Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This report contains forward-looking statements, within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, that involve risks and uncertainties, such as statements concerning: the difficulties in forecasting future sales caused by current economic and market conditions, the effect of military actions on government and corporate spending on information security products, the impact of our cost reduction programs, the difficulties and uncertainties in successfully developing and introducing new products, our ability to continue to meet operating expenses through current cash flow or additional financings, the continuance and strength of our relationship with Check Point, the highly competitive market for our products, difficulties in accurately estimating market growth, the consolidation of the information security industry, the impact of changing economic conditions, business conditions in the information security industry, our ability to manage acquisitions effectively, our ability to manage discontinued operations effectively, the impact of market peers and their products as well as risks concerning future technology and others identified in our Annual Report on Form 10-K and other Securities and Exchange Commission filings. Such forward-looking statements are generally accompanied by words such as "plan," "estimate," "expect," "believe," "should," "would," "could," "anticipate," "may" or other words that convey uncertainty of future events or outcomes. These forward-looking statements and other statements made elsewhere in this report are made in reliance on the Private Securities Litigation Reform Act of 1995. The section below entitled "Factors That May Affect Future Results of Operations" sets forth and incorporates by reference certain factors that could cause actual future results of the company to differ materially from these statements.

OVERVIEW

We develop, market and support a family of security software and appliances that address vital security issues facing organizations deploying business applications over the Internet or internally via Intranets. We

currently provide 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 included our Essential Communications division and our local area networking assets and began accounting for these networking divisions as discontinued operations.

The following management's discussion and analysis of financial condition and results of operations pertains only to our continuing operations unless otherwise disclosed. Certain prior year information has been reclassified to conform with the current presentation.

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, 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 by us. 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.

In March 2002 we sold the assets of our last remaining discontinued operation, our Essential Communications division, for $1 million generating a gain of $0.4 million, which we have shown as a gain from discontinued operations in the accompanying financial statements. Terms of the sale included transferring $0.7 million in net property, plant and equipment, $0.1 million in current liabilities and product maintenance of which $0.4 million was recorded in deferred revenue at December 31, 2001. Included in the gain on the sale of Essential is a $0.3 million reserve to terminate an office lease, which is the equivalent of 2 years' lease and maintenance of the facility. Successful termination for less than 2 years 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. The contractual term of the lease runs through February 2009 and remaining contractual lease payments total $1.2 million at March 31, 2002.

                                                              Three Months Ended
                                                          --------------------------
                                                          March 31,        March 31,
                                                            2002             2001
                                                          ---------        ---------
Net sales                                                    100.0%           100.0%
Cost of sales                                                 68.0             84.6
                                                          ---------        ---------
Gross profit                                                  32.0             15.4
Operating expenses:
  Sales and marketing                                        155.2            150.6
  Research and development                                    74.7             80.5
  General and administrative                                  28.2             34.0
  Amortization of intangibles                                  7.9              6.3
  Restructuring costs and other
   special charges                                               -                -
                                                          ---------        ---------
Operating loss                                              (234.0)          (256.0)

Interest income, net                                           3.5             13.4
Other income                                                     -              0.6
                                                          ---------        ---------
Loss before income taxes                                    (230.5)          (242.0)

Income tax benefit                                               -            (19.5)
                                                          ---------        ---------

Loss from continuing operations                             (230.5)          (222.5)
Gain (loss) from discontinued
 operations, net of tax                                       16.0            (14.5)
                                                          ---------        ---------

Net loss                                                    (214.5)          (237.0)
                                                          =========        =========

                                                              Three Months Ended
                                                          --------------------------
                                                          March 31,        March 31,
                                                            2002             2001
                                                          ---------        ---------
Domestic sales                                                70.4%           78.5%
Export sales to:
  Europe                                                       7.3            12.9
  Canada                                                       4.9             3.1
  Asia                                                        17.3             4.9
  Latin America                                                0.1             0.6
                                                          ---------        ---------

Net sales                                                    100.0%          100.0%
                                                          =========        =========

NET SALES. Net sales decreased to $2.5 million for the quarter ended March 31, 2002 compared to $5.3 million for the same period of 2001 as sales

from our SecureNet Pro intrusion detection and PDS security appliance families of products did not increase as fast as our SecureCom and other security product lines declined.

