 shares of stock were issued under the Purchase Plan
for an aggregate purchase price of approximately $50,550 related to the purchase
period which commenced on August 1, 2001 and ended on January 31, 2002.

EMPLOYEE 401(K) PLAN

We have adopted a plan known as the Intrusion Inc. 401(k) Savings Plan (the
"Plan") to provide retirement and incidental benefits for our 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, the
Plan provides tax deferred salary deductions for eligible employees.

The Plan was amended on January 10, 2002 to allow employees to contribute
from 1% to 25% of their annual compensation to the Plan, limited to a maximum
amount as set by the Internal Revenue Service. This limit was increased from
19%. A feature was also added to the Plan to allow participants who are over the
age of 50 to contribute an additional amount of their salary per year, as
defined annually by the Internal Revenue Service. The Company matches employee
contributions at the rate of $0.25 per each $1.00 of contribution on the first
4% of deferred compensation. Company matching contributions to the Plan were
approximately $110,000, $120,000, and $112,000 in 2001, 2000 and 1999,
respectively.

F-15

INTRUSION INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

8. 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 and liabilities as of December 31, 2001 and
2000 are as follows (in thousands):

2001 2000
-------- --------

Deferred tax assets:
Foreign subsidiaries net operating loss carryforward...... $ 374 $ 341
U.S. net operating loss carryforward...................... 14,385 1,592
Minimum tax credit carryforward........................... 607 --
Book over tax depreciation................................ 273 273
Intangibles............................................... 262 595
Equity investments........................................ 458 458
Vacation accrual.......................................... 261 386
Allowance for doubtful accounts and returns............... 434 413
Warranty accrual.......................................... 73 174
Inventory................................................. 2,924 2,615
Other..................................................... 451 176
-------- -------
Deferred tax assets..................................... 20,502 7,023
Valuation allowance for deferred tax assets............... (20,502) (1,932)
-------- -------
Deferred tax assets, net of allowance................... -- 5,091
-------- -------
Deferred tax liabilities:
Intangibles............................................... -- 668
Unrealized gain on securities held for sale............... -- --
Other..................................................... -- 2,500
-------- -------
Total deferred tax liabilities.......................... -- 3,168
-------- -------
Net deferred tax assets (liabilities)....................... $ -- $ 1,923
======== =======
Current deferred assets (liabilities)....................... $ -- $ 3,764
Noncurrent deferred assets (liabilities).................... $ -- $(1,841)
-------- -------
Net deferred tax assets (liabilities)....................... $ -- $ 1,923
======== =======

Deferred tax assets are required to be reduced by a valuation allowance if
it is more likely than not that some portion or all of 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 our ability to generate
taxable income within the near to medium term. Management has considered these
factors in determining the valuation allowance in 2001.

F-16

INTRUSION INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

8. INCOME TAXES (CONTINUED)
Significant components of the provision for income taxes for the years ended
2001, 2000 and 1999 are as follows (in thousands):

YEAR ENDED DECEMBER 31,
-------------------------------
2001 2000 1999
-------- -------- ---------

Income tax provision
Federal:
Current................................................. $(4,050) $ 4,864 $ --
Deferred................................................ 3,063 (5,270) --
State:
Current................................................. (136) 236 --
Deferred................................................ (1,140) 1,861 --
Foreign:
Current................................................. 475 -- --
------- ------- ---------
$(1,788) $ 1,691 $ --
======= ======= =========

Income tax expense (benefit) is included in the consolidated financial
statements for the years ended 2001, 2000 and 1999 as follows (in thousands):

YEAR ENDED DECEMBER 31,
-------------------------------
2001 2000 1999
-------- -------- ---------

Continuing Operations....................................... $(1,877) $1,999 $ --
Discontinued Operations..................................... 89 (308) --
------- ------ ---------
$(1,788) $1,691 $ --
======= ====== =========

The differences between the provision for income taxes and income taxes
computed using the federal statutory rate for the years ended 2001, 2000, and
1999 are as follows (in thousands):

