UNITED STATES SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549





FORM 10-Q





(Mark One)


R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended June 30, 2011OR£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934





Commission file number: 1-31949





INX Inc.


(Exact name of Registrant as specified in its charter)





Delaware

76-0515249(State of incorporation)

(I.R.S. Employer Identification Number)





1955 Lakeway Drive


Lewisville, Texas 75057


(Address of principal executive offices)


(Zip code)





(469) 549-3800


(Registrant’s telephone number including area code)




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 £ No R





Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  £ Yes  £ No





Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):





Large accelerated filer £
Accelerated filer £
Non-accelerated filer £
Smaller reporting company R(Do not check if a smaller reporting company)





Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).


Yes £    No R





The Registrant has 9,714,792 shares of common stock outstanding as of August 1, 2011.





1




INX Inc.


FORM 10-Q for the Quarter Ended June 30, 2011





INDEX





PagePart I. Financial InformationItem 1. Financial Statements (Unaudited):Condensed Balance Sheets at June 30, 2011 and December 31, 2010
3Condensed Statements of Operations for the three months ended June 30, 2011 and 2010
4Condensed Statements of Operations for the six months ended June 30, 2011 and 2010
5Condensed Statement of Stockholders’ Equity for the six months ended June 30, 2011
6Condensed Statements of Cash Flows for the six months ended June 30, 2011 and 2010
7Notes to Condensed Financial Statements
8Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
14Item 4. Controls and Procedures
18Part II. Other InformationItem 1. Legal Proceedings
22Item 6. Exhibits
22Signature
22





2




PART 1. FINANCIAL INFORMATION


Item 1. Financial Statements (Unaudited):


INX INC.


CONDENSED BALANCE SHEETS


(In thousands, except share and par value amounts)




June 30,

2011


December 31,

2010ASSETS

(Unaudited)Current assets:Cash and cash equivalents

$
8,034


$
12,089Accounts receivable, net of allowance of $701 and $651


91,768



64,493Inventory, net


4,450



3,239Deferred costs


2,549



2,767Deferred income taxes


5,925



4,146Other current assets


1,201



960Total current assets


113,927



87,694Property and equipment, net of accumulated depreciation of $8,382 and $7,312


5,300



4,793Goodwill


12,490



13,532Intangible assets, net of accumulated amortization of $2,317 and $1,946


376



1,015Deferred income taxes


3,140



2,029Other assets


179



75Total assets

$
135,412


$
109,138LIABILITIES AND STOCKHOLDERS’ EQUITYCurrent liabilities:Current portion of capital lease obligations

$
125


$
178Accounts payable floor plan


62,067



41,129Accounts payable


10,546



9,423Accrued payroll and related costs


10,382



7,145Accrued expenses


3,100



4,189Deferred revenue


4,985



4,055Other current liabilities


1,878



1,461Total current liabilities


93,083



67,580Non-current liabilities:Non-current portion of capital lease obligations


—



55Other liabilities


978



659Total liabilities


94,061



68,294Commitments and contingencies (Note 10)Stockholders’ equity:Preferred stock, $.01 par value, 5,000,000 shares authorized, no shares issued


—



—Common stock, $.01 par value, 15,000,000 shares authorized, 9,691,672 and9,514,542 issued and outstanding as of June 30, 2011 and December 31, 2010,respectively


96



95Additional paid-in capital


59,241



57,777Accumulated deficit


(17,986
)


(17,028
)Total stockholders’ equity


41,351



40,844Total liabilities and stockholders’ equity

$
135,412


$
109,138





The accompanying notes are an integral part of these condensed financial statements.





3


INX INC.


CONDENSED STATEMENTS OF OPERATIONS


(In thousands, except share and per share amounts)


(Unaudited)





Three Months Ended June 30,2011


2010Revenue:Products

$
104,802


$
74,263Services


12,108



9,792Total revenue


116,910



84,055Cost of goods and services:Products


84,465



59,219Services


9,408



7,768Total cost of goods and services


93,873



66,987Gross profit


23,037



17,068Selling, general and administrative expenses


21,612



15,947Operating income


1,425



1,121Interest and other income (expense), net


24



(11
)Income before income taxes


1,449



1,110Income tax expense (benefit)


864



(5,263
)Net income

$
585


$
6,373Net income per share:Basic

$
0.06


$
0.69Diluted

$
0.06


$
0.65Weighted average shares – basic


9,666,869



9,200,788Weighted average shares – diluted


10,238,720



9,753,846




The accompanying notes are an integral part of these condensed financial statements.





4


INX INC.


CONDENSED STATEMENTS OF OPERATIONS


(In thousands, except share and per share amounts)


(Unaudited)





Six Months Ended June 30,2011


2010Revenue:Products

$
173,002


$
135,164Services


22,862



18,939Total revenue


195,864



154,103Cost of goods and services:Products


139,845



109,166Services


17,876



15,336Total cost of goods and services


157,721



124,502Gross profit


38,143



29,601Selling, general and administrative expenses


40,326



29,118Operating (loss) income


(2,183
)


483Interest and other income, net


31



80(Loss) income before income taxes


(2,152
)


563Income tax benefit


(1,194
)


(5,263
)Net (loss) income

$
(958
)

$
5,826Net (loss) income per share:Basic

$
(0.10
)

$
0.64Diluted

$
(0.10
)

$
0.60Weighted average shares – basic


9,596,495



9,155,356Weighted average shares – diluted


9,596,495



9,725,309





The accompanying notes are an integral part of these condensed financial statements.





5


INX INC.


CONDENSED STATEMENT OF STOCKHOLDERS’ EQUITY


(In thousands, except share amounts)


(Unaudited)





AdditionalCommon Stock


Paid-In


AccumulatedShares


Amount


Capital


Deficit


TotalBalance at December 31, 2010


9,514,542


$
95


$
57,777


$
(17,028
)

$
40,844Issuance of vested restricted commonstock


54,853



—



—



—



—Share-based compensation expenserelated to employee stock optionsand employee restricted stock grants


—



—



763



—



763Exercise of common stock options andwarrants


23,255



—



61



—



61Purchase price consideration issued for NetTeks acquisition


113,182



1



727



—



728Purchase and retirement of stock resulting from grantee election to fund payroll taxes out of restricted stock grant


(14,160
)


—



(87
)


—



(87
)Net loss


—



—



—



(958
)


(958
)Balance at June 30, 2011


9,691,672


$
96


$
59,241


$
(17,986
)

$
41,351




The accompanying notes are an integral part of this condensed financial statement.