EXPORT SALES. Export sales for the quarter ended March 31, 2002 decreased to $0.7 million compared to $1.1 million for the same period of 2001 as sales from our SecureNet Pro intrusion detection and PDS security appliance families of products did not increase as fast as our SecureCom and other security product lines declined. Though we expect increased sales from export sales going forward, such export sales may vary as a percentage of net sales in the future.

CONCENTRATION OF SALES. Sales to Westcon Group, Inc. ("Westcon") and subsidiaries were 13.4% for the quarter ended March 31, 2002, compared to 9.8% for the same period of 2001. Sales to Computer Science Corporation ("CSC") and subsidiaries were 10.4% for the quarter ended March 31, 2002, compared to 2.0% for the same period of 2001. Sales to TRW Systems & Information Technology ("TRW") were 0% for the quarter ended March 31, 2002, compared to 13.0% for the same period of 2001. Sales to Lockheed Martin Federal Systems ("Lockheed Martin") were 0.1% for the quarter ended March 31, 2002, compared to 11.8% for the same period of 2001. In addition, a portion of our sales to TRW, Lockheed Martin and other corporations were for products resold by those organizations to various agencies of the U.S. Government.

GROSS PROFIT. Gross profit was $0.8 million or 32.0% of net sales for the quarter ended March 31, 2002, compared to $0.8 million or 15.4% of net sales for the quarter ended March 31, 2001. Gross profit margins as a percentage of net sales were up for the three months ended March 31, 2002 primarily because of the change in product mix from lower margin hardware products to higher margin intrusion detection products.

Gross profit as a percentage of net sales is impacted by several factors, including shifts in product mix, changes in channels of distribution, sales volume, fluctuations in manufacturing costs, pricing strategies, and fluctuations in sales of integrated third-party products.

SALES AND MARKETING. Sales and marketing expenses decreased to $3.9 million for the quarter ended March 31, 2002, compared to $8.0 million for the quarter ended March 31, 2001. Sales and marketing expenses decreased in the quarter ended March 31, 2002, compared to the same period of 2001, primarily due to the reorganization of our sales and marketing departments and other cost reduction initiatives. We expect sales and marketing expenses to continue to decline in the second quarter of 2002, in comparison to the first quarter of 2002. Sales and marketing expenses may vary as a percentage of net sales in the future.

RESEARCH AND DEVELOPMENT. Research and development expenses decreased to $1.9 million for the quarter ended March 31, 2002, compared to $4.3 million for the quarter ended March 31, 2001. Research and development costs are expensed in the period incurred. Research and development expenses decreased in the three months ended March 31, 2002, compared to the same period in 2001 as we focused more of our development efforts on our core security products, SecureNet Pro and PDS security appliances, while reducing efforts on our other security products. It is expected that research and development expenses will continue to decrease in the second quarter of 2002, in comparison to the first quarter of 2002. Research and development expenses may vary as a percentage of net sales in the future.

GENERAL AND ADMINISTRATIVE. General and administrative expenses decreased to $0.7 million for the quarter ended March 31, 2002, compared to $1.8 million for the quarter ended March 31, 2001. General and administrative expenses decreased in the three months ending March 31, 2002 compared to the same period of 2001, primarily due to the restructuring done in 2001 and other cost reduction initiatives. It is expected that general and administrative expenses will continue to decrease in the second quarter of 2002, in comparison to the first quarter of 2002. General and administrative expense may vary as a percentage of net sales in the future.

