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NFRX > SEC Filings for NFRX > Form 10-Q on 5-Aug-2013All Recent SEC Filings

Show all filings for INFERX CORP

Form 10-Q for INFERX CORP


5-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis or Plan of Operation.

The information set forth and discussed in this Management's Discussion and Analysis or Plan of Operation is derived from our financial statements and the related notes, which are included. The following information and discussion should be read in conjunction with those financial statements and notes, as well as the information provided in our Annual Report on Form 10-K for our fiscal year ended December 31, 2011.

Overview

InferX is a provider of next generation Predictive Analytics and Business Intelligence solutions for financial services, healthcare, and government enterprises. Our solutions include a wide variety of innovative technologies that provide critical results for challenges such as healthcare fraud mitigation, healthcare research, financial services risk management and complex intelligence analysis, to name a few. We have pioneered and commercialized a suite of powerful patented technologies for advanced analytical solutions that direct decision making and improve corporate performance across the entire enterprise. Our solutions are targeted towards select sub-subsectors within the healthcare, financial services and public sector markets to address significant ROI opportunities for our clients. Through broad, diversified market adoption of our predictive data analytical solutions, InferX plays a critical role in promoting the safety and security of our nation's assets and its citizens, while also empowering commercial enterprises with the knowledge and material insight necessary to make better business decisions and maximize profits.

Predictive analytics helps organizations make better decisions by providing empirical, objective and consistent methods of evaluating transactions, customers, or shippers in this context; and doing it at high volumes using disparate and geographically dispersed enterprise databases. These models are often "behavioral" because they may be used to predict future behavior of account or customer actions in regard to; e.g. likelihood of fraudulent behavior. By enabling organizations to instantly differentiate between desirable and undesirable business, predictive models allow them to control the level of risk they are willing to assume and actions to increase profitability. Our patented and patent-pending products simultaneously analyze data in multiple remote locations with disparate formats without the need to move the data to a central data warehouse, thereby preserving the privacy and security of the data.

Since inception, InferX has evolved from a leading technical, database research and development firm to its current position as a developer of the next generation predictive analytics technology. InferX and its predecessor Datamat Systems Research, Inc. have been in business since 1992, originally as a professional services research and development firm, specializing in technology for distributed analysis of sensory data relating to airborne missile threats under contracts with the Missile Defense Agency and other Department of Defense (DoD) contracts. InferX Delaware was formed in 1999 to commercialize Datamat's missile defense technology to build applications of real time predictive analytics. InferX and Datamat were merged together in August 2006. In October 2006 InferX

became public by completing a "reverse merger" with Black Nickel Acquisition Corp. which was a fully reporting "shell company".

On March 16, 2009, InferX entered into an agreement and plan of reorganization (the "Merger Agreement") with the Irus Group, Inc. to effect a reverse triangular merger between The Irus Group, Inc. and the Company's wholly-owned subsidiary, Irus Acquisition Corp. (formed for the purpose of completing this transaction). The Merger Agreement was then amended on June 15, 2009 (the "First Amended and Restated Agreement") to reflect the change in the amount of the issued shares to Irus in the transaction. Under the terms of the First Amended and Restated Agreement, the issued and outstanding shares of The Irus Group common stock was automatically converted into the right to receive 56% of the issued and outstanding shares of the Company's common stock. On October 28, 2009 the merger was completed.

The Irus Group, Inc. ("Irus"), founded in 1996, was a consulting firm specializing in bridging corporate performance management and business intelligence systems to help clients answer challenging business questions. Irus' specific domain expertise revolved around the planning, consulting, implementation and development of complex business intelligence solutions. Irus developed knowledge in enterprise budgeting and planning systems, allowing it to provide their customers, which have included government, financial services, retail, manufacturing, and telecommunications companies, many critical systems and processes for business intelligence into corporate performance management solutions.

Historically, we have derived nearly all of our sales revenues under federal government contracts. Under these contracts, we performed several critical tasks, including research and development and professional services consulting. Through terms of the contracts with our customers, we were able to retain ownership of the intellectual property associated with R&D efforts; which ultimately led to the creation of our current products. In fiscal 2002, faced with the prospect of continuing to receive relatively small and uncertain margins associated with fixed price government contracts, and the inherent limit of the market size, we began to further develop our software as a commercial product, concentrating on building specific applications that we believed would meet the growing needs of our potential new customers. In fiscal 2003, we sold our first commercial licenses and, since fiscal 2004, all of our revenues have derived from government contracts.