YEAR ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------

Reconciliation of income tax provision to statutory rate:
Income tax expense (benefit) at statutory rate......... $(16,649) $ 8,716 $(4,131)
State income taxes, net of federal income tax
benefit.............................................. (829) 1,393 --
Change in valuation allowance.......................... 18,570 (9,326) 4,075
Goodwill amortization.................................. 578 164 193
Tax credit carryforwards............................... (607) (361) --
Other.................................................. (2,851) 1,105 (137)
-------- ------- -------
$ (1,788) $ 1,691 $ --
======== ======= =======

At December 31, 2001, we had federal net operating loss carryforwards of
$36.5 million for income tax purposes that begin to expire in 2008. Of this
amount $2.6 million are subject to the ownership change limitations under
Internal Revenue Code Section 382. We also have $71.1 million of state net
operating loss carryforwards. Net operating loss carryforwards of the foreign
subsidiaries of $0.7 million

F-17

INTRUSION INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

8. INCOME TAXES (CONTINUED)
at December 31, 2001 are available indefinitely for offset only against taxable
income generated by the foreign subsidiaries.

We made income tax payments of $6.2 million and $0.1 million during 2000 and
1999, respectively. We made no federal tax payments during 2001, but received
$3.2 million in tax refunds in 2001, and expect to receive a federal income tax
refund in 2002 of $2.8 million for income taxes paid in 2000.

9. STOCK, STOCK OPTIONS AND WARRANTS

On September 25, 1998, in connection with our acquisition of certain assets
from Science Applications International Corporation ("SAIC"), we issued to SAIC
1.6 million shares of Intrusion Inc.'s common stock and warrants to purchase an
additional 1.5 million shares of its common stock. Two separate warrants each
granted SAIC the right to purchase 750,000 shares of its common stock. The first
warrant had an exercise price of $8.00 per share and a term of 18 months. The
second warrant had an exercise price of $10.50 per share and a term of
24 months. On March 23, 2000, SAIC exercised the first warrant for 750,000 at an
exercise price of $8.00 per share. On September 22, 2000, SAIC exercised the
remaining 750,000 shares at an exercise price of $10.50 per share.

On May 7, 1998, in connection with our acquisition of Essential, we issued
approximately 306,000 shares of the Company's common stock for all outstanding
shares of Essential capital stock, and we issued approximately 104,000 stock
options in exchange for all unexpired and unexercised options to acquire
Essential capital stock. At December 31, 2001, there are 26,344 options
outstanding from the Essential assumed options.

At December 31, 2001, we had four stock-based compensation plans, which are
described below. These plans were developed to retain and attract key employees
and directors.

We established an Incentive Stock Option Plan in 1983, which provides for
the issuance of options to key employees of the Company to purchase common stock
of the Company. The 1983 Incentive Stock Option Plan was terminated on
November 10, 1993.

In 1987, an additional Incentive Stock Option Plan was established with
similar provisions to allow for further issuance of options. The 1987 Incentive
Stock Option Plan was terminated on January 26, 1997. The 1983 and 1987 plans
each provided for the issuance of up to 1.2 million shares of common stock upon
exercise of options granted pursuant to the plans.

In 1995, we adopted the 1995 Stock Option Plan (the "1995 Plan") which
provides for the issuance of up to 1.6 million shares of common stock upon
exercise of options granted pursuant to the 1995 Plan. On April 19, 2000, the
stockholders approved a 850,000 share increase and on April 26, 2001, the
stockholders approved an additional 850,000 share increase to the 1995 Plan.
Therefore, the overall shares available for issuance pursuant to the plan was
increased to 3,300,000 shares. The 1995 Plan provides for the issuance of both
non-qualified and incentive stock options to employees, officers, and
employee-directors of the Company.

In 1995, we adopted the 1995 Non-Employee Director Stock Option Plan (the
"1995 Non-Employee Director Plan") which provides for the issuance of up to
160,000 shares of common stock upon exercise of options granted pursuant to the
1995 Non-Employee Director Plan. The Plan provides for the issuance of
non-qualified stock options to non-employee directors. No shares have been
issued upon exercise of options granted under the 1995 Non-Employee Director
Plan. Options to

F-18

INTRUSION INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

9. STOCK, STOCK OPTIONS AND WARRANTS (CONTINUED)
purchase a total of 100,000 shares of Common Stock are outstanding and options
for 60,000 shares remain available for issuance. Since inception, 120,000 shares
have been granted to directors pursuant to the 1995 Non-Employee Director Plan.
No shares were granted to directors in 2001.