AMORTIZATION. Amortization expenses decreased to $0.2 million for the quarter ended March 31, 2002, compared to $0.3 million for the quarter ended March 31, 2001. Amortization expenses decreased in the three-month period ended March 31, 2002, compared with the same period in 2001, as a result of the June 30, 2001 write off of certain impaired intangible assets and intellectual properties acquired from Science Applications International Corporate ("SAIC") in 1998 and the discontinuance of the amortization of goodwill effective January 1, 2002. Absent subsequent acquisitions, all future amortization will continue to be associated only with Mimestar identifiable intangibles and will be approximately $0.2 million per quarter.

INTEREST. Net interest income decreased to $0.1 million for the quarter ended March 31, 2002, compared to $0.7 million for the same period in 2001. The net interest income decreases were primarily due to the reduced overall cash balances resulting from operating losses. Net interest income may vary in the future based on our cash flow and rate of return on investments.

INCOME TAXES. Our effective tax rate for the quarter ended March 31, 2002 was 0% compared to income tax benefit of 8.0% for the quarter ended March 2001. We fully utilized our net operating loss carryback in 2001. We did not record an income tax benefit as of March 31, 2002 related to net operating losses which can be carried forward to offset taxable income in future years. We will recognize the benefit of net operating loss carryforwards when we generate taxable income and can be assured that such net operating loss carryforwards can be utilized.

LIQUIDITY AND CAPITAL RESOURCES

Our principal source of liquidity at March 31, 2002 is $13.3 million of cash and cash equivalents and $5.4 million of short-term investments. As of March 31, 2002, excluding discontinued operations, working capital was $21.4 million compared to $25.2 million as of December 31, 2001.

Cash used in continuing operations for the three months ended March 31, 2002 was $2.4 million, primarily due to an operating loss from continuing operations of $5.8 million, offset by a decrease in income taxes receivable, accounts receivable and inventories. Future fluctuations in inventory balances, accounts receivable and accounts payable will be dependent upon several factors, including, but not limited to, quarterly sales, our strategy in building inventory in advance of receiving orders from customers, and the accuracy of our forecasts of product demand and component requirements.

Cash used in investing activities of continuing operations in the three months ended March 31, 2002 was $0.8 million, which consisted primarily of

the net proceeds from the maturities and purchases of available for sale securities.

Cash provided by financing activities of continuing operations in the three months ended March 31, 2002 was $30 thousand, which was primarily the result of the issuance of common stock upon the exercise of employee stock options.

Net cash provided by discontinued operations in the three months ended March 31, 2002 was $0.6 million, which consisted primarily of the net proceeds of the sale of the assets of our final remaining discontinued operation, Essential Communications.

At March 31, 2002, the Company did not have any material commitments for capital expenditures.

During the three months ended March 31, 2002, the Company funded its operations through the use of cash and cash equivalents.

Although we believe we have sufficient cash resources to finance our operations and expected capital expenditures for the remainder of 2002, 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.

FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS

Numerous factors may affect our business and future results of operations. These factors include, but are not limited to, current economic and market conditions, the effect of military actions on government and corporate spending on information security products, technological changes, competition and market acceptance, acquisitions, product transitions, timing of orders, manufacturing and suppliers, reliance on outsourcing vendors and other partners, intellectual property and licenses, third-party products,

dependence on government customers, international operations, intellectual property issues, liquidity and cash resources and effects of restructuring plans and cost reductions. The discussion below addresses some of these and other factors. For a more thorough discussion of these and other factors that may affect our business and future results, see the discussion under the caption "Factors That May Affect Future Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2001.

TECHNOLOGICAL CHANGES. The market for our products is characterized by frequent product introductions, rapidly changing technology and continued evolution of new industry standards. The market for security products requires our products to be compatible and interoperable with products and architectures offered by various vendors, including other security products, networking products, workstation and personal computer architectures and computer and network operating systems. Our success will depend to a substantial degree upon our ability to develop and introduce in a timely manner new products and enhancements to our existing products that meet changing customer requirements and evolving industry standards. The development of technologically advanced products is a complex and uncertain process requiring high levels of innovation as well as the accurate anticipation of technological and market trends. There can be no assurance that we will be able to identify, develop, manufacture, market and support new or enhanced products successfully in a timely manner. Further, we or our competitors may introduce new products or product enhancements that shorten the life cycle of or make obsolete our existing product lines, any of which could have a material adverse effect on our business, operating results and financial condition.