Following our merger with the Irus Group, we expanded our customer base and services offerings, which we believed would increase our revenues and expenses in comparison to recent periods. Our services business, which represented over 99% of our total revenues in fiscal 2011, has significantly lower margins than our software business. The proportion of our services revenues relative to our total revenues in the nine months ended September 30, 2012 was affected by our continued focus on the PA software side of the business and the continued uncertainty of the U.S. Government budget.

Consulting: Our consulting line of business is comprised of two operating segments: (i) providing services to our customers in support of their corporate enterprise predictive and advanced analytics requirements; and (ii) providing services to BI customers in enterprise architecture design and implementation; business / IT strategy alignment; business process simplification; solution integration; and product implementation, enhancements, and upgrades. Our consulting revenues are dependent upon general economic conditions and the level of product revenues, including the new software license sales of our application products. To the extent we are able to grow our software products revenues; we would also generally expect to be able to grow our consulting revenues.

Software Business: Our software business is comprised of two operating segments:
(i) new software licenses and (ii) software license updates and product support. The company made significant investment in developing new healthcare and financial services solutions working with partners as addressed in business section. We expect that our software business' total revenues in 2014 will increase due to the continued demand for our PA software products and software license updates and product support offerings. InferX will continue to make further investments in research and development to meet customer demand and changing market conditions. Future software revenues will significantly increase, as we bring to market our software-as-a-service (SaaS) and platform-as-a-service (PaaS) delivery models.

During this fiscal quarter, the Company continued to place great emphasis on the enhancement and development of our core technology products and the adaptation into market-sector specific solutions. This concentration of effort resulted in higher overhead, on a year over year basis, consisting primarily of personnel related expenditures; as noted by the recent management hire for our Cyber Security solution. We intend to continue to invest significantly in our product research and development and market-driven technology solutions which are essential to maintaining our competitive position.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. We rely on historical experience and on other assumptions we believe to be reasonable under the circumstances in making our judgments and estimates. Actual results could differ from those estimates. We consider our critical accounting policies to be those that are complex and those that require significant judgments and estimates, including the following: recognition of revenue, capitalization of software development costs and income taxes.

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Allowance for Doubtful Accounts

We provide an allowance for doubtful accounts, which is based upon a review of outstanding receivables as well as historical collection information. Credit is granted to substantially all customers on an unsecured basis. In determining the amount of the allowance, management is required to make certain estimates and assumptions.

Fixed Assets

Fixed assets are stated at cost, less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful lives of the related assets (primarily three to five years). Costs of maintenance and repairs are charged to expense as incurred.

Computer Software Development Costs

The Company capitalized certain software development costs. The Company capitalizes the cost of software in accordance with ASC 985-20 once technological feasibility has been demonstrated, as the Company has in the past sold, leased or otherwise marketed their software, and plans on doing so in the future. The Company capitalizes costs incurred to develop and market their privacy preserving software during the development process, including payroll costs for employees who are directly associated with the development process, services performed by consultants, and attributable overhead costs. Amortization of such costs is based on the greater of (i) the ratio of current gross revenues to the sum of current and anticipated gross revenues, or (ii) the straight-line method over the remaining economic life of the software, of five years, as specified in the technological feasibility study performed by an independent valuation consultant. It is possible that those anticipated gross revenues, the remaining economic life of the products, or both, may be reduced as a result of future events. The Company has not developed any software for internal use.

Recoverability of Long-Lived Assets

The Company reviews the recoverability of its long-lived assets on a periodic basis whenever events and changes in circumstances have occurred which may indicate a possible impairment. The assessment for potential impairment is based primarily on the Company's ability to recover the carrying value of its long-lived assets from expected future cash flows from its operations on an undiscounted basis. If such assets are determined to be impaired, the impairment recognized is the amount by which the carrying value of the assets exceeds the fair value of the assets. Fixed assets to be disposed of by sale are carried at the lower of the then current carrying value or fair value less estimated costs to sell.

Revenue Recognition

Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is probable. We enter into certain arrangements where we are obligated to deliver multiple products and/or services (multiple elements). In these transactions, we allocate the total revenue among the elements based on the sales price of each element when sold separately (vendor-specific objective evidence). We generate revenue from application license sales, application maintenance and support, professional services rendered to customers as well as from application management support contracts. Ourrevenue is generated under time-and-material contracts and fixed-price contracts, usually performing consulting services.