Common shares reserved for future issuance under all of the stock option
plans and employee stock purchase plans total approximately 3.6 million shares
at December 31, 2001.

The Compensation Committee of the Board of Directors determines the term of
each option, option exercise price within limits set forth in the plans, number
of shares for which each option is granted and the rate at which each option is
exercisable (generally ratably over three or five years from grant date).
However, the exercise price of any incentive stock option may not be less than
the fair market value of the shares on the date granted (or less than 110% of
the fair market value in the case of optionees holding more than 10% of the
voting stock of the Company), and the term cannot exceed ten years (five years
for incentive stock options granted to holders of more than 10% of the Company's
voting stock).

A summary of the Company's stock option activity and related information for
the years ended December 31, 2001, 2000 and 1999, is as follows:

2001 2000 1999
----------------------------- ----------------------------- -----------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER OF OPTIONS EXERCISE NUMBER OF OPTIONS EXERCISE NUMBER OF OPTIONS EXERCISE
(IN THOUSANDS) PRICE (IN THOUSANDS) PRICE (IN THOUSANDS) PRICE
------------------ -------- ------------------ -------- ------------------ --------

Outstanding at beginning of
year......................... 1,589 $10.03 1,454 $ 7.83 1,683 $7.53
Granted........................ 1,578 4.05 1,087 11.60 479 4.95
Exercised...................... (55) 2.75 (275) 4.47 (91) 3.26
Cancelled...................... (1,123) 7.85 (677) 10.10 (617) 6.77
------ ----- -----
Outstanding at end of Year..... 1,989 6.71 1,589 10.03 1,454 7.83
====== ===== =====
Options exercisable at End of
year......................... 622 454 551

Information related to stock options outstanding at December 31, 2001, is
summarized below:

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- -------------------------
WEIGHTED WEIGHTED WEIGHTED
OUTSTANDING AT AVERAGE AVERAGE EXERCISABLE AT AVERAGE
12/31/01 (IN REMAINING EXERCISE 12/31/01 (IN EXERCISE
RANGE OF EXERCISE PRICES THOUSANDS) CONTRACTUAL LIFE PRICE THOUSANDS) PRICE
------------------------ -------------- ---------------- -------- -------------- --------

$1.05--$4.50 859 8.91 years $ 2.75 180 $ 2.78
5.00--9.94 692 8.16 years 6.34 216 7.32
11.44--23.25 438 6.50 years 15.06 226 16.33
----- ---
1,989 8.12 years 6.71 622 9.28
===== ===

SFAS No. 123, ACCOUNTING FOR STOCK BASED COMPENSATION, requires the
disclosure of pro forma net income and earnings per share information computed
as if the Company had accounted for its employee stock options granted
subsequent to December 31, 1994, under the fair value method set

F-19

INTRUSION INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

9. STOCK, STOCK OPTIONS AND WARRANTS (CONTINUED)
forth in SFAS 123. The fair value for these options was estimated using a
Black-Scholes option pricing model with the following weighted-average
assumptions:

EMPLOYEE STOCK OPTIONS
------------------------------
2001 2000 1999
-------- -------- --------

Expected dividend yield..................................... 0.0% 0.0% 0.0%
Risk-free interest rate..................................... 4.3% 6.7% 5.5%
Expected volatility......................................... 130.0% 120.0% 70.0%
Expected life (in years).................................... 3.0 2.0 2.0

The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options. In addition, because
SFAS 123 is applicable only to options granted subsequent to December 31, 1994,
the pro forma information does not reflect the pro forma effect of all previous
stock option grants of the Company, and thus the pro forma information is not
necessarily indicative of future amounts until SFAS 123 is applied to all
outstanding stock options.