6


INX INC.


CONDENSED STATEMENTS OF CASH FLOWS


(In thousands)


(Unaudited)





Six Months Ended June 30,2011


2010Cash flows from operating activities:Net (loss) income

$
(958
)

$
5,826Adjustments to reconcile net loss to net cash provided by (used in)operating activities:Depreciation and amortization


1,519



1,439Share-based compensation expense


724



992Deferred income taxes


(2,890
)


(5,745
)Excess tax benefits from stock option exercises


—



(374
)Impairment charges


1,188



594Adjustment to estimated acquisition contingent consideration


15



(254
)Provision for doubtful accounts


116



47Loss on disposal of property and equipment


1



2Changes in assets and liabilities that (used) provided cash:Accounts receivable, net


(27,391
)


(20,191
)Inventory


(1,211
)


2,756Accounts payable


1,123



1,423Other assets and liabilities


4,985



2,904Net cash used in operating activities


(22,779
)


(10,581
)Cash flows from investing activities:Purchases of property and equipment


(1,247
)


(1,023
)Acquisition of NetTeks Technology Consultants, Inc.


(850
)


(1,000
)Proceeds from sale of property and equipment


22



1Net cash used in investing activities


(2,075
)


(2,022
)Cash flows from financing activities:Borrowings under non-interest bearing floor plan financing, net


20,938



7,524Excess tax benefits from stock option exercises


—



374Proceeds from shares issued under Employee Stock Purchase Plan


—



372Exercise of common stock options


61



6Payments on other borrowings


(113
)


(103
)Purchase of stock resulting from grantee election


(87
)


(125
)Net cash provided by financing activities


20,799



8,048Net decrease in cash and cash equivalents


(4,055
)


(4,555
)Cash and cash equivalents at beginning of period


12,089



13,247Cash and cash equivalents at end of period

$
8,034


$
8,692Supplemental disclosure of non-cash finance and investing activities:Contractual obligations

$
285


$
—Purchase of software for debt

$
146


$
—Acquisition of NetTeks Technology Consultants, Inc.

$
728


$
—Acquisition of Access Flow, Inc.

$
—


$
522Issuance of vested restricted common stock

$
188


$
374





The accompanying notes are an integral part of these condensed financial statements.





7


INX INC.


NOTES TO CONDENSED FINANCIAL STATEMENTS


(In thousands, except share and per share amounts)





1. Description of Business





INX Inc. (“INX” or the “Company”) is a technology solutions provider focused on delivering technology services infrastructure solutions to enterprise customers.  Our solutions architectures consist of three broad categories of technology infrastructure: network infrastructure, unified communications and collaboration (“UC&C”) and data center. Our value-added proposition is delivered in the form of combining our professional services with certain manufacturer’s products to address our customers’ needs.  Our professional services include consulting, planning and design engineering, implementation engineering, system integration.  We provide technology infrastructure solutions for enterprise-class organizations such as corporations, healthcare organizations, educational institutions, and Federal, state and local governmental agencies located in the United States.





2. Basis of Presentation





The accompanying unaudited financial data as of June 30, 2011 and for the three-month and six-month periods ended June 30, 2011 and 2010 have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. The December 31, 2010 Condensed Balance Sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. However, the Company believes the disclosures are adequate to make the information presented not misleading. These Condensed Financial Statements should be read in conjunction with the Financial Statements and the notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.





In the opinion of management, all adjustments (which include normal recurring adjustments, except as disclosed herein) necessary for a fair presentation of financial position as of June 30, 2011, results of operations for the three-month and six-month periods ended June 30, 2011 and 2010, cash flows for the six months ended June 30, 2011 and 2010, and stockholders’ equity for the six months ended June 30, 2011, have been included. The results of the interim periods are not necessarily indicative of results for the full year or any future period.





Certain amounts in the balance sheet as of December 31, 2010 presented herein have been reclassified to conform to the current period presentation.





3.  Recently Adopted and New Accounting Pronouncements





In October 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting standards for multiple deliverable revenue arrangements (formerly Emerging Issues Task Force No. 08-1) to:





·
provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the consideration should be allocated;


·
require an entity to allocate revenue in an arrangement using estimated selling prices (“ESP”) of deliverables if a vendor does not have vendor-specific objective evidence of selling price (“VSOE”) or third-party evidence of selling price (“TPE”); and


·
eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.





In October 2009, the FASB also amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry specific software revenue recognition guidance. The Company adopted the new guidance on a prospective basis as of the beginning of fiscal 2011 for revenue arrangements entered into or materially modified on or after January 1, 2011.





The new guidance generally did not change the units of accounting for the Company’s revenue transactions as products and services qualified as separate units of accounting in most transactions under the historical guidance.  Under both the historical and new guidance, the Company has vendor-specific objective evidence (“VSOE”) of fair value for product and professional service deliverables and does not have VSOE or third-party evidence of fair value for managed services deliverables.  Because the Company did not have the ability to establish the fair value of managed services deliverables under historical guidance, multiple element arrangements that contain managed services were recognized ratably over the initial term of the managed services contract that is part of the arrangement because managed services are always the last element to be delivered in the arrangement.  The costs of products and services and commission costs directly related to multiple element arrangements containing managed services were deferred and recognized ratably over the initial term of the managed services contract.  Beginning January 1, 2011 for new or materially modified arrangements, the Company can establish the selling price for managed services using ESP and therefore account for all elements within multiple-element arrangements containing managed services as separate units of accounting.