Our business is not seasonal in nature. The timing of contract awards, the availability of funding from the customer, the incurrence of contract costs and unit deliveries are the primary drivers of our revenue recognition. These factors are influenced by the federal government's October-to-September fiscal year. This process has historically resulted in higher revenues in the latter half of the year. Many of our government customers schedule deliveries toward the end of the calendar year, resulting in increasing revenues and earnings over the course of the year.

At this time we do not derive revenue from projects involving multiple revenue-generating activities. If a contract would involve the provision of multiple service elements, total estimated contract revenue would be allocated to each element based on the fair value of each element. The amount of revenue allocated to each element would then be limited to the amount that is not contingent upon the delivery of another element in the future. Revenue for each element would then be recognized depending upon whether the contract is a time-and-materials contract or a fixed-price, fixed-time contract.

Stock-Based Compensation

In 2006, we adopted the provisions of ASC 718-10 "Share-Based Payments" ("ASC 718-10") which requires recognition of stock-based compensation expense for all share-based payments based on fair value. Share-based payment transactions within the scope of ASC 718-10 include stock options, restricted stock plans, performance-based awards, stock appreciation rights, and employee share purchase plans. This adoption had no effect on the Company's operations. Prior to January 1, 2006, we measured compensation expense for all of our share-based compensation using the intrinsic value method.

We have elected to use the modified-prospective approach method. Under that transition method, the calculated expense in 2006 is equivalent to compensation expense for all awards granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair values. Stock-based compensation expense for all awards granted after January 1, 2006 is based on the grant-date fair values. We recognize these compensation costs, net of an estimated forfeiture rate, on a pro rata basis over the requisite service period of each vesting tranche of each award. We consider voluntary termination behavior as well as trends of actual option forfeitures when estimating the forfeiture rate.

We measure compensation expense for non-employee stock-based compensation under ASC 505-50, "Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services". The fair value of the option issued is used to measure the transaction, as this is more reliable than the fair value of the services received. The fair value is measured at the value of the Company's common stock on the date that the commitment for performance by the counterparty has been reached or the counterparty's performance is complete. The fair value of the equity instrument is charged directly to compensation expense and additional paid-in capital. For common stock issuances to non-employees that are fully vested and are for future periods, we classify these issuances as prepaid expenses and expense the prepaid expenses over the service period. At no time have we issued common stock for a period that exceeds one year.

Concentrations

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of accounts receivable. To date, accounts receivable have been derived from contracts with agencies of the federal government. Accounts receivable are generally due within 30 days and no collateral is required.

Segment Reporting

We follow the provisions of ASC 280-10, "Disclosures about Segments of an Enterprise and Related Information." This standard requires that companies disclose operating segments based on the manner in which management disaggregates the company in making internal operating decisions. We believe that there is only one operating segment.

Fair Value of Financial Instruments (other than Derivative Financial Instruments)

The carrying amounts reported in the consolidated balance sheet for cash and cash equivalents, and accounts payable approximate fair value because of the immediate or short-term maturity of these financial instruments. For the notes payable, the carrying amount reported is based upon the incremental borrowing rates otherwise available to the Company for similar borrowings.

Convertible Instruments

We review the terms of convertible debt and equity securities for indications requiring bifurcation, and separate accounting, for the embedded conversion feature. Generally, embedded conversion features, where the ability to physical or net-share settle the conversion option is not within our control, are bifurcated and accounted for as a derivative financial instrument. Bifurcation of the embedded derivative instrument requires allocation of the proceeds first to the fair value of the embedded derivative instrument with the residual allocated to the debt instrument. The resulting discount to the face value of the debt instrument is amortized through periodic charges to interest expense using the Effective Interest Method.

Income Taxes

Under ASC 740 the liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.

Income (Loss) Per Share of Common Stock

Basic net income (loss) per common share ("EPS") is computed using the weighted average number of common shares outstanding for the period. Diluted earnings per share include additional dilution from common stock equivalents, such as stock issuable pursuant to the exercise of stock options and warrants. Common stock equivalents are not included in the computation of diluted earnings per share when the Company reports a loss because to do so would be anti-dilutive for the periods presented.

Research and Development

Research and development expenses include payroll, employee benefits, equity compensation, and other headcount-related costs associated with product development. The Company has determined that technological feasibility for the software products is reached shortly before the products are released to manufacturing. Costs incurred after technological feasibility is established are not material, and accordingly, the Company expenses all research and development costs when incurred.