Information relating to the fair value of option grants made during 2001,
2000 and 1999 is as follows:

2001 2000 1999
-------- -------- --------

Options granted (all with exercise price equal to fair value
of common stock):
Number of options (in thousands).......................... 1,578 1,087 479
Weighted average exercise price per share................. $ 4.05 $11.60 $4.95
Weighted average fair value of stock options grants per
Black-Sholes option valuation model..................... $ 3.02 $ 8.40 $2.44

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. For purposes
of pro forma disclosure, the Company assumed that it would not receive a tax
deduction or tax benefit for financial reporting purposes related to incentive
stock options. In management's opinion, the pro forma disclosure is not
necessarily indicative of the net financial effect, assuming the Company was
required to expense the fair value of employee stock options, because an
incentive stock option often generates a tax deduction for the Company whereby
the stock option holder does not comply with the holding period requirements
under applicable tax laws. The Company's pro forma information follows (in
thousands, except earnings per share information):

2001 2000 1999
-------- -------- --------

Pro forma net income (loss)................................. $(47,677) $20,511 $(12,884)
Pro forma earnings (loss) per share......................... $ (2.32) $ 1.00 $ (0.69)

F-20

INTRUSION INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

10. EARNINGS PER SHARE

FOR THE YEAR ENDED DECEMBER 31,
---------------------------------
2001 2000 1999
--------- --------- ---------

Numerator:
Net income (loss)........................................... $(45,780) $23,211 $(12,040)
-------- ------- --------
Numerator for basic and diluted earnings per share.......... $(45,780) $23,211 $(12,040)
Income (loss) from continuing operations.................... $(39,615) $24,185 $(18,230)
-------- ------- --------
Numerator for basic and diluted earnings per share,
continuing operations..................................... $(39,615) $24,185 $(18,230)
Denominator:
Denominator for basic earnings per share--weighted average
common shares outstanding................................. 20,565 19,624 18,565
Effect of dilutive securities:
Stock options and warrants................................ -- 854 --
-------- ------- --------
Denominator for diluted earnings per share--adjusted
weighted average common shares outstanding................ 20,565 20,478 18,565
======== ======= ========
Basic earnings (loss) per share, continuing Operations...... $ (1.93) $ 1.23 $ (0.98)
======== ======= ========
Diluted earnings (loss) per share, continuing Operations.... $ (1.93) $ 1.18 $ (0.98)
======== ======= ========
Basic earnings (loss) per share............................. $ (2.23) $ 1.18 $ (0.65)
======== ======= ========
Diluted earnings (loss) per share........................... $ (2.23) $ 1.13 $ (0.65)
======== ======= ========

Total stock options and warrants outstanding in 2001, 2000 and 1999 that are
not included in the diluted earnings per share computation due to the
antidilutive effect are 2.0 million, 378 thousand and 3 million, respectively.
Such options are excluded due to us incurring a net loss per share in that year
or due to exercise prices exceeding the average market value of our common stock
in the applicable period.

11. OTHER INCOME

On March 2, 2000, we sold our investment of 770,745 shares of Alteon
WebSytems, Inc. common stock for $87.00 per share, net of applicable expenses,
generating cash of approximately $67.1 million. The disposition of this stock
generated a pre-tax gain of approximately $66.4 million which was recognized as
other income.

12. MAJOR CUSTOMERS AND GEOGRAPHIC INFORMATION

The Company's continuing operations are concentrated in one segment--the
design, development, marketing and support of data security via a suite of
security software and appliances. Sales to customers exceeding 10% of total
sales were as follows: 2001--none; 2000--$3.3 million to iGov.com and
$5.6 million to TRW; 1999--$1.7 million to iGov.com, $0.9 million to AT&T,
$1.3 million to Federal Data and $1.0 million to Comstor.

F-21

12. MAJOR CUSTOMERS AND GEOGRAPHIC INFORMATION (CONTINUED)
Export sales, primarily to Europe, Asia, Latin America and Canada, were
$6.1 million in 2001, $4.5 million in 2000 and $1.1 million in 1999. No
significant long-lived assets were deployed outside of the United States.