8


Under the new guidance, the Company allocates the total arrangement consideration to each separable deliverable of an arrangement based on the relative selling price method of each deliverable and revenue is recognized upon delivery or completion of those units of accounting. As a result of adopting the new guidance, net revenues for the three month and six month periods ended June 30, 2011 were not materially different from the net revenues that would have been recorded under the historical accounting guidance. The Company cannot reasonably estimate the effect of adopting the new guidance on future financial periods as the impact will vary depending on the nature and volume of new or materially modified multiple deliverable arrangements in any given period.





In May 2011, the FASB issued Accounting Standards Update 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, (“ASU 2011-04”).  ASU 2011-04 amends Accounting Standards Codification (“ASC”) 820, providing a consistent definition and measurement of fair value, as well as similar disclosure requirements between U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 changes certain fair value measurement principles, clarifies the application of existing fair value measurement and expands the ASC 820 disclosure requirements, particularly for Level 3 fair value measurements. ASU 2011-04 will be effective for interim and annual periods beginning after December 15, 2011. The adoption of ASU 2011-04 is not expected to have a material effect on the Company’s financial statements, but may require certain additional disclosures.





In June 2011, the FASB issued new guidance related to the presentation of comprehensive income. The guidance requires that all non-owner changes in stockholder’s equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements and eliminates the option for companies to present components of other comprehensive income as part of the statement of changes in stockholder’s equity. This becomes effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company does not believe this will have a material impact on our disclosures.





4.  Acquisitions, Goodwill and Impairment Charges





(a)
Additional Purchase Consideration





The Company completed two acquisitions in 2009 for which additional purchase consideration may be payable in future periods.  The estimated amount payable was accrued at the respective acquisition dates and is remeasured to fair value at each reporting date until settled with changes in fair value recognized as a component of selling, general and administrative expenses.





Marketware Inc.





On December 31, 2009, the Company purchased the operations and certain assets, and assumed specified liabilities of Marketware Inc. (“Marketware”), a Sacramento-based provider of Cisco IP-network-based physical security and networking solutions.  Under the terms of the asset purchase agreement, additional purchase consideration may be payable based on the Northern California region’s operating income contribution during the twelve-month period ending December 31, 2011.  A minimum of zero and a maximum of $1,313 additional purchase price consideration can be earned. Up to 50% of the additional purchase price consideration may be paid in the form of common stock, at the Company’s option.  As of June 30, 2011 and December 31, 2010, the estimated additional purchase consideration payable was zero.





AdvancedNetworX, Inc.





On July 17, 2009, the Company purchased the operations and certain assets, and assumed specified liabilities of AdvancedNetworX, Inc. (“ANX”), a Raleigh, North Carolina-based network consulting organization.  Additional purchase consideration of between zero and $700 per year is payable based on ANX’s branch office operating income contribution during each of the one-year periods ending July 31, 2011 and 2012.  Up to 60% of such additional purchase price may be paid in the form of Common Stock, at the Company’s option.   As of June 30, 2011 and December 31, 2010, estimated additional purchase consideration payable of $0 and $11 are classified as accrued expenses and $148 and $122 are classified as other non-current liabilities, respectively, based on when the amounts are expected to be earned.  The increase in estimated additional purchase consideration payable of $26 and $15 for the three month and six month periods ended June 30, 2011, respectively, were recorded as an increase in selling, general and administrative expenses.





NetTeks Technology Consultants, Inc.





In 2008, the Company purchased the operations and certain assets, and assumed specified liabilities of NetTeks Technology Consultants, Inc. (“NetTeks”). Additional purchase price consideration of $1,700 was earned by NetTeks for exceeding the New England region operating income contribution target for the year ending December 31, 2010, which was recorded as goodwill and a component of accrued expenses at December 31, 2010. The additional consideration was paid in April 2011, consisting of a cash payment of $850 and the issuance of 113,182 shares of the Company’s common stock that were valued at $728.





9


(b)
Goodwill





The changes in the carrying value of goodwill during 2011 consisted of the following:





Gross


Impairment

Losses


NetBalance, December 31, 2010

$
13,532


$
—


$
13,532Acquisitions


—



—



—Additional purchase price earned underacquisition agreements


—



—



—Purchase price adjustments


(122
)


—



(122
)Impairment charge


—



(920
)


(920
)Balance, June 30, 2011

$
13,410


$
(920
)

$
12,490





(c)
Impairment Charge





During the second quarter of 2011, the Company performed an assessment of its Northern California reporting unit (“NCA”) as a result of 2011 operating performance being below forecast.  The Company performed a review of NCA’s second quarter bookings estimates, a review of its operating results compared to previous forecasts, and an evaluation of the NCA management team.  This review resulted in the termination of NCA’s manager during the second quarter of 2011.  As a result of this review and termination, management revised downward the forecasted future operating results of the NCA reporting unit, concluding that these factors were a triggering event requiring an interim second quarter  goodwill impairment test.  In connection with this triggering event, the Company tested the recoverability of NCA’s long-lived assets and concluded the carrying values of intangible assets were no longer recoverable. Consequently, during the second quarter of 2011, the Company recorded an impairment charge totaling $1,188 to reduce the carrying values of NCA’s goodwill and intangible assets to their estimated fair values.  The goodwill impairment charge of $920 and intangible assets impairment charge of $268 were reported as a component of selling, general and administrative expenses.





During the first two quarters of 2010, NCA generated substantial operating losses compared to the operating income as forecasted in connection with the 2009 annual goodwill impairment assessment.  This financial underperformance triggered the need to perform an interim impairment test, resulting in a goodwill impairment charge of $594 recorded in selling, general and administrative expenses during the second quarter of 2010.





5. Earnings Per Share





Basic earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted earnings per share is based on the weighted-average number of shares outstanding during each period and the assumed exercise of dilutive stock options and warrants less the number of treasury shares assumed to be purchased from the exercise proceeds using the average market price of the Company’s common stock for each of the periods presented.