MARKET ACCEPTANCE. We are pursuing a strategy to increase the percentage of our revenue generated through indirect sales channels including distributors, value added resellers, system integrators, original equipment manufacturers and managed service providers. There can be no assurance that our products will gain market acceptance in these indirect sales channels. Further, competition among security companies to sell products through these indirect sales channels could result in significant price competition and reduced profit margins.

We are also pursuing a strategy to further differentiate our product line by introducing complementary security products and incorporating new technologies into our existing product line. There can be no assurance that we will successfully introduce these products or that such products will gain market acceptance. We anticipate competition from networking companies, network security companies and others in each of our product lines. We anticipate that profit margins will vary among our product lines and that product mix fluctuations could have an adverse effect on our overall profit margins.

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.

In March 2002 we sold the assets of our last remaining discontinued operation, Essential Communications division, for $1 million generating a gain of $0.4 million. 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 2 years 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. The contractual term of the lease runs through February 2009 and remaining contractual lease payments total $1.2 million at March 31, 2002.

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.

We have made acquisitions in the past, and 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 ourself and our customers against any such claim regardless of the merits of such claims. In the event of a successful claim of infringement, we may be required to obtain one or more licenses from third parties. There can be no assurance that we could obtain the necessary licenses on reasonable terms.

SUFFICIENCY OF CASH FLOW. As of March 31, 2002, we had cash, cash equivalents and investments in the amount of approximately $18.7 million, down from approximately $20.4 million as of December 31, 2001. Although we believe we have sufficient cash resources to finance our operations and expected capital expenditures for the remainder of 2002, 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.

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. $0.4 million or 14.3% of revenue in the quarter ended March 31, 2002 was derived from sales to the U.S. government, either directly by Intrusion or through system integrators and other resellers compared to $1.7 million or 32.4% of revenue in the quarter ended March 31, 2001. Sales to the government present risks in addition to those involved in sales to commercial customers, including potential disruptions due to appropriation and spending patterns and the government's reservation of the right to cancel contracts and purchase orders for its convenience.

EFFECTS OF RECENT TERRORIST ATTACKS AND MILITARY ACTIONS. Terrorist attacks in the United States on September 11, 2001, 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 and April 2002. 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 involved, among other things, reductions in our workforce and facilities, aligning our

organization around our business objectives, realignment of our sales force and changes in our sales management. The workforce reductions could result in temporary reduced productivity of our remaining employees. Additionally, our customers and prospects may delay or forgo purchasing our products due to a perceived uncertainty caused by the restructuring and other changes. Failure to achieve the desired results of our initiatives could seriously harm our business, results of operations and financial condition.

GENERAL. Sales of our products fluctuate, from time to time, based on numerous factors, including customers' capital spending levels and general economic conditions. While certain industry analysts believe that there is a significant market for data security products, there can be no assurance as to the rate or extent of the growth of such market or the potential adoption of alternative technologies. Currently, capital spending for information technology products, including security products is being adversely affected by uncertain economic conditions. Future declines in data security product sales as a result of general economic conditions, adoption of alternative technologies or any other reason could have a material adverse effect on our business, operating results and financial condition.

Due to the factors noted above and in "Management's Discussion and Analysis of Financial Condition and Results of Operations", our future earnings and common stock price may be subject to significant volatility, particularly on a quarterly basis. Past financial performance should not be considered a reliable indicator of future performance and investors should not use historical trends to anticipate results or trends in future periods. Any shortfall in revenue and earnings from the levels anticipated by securities analysts could have an immediate and significant effect on the trading price of our common stock in any given period. Also, we participate in a highly dynamic industry which often results in volatility of our common stock price.