13. SUBSEQUENT EVENTS

SUPPLEMENTAL FINANCIAL DATA

SUMMARIZED QUARTERLY DATA (UNAUDITED)

2001
----------------------------------------------------
Q1 Q2(2)(3) Q3 Q4(3) TOTAL
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Continuing Operations:
Revenue...................................... $ 5,318 $ 4,451 $ 3,612 $ 3,304 $ 16,685
Gross profit................................. 819 54 1,258 1,064 3,195
Net loss..................................... (11,833) (14,027) (6,889) (6,866) (39,615)
Net loss per share--Basic.................... (0.58) (0.68) (0.33) (0.33) (1.93)
Net loss per share--Diluted.................. (0.58) (0.68) (0.33) (0.33) (1.93)
Discontinued Operations:
Loss, net of tax............................. (772) (5,393) -- -- (6,165)
Net loss per share--Basic.................... (0.04) (0.27) (0.00) (0.00) (0.30)
Net loss per share--Diluted.................. (0.04) (0.27) (0.00) (0.00) (0.30)

2000
----------------------------------------------------
Q1(1) Q2 Q3 Q4 TOTAL
-------- -------- -------- -------- --------

Continuing Operations:
Revenue...................................... $ 6,997 $ 5,123 $ 6,456 $ 4,634 $ 23,210
Gross profit................................. 1,965 773 1,410 53 4,201
Net income (loss)............................ 46,379 (7,027) (7,066) (8,101) 24,185
Net income (loss) per share--Basic........... 2.48 (0.36) (0.36) (0.40) 1.23
Net income (loss) per share--Diluted......... 2.28 (0.36) (0.36) (0.40) 1.18
Discontinued Operations:
Income (loss), net of tax.................... (240) 154 (486) (402) (974)
Net income (loss) per share--Basic........... (0.01) 0.01 (0.02) (0.02) (0.05)
Net income (loss) per share--Diluted......... (0.01) 0.01 (0.02) (0.02) (0.05)

------------------------

(1) The results for the first quarter of 2000 include a $66.4 million pre-tax
gain realized on the sale of Alteon WebSystems, Inc. common stock.

F-22

(2) Loss, net of tax, for Discontinued Operations includes a second quarter 2001
charge of $5.0 million to write down the net assets of Essential to reflect
its net realizable value of $0.8 million in response to unfavorable market
conditions and efforts to sell Essential. See Note 6.

(3) Net loss from Continuing Operations includes a second quarter 2001 charge of
$3.1 million to recognize the impairment of certain intangible assets and
$0.8 million for severance as a result of reductions in workforce. In the
fourth quarter of 2001 we recorded a charge of $0.5 million for severance as
a result of reductions in workforce and $0.2 million for early termination
of excess lease space. See Note 2.

F-23

SCHEDULE II
INTRUSION INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)

BALANCE AT CHARGED TO BALANCE AT
BEG. OF COSTS AND ADDITIONS END OF
PERIOD EXPENSE (DEDUCTIONS) PERIOD
---------- ---------- ------------ ----------

Year ended December 31, 1999
Deducted from asset accounts:
Allowance for doubtful accounts and returns... $ 880 $85 $ 206 (2) $1,171
Year ended December 31, 2000
Deducted from asset accounts:
Allowance for doubtful accounts and returns... $1,171 $-- $ (252)(1) $ 919
Year ended December 31, 2001
Deducted from asset accounts:
Allowance for doubtful accounts and returns... $ 919 $-- $ (122)(1) $ 797

------------------------

(1) Uncollectible accounts written off.

(2) Unapplied cash, net of write-offs.

S-1

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

Dated: March 20, 2002 INTRUSION INC.
(Registrant)

By: /s/ G. WARD PAXTON
-----------------------------------------
G. Ward Paxton
CHAIRMAN, PRESIDENT, AND CHIEF EXECUTIVE
OFFICER (PRINCIPAL EXECUTIVE OFFICER)

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

SIGNATURE TITLE DATE
--------- ----- ----

/s/ G. WARD PAXTON Chairman, President, Chief
------------------------------------------- Executive Officer, and March 20, 2002
G. Ward Paxton Director

/s/ T. JOE HEAD
------------------------------------------- Vice Chairman of the Board March 20, 2002
T. Joe Head and Director

Vice President, Chief
/s/ JAY R. WIDDIG Financial Officer,
------------------------------------------- Treasurer and Secretary March 20, 2002
Jay R. Widdig (Principal Financial and
Accounting Officer)

/s/ J. FRED BUCY
------------------------------------------- Director March 20, 2002
J. Fred Bucy

/s/ GRANT A. DOVE
------------------------------------------- Director March 20, 2002
Grant A. Dove

/s/ DONALD M. JOHNSTON
------------------------------------------- Director March 20, 2002
Donald M. Johnston

II-1