The following table presents the calculation of basic and diluted earnings per share:





Three Months Ended

June 30,


Six Months Ended

June 30,2011


2010


2011


2010Numerator for basic and diluted earnings per share:Net income (loss)

$
585


$
6,373


$
(958
)

$
5,826Denominator for basic earnings per share — weighted-average shares outstanding


9,666,869



9,200,788



9,596,495



9,155,356Effect of dilutive securities — shares issuable from assumed conversion of common stock options, restricted stock, and warrants


571,851



553,058



—



569,953Denominator for diluted earnings per share — weighted-average shares outstanding


10,238,720



9,753,846



9,596,495



9,725,309




10


For 2010 and the three month period ended June 30, 2011, the computation of diluted earnings per share excludes outstanding stock options and warrants with exercise prices greater than the average market price of the Company's common shares, because the inclusion of such options and warrants would be anti-dilutive and such options and warrants are not considered participating securities. For the six month period ended June 30, 2011, the computation of diluted loss per share excludes warrants and outstanding stock options, and restricted stock awards because the Company reported losses during the period and including them would have had an anti-dilutive effect on loss per share. In any period during which the average market price of the Company's common shares exceeds the exercise prices of these stock options and warrants, such stock options and warrants will be included in our diluted earnings (losses) per share computation using the if converted method of accounting.





The following table presents the number of shares of common stock that were excluded in the calculation of diluted earnings per share since their effect would have been antidilutive.





Three Months Ended

June 30,


Six Months Ended

June 30,2011


2010


2011


2010Warrants


—



40,000



—



40,000Stock options


484,168



561,468



408,168



551,468Restricted stock


—



—



322,704



—Weighted-average shares considered antidilutive


484,168



601,468



730,872



591,468





6. Share-Based Compensation





The Company recognized employee share-based compensation expense for stock options, restricted stock grants, and the employee stock purchase plan of $412 and $424 during the three months ended June 30, 2011 and 2010, respectively and $724 and $963 during the six months ended June 30, 2011 and 2010, respectively. The unrecognized compensation cost related to the Company's unvested stock options as of June 30, 2011 and 2010 was $280 and $728, respectively and is expected to be recognized over a weighted-average period of 0.8 years and 1.2 years, respectively.  The unrecognized compensation cost related to the Company's unvested restricted shares as of June 30, 2011 and 2010 was $1,498 and $2,422, respectively, and is expected to be recognized over a weighted-average period of 1.6 years and 1.8 years, respectively.





7. Senior Credit Facility





The Company has a $70,000 maximum aggregate line of credit with Castle Pines Capital LLC (“CPC”) under a senior credit facility. The CPC senior credit facility (“Facility”) is used primarily for inventory financing and working capital requirements and is collateralized by substantially all assets of the Company.  CPC has authorized a temporary increase in the Facility to $100,000 during the period  from June 27, 2011 to September 30, 2011 to accommodate the Company’s current sales levels.  At June 30, 2011, $62,067 was outstanding under the Facility and reported under accounts payable floor plan, and the unused availability was $37,933.  At December 31, 2010, $41,129 was outstanding under the Facility and reported under accounts payable floor plan, and the unused availability was $7,186.





At June 30, 2011, the Company was operating under a waiver from CPC requiring compliance with the loan covenants as the Company had not filed its required Form 10-Q for the quarterly period ended March 31, 2011, which was filed with the SEC on July 18, 2011. In the future, if any of the loan covenants are violated, the Company would be required to seek waivers from CPC. If CPC refused to provide waivers, the amount due under the Facility could be accelerated and the Company could be required to seek other sources of financing.





8. Income Taxes





The Company records income tax expense for interim periods on the basis of an estimated annual effective tax rate.  The estimated annual effective tax rate is recomputed on a quarterly basis and may fluctuate due to changes in forecasted annual operating income, positive or negative changes to the valuation allowance for net deferred tax assets, and changes to actual or forecasted permanent book to tax differences.  In addition, the Company reflects the tax effect of discrete items such as tax benefits related to certain stock compensation transactions in the quarter these events occur.





For the three month period ended June 30, 2011, the effective tax rate was 51%.  The primary reason that the tax rate differs from the 34% Federal statutory corporate rate is the impact of permanent tax differences including meals and entertainment, stock compensation and state tax expense.  For the three month period ended June 30, 2010, before considering the impact of releasing the valuation allowance, the effective tax rate was 44%.  The primary reason that the tax rate differs from the 34% Federal statutory corporate rate is the impact of permanent tax differences including meals and entertainment, stock compensation and non-deductible goodwill.  In addition, the Company released the valuation allowance in full and recognized an income tax benefit of $5,492.   The Company reached this determination after giving consideration to a variety of factors including but not limited to:  (a) the current period realization of all net operating loss (NOL) carry forwards totaling $3,510, (b) the current period taxable income and (c) the expectation of future earnings, thus concluding that it is more likely than not that the Company’s deferred tax assets will be realized.





11


For the six month period ended June 30, 2011, the effective tax rate was 52%.  The primary reason that the tax rate differs from the 34% Federal statutory corporate rate is the impact of permanent tax differences including meals and entertainment, stock compensation and state tax expense.  For the six month period ended June 30, 2010, before considering the impact of releasing the valuation allowance, the effective tax rate was 69%.  The primary reason that the tax rate differs from the 34% federal statutory corporate rate is the impact of permanent tax differences including meals and entertainment, stock compensation and non-deductible goodwill.  In addition, the Company released the valuation allowance in full and recognized an income tax benefit of $5,492.





9. Stockholders’ Equity





In January 2006, the Company issued warrants to the investment banker of the Stratasoft, Inc. sale to purchase up to 40,000 shares of common stock at an exercise price equal to $6 per share expiring January 27, 2011.  The warrants were exercised in full on January 26, 2011 by cashless exercise resulting in the issuance of 3,855 shares of common stock.





On January 5, 2010, the Company entered into a service agreement with an investor relations firm and per the terms of the agreement the Company issued to them 5,000 shares of Common Stock valued at $28 on February 1, 2010 and an additional 5,000 shares of Common Stock valued at $25 on July 1, 2010.  The Company recognized expense based on the fair value of the shares issued by multiplying the shares issued by the closing price per share on the respective date the shares were issued.