Nine Months Ended September 30, 2012 and 2011

Revenue

Revenue for the nine months ended September 30, 2012 was $1,325,318, a decrease from $2,789,456 for the same period in 2011; an approximate 53% decrease, our revenues were directly impacted by the termination of a couple of U.S. Government contracts, which directly impacted our revenue delivered government contracts and U.S. Government's authority to finalize new contract starts to coincide with the previous contract termination. This situation also reflects the continuing uncertain economic environment across all of our focus market areas and the slowness of the national economic recovery. From a customer market perspective, we did not see a significant improvement in the business environment for capital expenditures across our enterprise, commercial, and government markets, during the nine months ended September 30, 2012.

Cost of Revenues

Costs of revenues for the nine months ended September 30, 2012 were $1,024,275, an approximate 45% decrease from $1,864,735 for the same period in 2011. The decrease resulted primarily from lower revenue and the associated lower attributable subcontractor costs as well as benefits from our ongoing program to optimize efficiency and reduce delivery costs.

Gross Margin

In the nine months ended September 30, 2012, our gross margin percentage decreased to 23% compared from approximately 33% from the corresponding period of fiscal 2011. This decrease in gross margin percentage for the nine months ended September 30, 2012 was the result of a substantial reduction in cost of goods sold which was less than the decrease in revenue.

Operating Expenses

For the nine months ended September 30, 2012 operating expenses increased by approximately 59% from the corresponding period of fiscal 2011, which was primarily attributable to an increase in stock based compensation and depreciation, amortization and impairment, offset by a reduction in labor costs.

Other Income (Expense)

Other income (expense) increased primarily due to a benefit recorded for the fair value adjustment of $35,128,550.

Contract Backlog

At September 30, 2012 and December 31, 2011, our estimated backlog was $1,866,624 and $5,790,000, respectively, of which $1,035,534 and $4,752,000, respectively, was funded. We define backlog as our estimate of the remaining future revenue from existing signed contracts over the remaining base contract performance period and from the option periods of those contracts, assuming the exercise of all related options. We define funded backlog as the portion of backlog for which funding currently is appropriated and obligated to us under a contract or other authorization for payment signed by an authorized purchasing agency, less the amount of revenue we have previously recognized. Our backlog does not include any estimate of future potential delivery orders that might be awarded under our Government Wide Acquisition Contracts (GWAC) or other multiple-award contract vehicles, or sales and services of our PA technology.

Factors That May Impact Net Sales and Gross Margin

Product sales may continue to be affected by multiple factors, including the continuing national economic downturn and related market uncertainty, which have resulted in reduced or cautious spending in our enterprise, commercial and government markets; changes in the national economic conditions; competition, including price-focused competitors; new product introductions; sales cycles and product implementation cycles; changes in the mix of our customers between government and commercial markets; changes in the mix of direct sales and indirect sales; variations in sales channels; and final acceptance criteria of the product, system, or solution as specified by the customer. For additional factors that may impact net product sales, see "Part II, Item 1A Risk Factors." Product gross margin may be adversely affected in the future by changes in the mix of products sold, including further periods of increased growth of some of our lower margin products; introduction of new products, changes in distribution channels; price competition, the timing of revenue recognition; sales discounts; increases in material or labor costs; warranty costs; and the extent to which we successfully execute on our strategy and operating plans. Service gross margin may be impacted by various factors such as the change in mix between technical support services and advanced services, the timing of technical support service contract initiations and renewals, and the timing of our strategic investments in headcount and resources to support this business.

Liquidity and Capital Resources

We had cash of $50,281 of September 30, 2012. During the nine months ended September 30, 2012, we used approximately $146,198 from our operating activities. Operations were funded primarily from consulting revenue generated in the nine month period.

We will need to generate significant additional revenue to support our projected increases in staffing and other operating expenses in light of the requirements created by our business plan and enhancement of our core technology products and the adaptation of that technology into market-sector specific solutions. We are currently expending approximately $120,000 per month to support our operations, and anticipate spending $120,000 monthly through December 31, 2012 and 2013. We expect to raise additional financing through the sale of common stock to supplement the cash generated from our existing contracts. We believe this will be sufficient to fund our operations until additional financing is procured. If we are unable to generate sufficient cash through the sale of our convertible preferred, preferred and common stock it will be necessary for us to further reduce expenses to manage our business. Although we believe the additional capital required will be provided through one of these sources, we cannot assure you that we will be successful in these financing efforts or accepting financing at acceptable prices. Our failure to generate such revenue, reduce expenses or obtain necessary financing could impair our ability to continue business operations and raises substantial doubt about our ability to remain as a going concern.

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