10. Commitments and Contingencies





On April 15, 2011, a former Company employee filed a lawsuit against INX in the State of California Superior Court, which was subsequently moved to United States District Court for the District of Southern California, alleging breach of contract, failure to pay all wages upon termination, retaliation, wrongful termination, and other claims.  The lawsuit seeks unspecified general, compensatory and punitive damages plus loss of earnings, interest, attorney fees, and costs of suit.   The Company believes the claims are without merit and is vigorously defending against them, and maintains insurance coverage applicable to certain allegations of the lawsuit.  However, the Company cannot predict the final outcome of this matter, including whether it could have a materially adverse effect on its results of operations, financial position, or cash flows.





On July 15, 2010, the Company filed a lawsuit in the United States District Court for the District of New Mexico (“US District Court”) styled “INX, Inc. v. Azulstar, Inc.” (“Azulstar”) seeking compensatory and punitive damages plus interest, attorney fees, and costs of suit for breach of contract, tortuous interference with business relations and existing contractual relations, and other allegations.  Azulstar provided professional services as a subcontractor to the Company in connection with the State of New Mexico, Department of Transportation RailRunner Wireless System Project (“RailRunner Project”).  Azulstar hired subcontractors to assist them and is alleged by the Company to not have paid those subcontractors for work performed.  In addition to paying Azulstar directly for all work performed except $23 held back, the Company paid Azulstar’s subcontractors $146 directly, charging the duplicate costs to professional services cost of sales in 2009.  On September 10, 2010, Azulstar filed a motion to dismiss the Company’s claim for failure to join a party under Rule 19 of the Federal Rules of Civil Procedure (“Motion to Dismiss”), which was denied.  The amount of damages and costs that may ultimately be recovered by the Company, if any, cannot be determined at this time.  The Motion to Dismiss includes statements that Azulstar intends to file breach of contract claims against the Company.  The nature and extent of Azulstar’s allegations cannot be determined and the final outcome of any lawsuit that may be filed by Azulstar on this matter cannot be predicted, including whether such threatened lawsuit could have a material adverse effect on INX’s results of operations or financial position.





The Company is also party to other litigation and claims which management believes are normal in the course of its operations. While the results of such litigation and claims cannot be predicted with certainty, the Company believes the final outcome of such matters will not have a materially adverse effect on its results of operations, financial position, or cash flows.





11.  Fair Value Measurements





Fair value is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants on the measurement date. When an asset or liability is required to be measured at fair value, an entity is required to maximize the use of observable inputs and minimize the use of unobservable inputs using a fair value hierarchy as follows:





Level 1: Observable inputs such as quoted prices for identical assets or liabilities in active markets.





12


Level 2: Observable inputs other than quoted prices that are directly or indirectly observable for the asset or liability, including quoted prices for similar assets or liabilities in active markets; quoted prices for similar or identical assets or liabilities in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.





Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.  Level 3 assets and liabilities include contingent consideration whose fair value is determined using projected income estimates for businesses acquired which require significant management judgment or estimation.





The carrying amount of cash and cash equivalents, receivables, accounts payable and accounts payable floor plan are a reasonable estimate of their fair values due to their short duration.





The Company’s financial instruments measured at fair value on a recurring basis that are subject to the hierarchy disclosure requirements are as follows:





Level 1


Level 2


Level 3


Total Fair ValueEstimated Contingent Consideration:Balance at December 31, 2010

$
—


$
—


$
133


$
133Adjustment of estimate


—



—



15



15Balance at June 30, 2011

$
—


$
—


$
148


$
148





Level 1


Level 2


Level 3


Total Fair ValueEstimated Contingent Consideration:Balance at December 31, 2009

$
—


$
—


$
1,411


$
1,411Adjustment of estimate


—



—



(254
)


(254
)Balance at June 30, 2010

$
—


$
—


$
1,157


$
1,157





The Company's other non-financial assets include goodwill, intangible assets and property and equipment, which are classified as Level 3 assets. These assets are measured at fair value on a non-recurring basis as part of the Company's impairment assessments and as circumstances require.





Fair Value Measurements UsingQuarter

Ended

June 30,


Quoted Prices in Active Markets for Identical Assets


Significant Other Observable Inputs


Significant Unobservable Inputs


Total GainsDescription

2011


(Level 1)


(Level 2)


(Level 3)


(Losses)Goodwill

$
12,490


$
—


$
—


$
12,490


$
(920
)Intangible assets, net


376



—



—



376



(268
)Property and equipment, net


5,300



—



—



5,300



—Total

















$
(1,188
)




Fair Value Measurements UsingQuarter

Ended

June 30,


Quoted Prices in Active Markets for Identical Assets


Significant Other Observable Inputs


Significant Unobservable Inputs


Total GainsDescription

2010


(Level 1)


(Level 2)


(Level 3)


(Losses)Goodwill

$
13,798


$
—


$
—


$
13,798


$
(594
)Intangible assets, net


1,387



—



—



1,387



—Property and equipment, net


4,787



—



—



4,487



—Total

















$
(594
)





13





Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations





The following discussion is qualified in its entirety by, and should be read in conjunction with, our consolidated financial statements, including the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended December 31, 2010. Amounts are presented in thousands except for share, percent and per share data.





Special notice regarding forward-looking statements





This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 relating to future events or our future financial performance. Readers are cautioned that any statement that is not a statement of historical fact including, but not limited to, statements which may be identified by words including, but not limited to, “anticipate,” “appear,” “believe,” “could,” “estimate,” “expect,” “hope,” “indicate,” “intend,” “likely,” “may,” “might,” “plan,” “potential,” “seek,” “should,” “will,” “would,” and other variations or negative expressions thereof, are predictions or estimations and are subject to known and unknown risks and uncertainties. Numerous factors, including factors that we have little or no control over, may affect INX’s actual results and may cause actual results to differ materially from those expressed in the forward-looking statements contained herein. In evaluating such statements, readers should consider the various factors identified in our Annual Report on Form 10-K for our fiscal year ended December 31, 2010, as filed with the Securities and Exchange Commission (“SEC”) including the matters set forth in Item 1A. — “Risk Factors,” which could cause actual events, performance or results to differ materially from those indicated by such statements.





Recently Adopted and New Accounting Pronouncements





In October 2009, the FASB amended the accounting standards for multiple deliverable revenue arrangements (formerly Emerging Issues Task Force No. 08-1) to:





·
provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the consideration should be allocated;


·
require an entity to allocate revenue in an arrangement using estimated selling prices (“ESP”) of deliverables if a vendor does not have vendor-specific objective evidence of selling price (“VSOE”) or third-party evidence of selling price (“TPE”); and


·
eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.





In October 2009, the FASB also amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry specific software revenue recognition guidance. We adopted the new guidance on a prospective basis as of the beginning of fiscal 2011 for revenue arrangements entered into or materially modified on or after January 1, 2011.





The new guidance generally did not change our units of accounting for revenue transactions as products and services qualified as separate units of accounting in most transactions under the historical guidance.  Under both the historical and new guidance, we have vendor-specific objective evidence (“VSOE”) of fair value for product and professional service deliverables and do not have VSOE or third-party evidence of fair value for managed services deliverables.  Because we did not have the ability to establish the fair value of managed services deliverables under historical guidance, multiple element arrangements that contain managed services were recognized ratably over the initial term of the managed services contract that is part of the arrangement because managed services are always the last element to be delivered in the arrangement.  The costs of products and services and commission costs directly related to multiple element arrangements containing managed services were deferred and recognized ratably over the initial term of the managed services contract.  Beginning January 1, 2011 for new or materially modified arrangements, we can establish the selling price for managed services using ESP and therefore account for all elements within multiple-element arrangements containing managed services as separate units of accounting.





Under the new guidance, we allocate the total arrangement consideration to each separable deliverable of an arrangement based upon the relative selling price of each deliverable and revenue is recognized upon delivery or completion of those units of accounting. As a result of adopting the new guidance, net revenues for the three month and six month periods ended June 30, 2011 were not materially different from the net revenues that would have been recorded under the historical accounting guidance.  We cannot reasonably estimate the effect of adopting the new guidance on future financial periods as the impact will vary depending on the nature and volume of new or materially modified multiple deliverable arrangements in any given period.





In May 2011, the FASB issued Accounting Standards Update 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, (“ASU 2011-04”).  ASU 2011-04 amends Accounting Standards Codification (“ASC”) 820, providing a consistent definition and measurement of fair value, as well as similar disclosure requirements between U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 changes certain fair value measurement principles, clarifies the application of existing fair value measurement and expands the ASC 820 disclosure requirements, particularly for Level 3 fair value measurements. ASU 2011-04 will be effective for interim and annual periods beginning after December 15, 2011. The adoption of ASU 2011-04 is not expected to have a material effect on our financial statements, but may require certain additional disclosures.




In June 2011, the FASB issued new guidance related to the presentation of comprehensive income. The guidance requires that all non-owner changes in stockholder’s equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements and eliminates the option for companies to present components of other comprehensive income as part of the statement of changes in stockholder’s equity. This becomes effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. We do not believe this will have a material impact on our disclosures.





14


Results Of Operations





Period Comparisons.The following tables set forth, for the periods indicated, certain financial data derived from our condensed statements of operations. Percentages shown in the table below are percentages of total revenue, except for the products and services components of gross profit, which are percentages of the respective product and service revenue.





Three Months Ended June 30, 2011 Compared To the Three Months Ended June 30, 2010





Three Months Ended June 30,2011


2010Amount


%


Amount


%Revenue:Products

$
104,802



89.6


$
74,263



88.4Services


12,108



10.4



9,792



11.6Total revenue


116,910



100.0



84,055



100.0Gross profit:Products


20,337



19.4



15,044



20.3Services


2,700



22.3



2,024



20.7Total gross profit


23,037



19.7



17,068



20.3Selling, general and administrative expenses


21,612



18.5



15,947



19.0Operating income


1,425



1.2



1,121



1.3Interest and other income (expense), net


24



—



(11
)


—Income tax expense (benefit)


864



0.7



(5,263
)


(6.2
)Net income

$
585



0.5


$
6,373



7.5





Revenue. Total revenue increased by $32,855, or 39.1%, to $116,910 from $84,055. Products revenue increased $30,539, or 41.1% to $104,802 from $74,263. The increase in products revenue was primarily due to higher sales in the North Texas ($14,780), Northwest ($5,858) and Gulf Coast ($4,708) regions, of which a significant portion was in the school district, health care, and energy industries.  Services revenue increased $2,316 or 23.7% to $12,108 from $9,792, primarily due to increases in the Gulf Coast ($1,188) and Northwest ($949) regions.





Gross Profit. Total gross profit increased by $5,969, or 35.0%, to $23,037 from $17,068 and gross profit as a percentage of revenue decreased to 19.7% from 20.3%. Gross profit on the products sales component increased $5,293 or 35.2%, to $20,337 from $15,044 and, as a percentage of sales, decreased to 19.4% from 20.3%, primarily due to a large volume, low margin orders in the school district and energy industries. Gross profit on services revenue increased $676 or 33.4% to $2,700 from $2,024 and gross profit as a percent of services revenue increased to 22.3% from 20.7%, primarily due to improved engineer utilization.





Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by $5,665, or 35.5% to $21,612 from $15,947.  As a percentage of total revenue, these expenses decreased to 18.5% in 2011 versus 19.0% in 2010.  Excluding restatement costs of $2,314 and $647 and impairment charges of $1,188 and $594 in 2011 and 2010, respectively, selling, general and administrative expenses represented 15.5% and 17.5% of total revenue in 2011 and 2010.  In addition to the restatement costs and impairment charge, 2011 expenses increased due to higher commissions on higher sales and increased bonuses.  In addition to the increased restatement costs and impairment charge, 2010 expenses were partially reduced by a $254 adjustment to estimated contingent purchase price consideration for the ANX acquisition and a $198 legal settlement.  The impairment charges are discussed further under “Impairment Charge” below.





Operating Income. Operating income increased $304 to $1,425 from $1,121, primarily due to the growth in sales and gross profit, partially offset by higher restatement costs, impairment charges and increased compensation related expenses.





15


Interest and Other Income(Expense), Net. Interest and other income (expense), net, increased by $35 to income of $24 from expense of $11.





Income Tax Expense (Benefit). Income tax expense (benefit) increased $6,127 to expense of $864 in 2011 compared to a benefit of $5,263 in 2010.  The 2010 income tax benefit was the result of the release of the valuation reserve in the second quarter of 2010 as discussed further under “Deferred Tax Assets” below.





Net Income. Net income decreased $5,788 to $585 from $6,373, primarily due to the release of the deferred tax valuation allowance in 2010 and higher restatement costs and impairment charges in 2011, partially offset by higher sales and gross profit in 2011.





Six Months Ended June 30, 2011 Compared To the Six Months Ended June 30, 2010





Six Months Ended June 30,2011


2010Amount


%


Amount


%Revenue:Products

$
173,002



88.3


$
135,164



87.7Services


22,862



11.7



18,939



12.3Total revenue


195,864



100.0



154,103



100.0Gross profit:Products


33,157



19.2



25,998



19.2Services


4,986



21.8



3,603



19.0Total gross profit


38,143



19.5



29,601



19.2Selling, general and administrative expenses


40,326



20.6



29,118



18.9Operating (loss) income


(2,183
)


(1.1
)


483



0.3Interest and other income, net


31



—



80



0.1Income tax benefit


(1,194
)


(0.6
)


(5,263
)


(3.4
)Net (loss) income

$
(958
)


(0.5
)

$
5,826



3.8





Revenue. Total revenue increased by $41,761, or 27.1%, to $195,864 from $154,103. Products revenue increased $37,838, or 28.0% to $173,002 from $135,164.  The increase in products revenue was primarily due to higher sales in the North Texas ($16,075), Central Texas ($8,886), Gulf Coast ($4,849), Northwest ($3,319), and New England ($3,497) regions, of which a significant portion was in the school district, health care, and energy industries.  Services revenue increased $3,923 or 20.7% to $22,862 from $18,939, primarily due to increases in the Gulf Coast ($1,378), Northwest ($1,191), New England ($425), and North Texas ($492) regions.





Gross Profit. Total gross profit increased by $8,542, or 28.9%, to $38,143 from $29,601 and gross profit as a percentage of revenue increased to 19.5% from 19.2%. Gross profit on the products sales component increased $7,159 or 27.5%, to $33,157 from $25,998 and, as a percentage of sales, was unchanged at 19.2%,. Gross profit on services revenue increased $1,383 or 38.4% to $4,986 from $3,603 and gross profit as a percent of services revenue increased to 21.8% from 19.0%, primarily due to improved engineer utilization.





Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by $11,208, or 38.5% to $40,326 from $29,118.  As a percentage of total revenue, these expenses increased to 20.6% in 2011 versus 18.9% in 2010.  Excluding restatement costs of $4,986 and $717 and impairment charges of $1,188 and $594 in 2011 and 2010, respectively, selling, general and administrative expenses represented 17.4% and 18.0% of total revenue in 2011 and 2010.  In addition to the restatement costs and impairment charge, 2011 expenses increased due to higher compensation related expenses.  2010 expenses were increased by restatement costs of $717 and a $594 impairment charge, partially offset by a $254 adjustment to estimated contingent purchase price consideration for the ANX acquisition and a $198 legal settlement.





Operating (Loss) Income. Operating (loss) income changed by $2,666 to a loss of $2,183 from income of $483, primarily due to the increased 2011 restatement costs of $4,269 and impairment charge of $594, partially offset by higher 2011 sales and gross profit.





Interest and Other Income, Net. Interest and other income, net, decreased by $49 to income of $31 from income of $80, primarily due to a special discount program in 2010 for payment of borrowings under our senior credit facility within the free interest period sponsored by Cisco.





Income Tax Benefit. Income tax benefit was $1,194 in 2011 compared to $5,263 in 2010.  An income tax benefit was recognized for the 2011 loss compared to the release of the valuation reserve in the second quarter of 2010 as discussed further under “Deferred Tax Assets” below.





16


Net (Loss) Income. Net (loss) income changed by $6,784 to a loss of $958 from income of $5,826, primarily due to the increased 2011 restatement costs and impairment charges and decrease in the income tax benefit, partially offset by higher 2011 sales and gross profit.





Impairment Charge.  During the second quarter of 2011, we performed an assessment of our Northern California reporting unit (“NCA”) as a result of 2011 operating performance being below forecast.  We performed a review of NCA’s second quarter bookings estimates, a review of its operating results compared to previous forecasts, and an evaluation of the NCA management team.  This review resulted in the termination of NCA’s manager during the second quarter of 2011.  As a result of this review and termination, management revised downward the forecasted future operating results of the NCA reporting unit, concluding that these factors were a triggering event requiring an interim second quarter  goodwill impairment test..  In connection with this triggering event, we tested the recoverability of NCA’s long-lived assets and concluded the carrying values of intangible assets were no longer recoverable. Consequently, during the second quarter of 2011, we recorded an impairment charge totaling $1,188 to reduce the carrying values of NCA’s goodwill and intangible assets to their estimated fair values, which was reported as a component of selling, general and administrative expenses.





During the first two quarters of 2010, NCA generated substantial operating losses compared to the operating income as forecasted in connection with the 2009 annual goodwill impairment assessment.  This financial underperformance triggered the need to perform an interim impairment test, resulting in a goodwill impairment charge of $594 recorded in selling, general and administrative expenses during the second quarter of 2010.





Deferred Tax Assets.In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences become deductible. Management considers the reversal of deferred tax liabilities, projected future income, and tax planning strategies in making this assessment. Management’s evaluation of the realizability of deferred tax assets must consider both positive and negative evidence. The weight given to the potential effects of positive and negative evidence is based on the extent to which it can be objectively verified.  As of June 30, 2010, the Company released the valuation allowance in full and recognized an income tax benefit of $5,492.  We reached this determination after giving consideration to a variety of factors including but not limited to:  (a) the current period realization of all net operating loss (NOL) carry forwards totaling $3,510, (b) the current period taxable income and (c) the expectation of future earnings, thus concluding that it is more likely than not that our deferred tax assets will be realized.





Liquidity and Capital Resources





Sources of Liquidity





Our principal sources of liquidity are collections from our accounts receivable and our credit facility with Castle Pines Capital LLC (the “Credit Facility”), which we believe are sufficient to meet our short-term and long-term liquidity requirements. We use the Credit Facility to finance the majority of our purchases of inventory and to provide working capital when our cash flow from operations is insufficient. Our working capital increased slightly to $20,844 at June 30, 2011 from $20,114 at December 31, 2010.





The total Credit Facility is $70,000 with an additional $10,000 credit facility specifically for acquisitions (“Acquisition Facility”).  CPC has authorized a temporary increase in the Credit Facility to $100,000 during the period from June 27, 2011 to September 30, 2011 to accommodate our current sales levels. Advances under the Acquisition Facility are specific to each acquisition and subject to approval by CPC based on pre-established criteria. There were no borrowings under the Acquisition Facility outstanding at June 30, 2011 or December 31, 2010.  The Credit Facility is collateralized by substantially all of our assets and is for a one year period with automatic one year renewals, except as otherwise provided.   Termination date of the senior credit facility was extended to December 31, 2011, subject to automatic annual renewal as defined in the Amendment.  We expect the Agreement to be extended under substantially similar terms.





As of June 30, 2011, borrowing capacity and availability were as follows:





Total Credit Facility

$
100,000Borrowing base limitation


—Total borrowing capacity


100,000Less interest-bearing borrowings


—Less non-interest bearing advances


(62,067
)Total unused availability

$
37,933





In addition to unused borrowing availability, liquidity at June 30, 2011 included our cash balance of $8,034. The “unused availability” is the amount not borrowed, but eligible to be borrowed. The borrowing base restrictions generally restrict our borrowings under the Credit Facility to 85% of the eligible receivables, 100% of our floor planned inventory and 75% of Cisco vendor rebates receivable.





17


We use the Credit Facility to finance purchases of Cisco products from Cisco and from certain wholesale distributors. Cisco provides 60-day terms, and other wholesale distributors typically provide 30-day terms. Balances under the Credit Facility that are within those respective 60-day and 30-day periods (the “Free Finance Period”) do not accrue interest and are classified as floor plan financing in our balance sheet. To the extent that we have credit availability under the Credit Facility, it gives us the ability to extend the payment terms past the Free Finance Period. Amounts extended past the Free Finance Period accrue interest and are classified as notes payable on our balance sheet, for which there was no balance outstanding at either June 30, 2011 or December 31, 2010.  The interest rate of the Credit Facility is the prime rate plus 0.5% (3.75% at June 30, 2011) and the interest rate of the Acquisition Facility is the prime rate plus 2.0% (5.25% at June 30, 2011).





As defined in the Credit Facility there are restrictive covenants measured at each quarter and year-end regarding minimum tangible net worth, maximum debt to tangible net worth ratio, and a minimum current ratio, with which we were in compliance at June 30, 2011. At June 30, 2011, we were operating under a waiver from CPC requiring compliance with the loan covenants we had not filed our required Form 10-Q for the quarterly period ended March 31, 2011, which was filed with the SEC on July 18, 2011.  If we violate any of the loan covenants, we would be required to seek waivers from CPC for those non-compliance events. If CPC refused to provide waivers, the amount due under the Credit Facility could be accelerated and we could be required to seek other sources of financing.





Cash Flows. During the six months ended June 30, 2011, our cash decreased by $4,055. Operating activities used cash of $22,779, investing activities used $2,075, and financing activities provided $20,799.





Operating Activities. Operating activities used $22,779 in the six months ended June 30, 2011, as compared to using cash of $10,581 in the comparable 2010 period. During the six months ended June 30, 2011, net income and noncash adjustments to net income used $285 and changes in asset and liability accounts used cash of $22,494, primarily due to increased accounts receivable resulting from higher sales. During the six months ended June 30, 2010, net income and noncash adjustments to net income provided cash of $2,527 and changes in asset and liability accounts used cash of $13,108, primarily due to increased accounts receivable resulting from higher sales.





Investing Activities. Investing activities used $2,075 in the six months ended June 30, 2011, compared to $2,022 used during the comparable period in 2010. Our investing activities primarily consisted of capital expenditures of $1,247 in 2011 and $1,023 in 2010 and additional cash purchase price for the NetTeks acquisition of $850 in 2011 and $1,000 in 2010. Capital expenditures in both years were primarily related to purchases of computer equipment and software.





Financing Activities. Financing activities provided $20,799 in the six months ended June 30, 2011, compared to providing $8,048 in the comparable 2010 period. Funds provided in the six months ended June 30, 2011 were primarily from net borrowings under the floor plan financing of $20,938 compared to funds used for net payments in the six months ended June 30, 2010 of $7,524.





Critical Accounting Policies





There were no significant changes during the six months ended June 30, 2011 to our critical accounting policies as disclosed in Part I, Item 7 of our 2010 Annual Report on Form 10-K, except for recently adopted accounting guidance as discussed in Note 3, “Recently Adopted and New Accounting Pronouncements” of Notes to Condensed Financial Statements in Part 1, Item I.  Also, there were no significant changes in our estimates associated with those policies.





Item 4. Controls and Procedures





INX management is responsible for establishing and maintaining effective disclosure controls and procedures, as such term is defined in Exchange Act Rule 13a-15(e).





Under the supervision and with the participation of certain members of our management, including our Chief Executive Officer and Chief Financial Officer, we completed an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)).  Based on this evaluation and as further set forth below, we believe our disclosure controls and procedures were not effective as of June 30, 2011.





As a result of the material weaknesses in our internal control over financial reporting identified as of December 31, 2010 and discussed below, we have concluded that our disclosure controls and procedures at June 30, 2011 were not effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC.





18


In addition to our material weaknesses in internal control over financial reporting as set forth in our management report below, we also determined that our disclosure controls and procedures had not been designed to ensure that information required to be disclosed by us in these reports was accumulated and communicated to our management, as appropriate, to allow timely decisions regarding required disclosures.  We determined that our disclosure controls were not effective, as follows:





1.
We have been over reliant on a few select employees, and have not developed and implemented sufficient management training programs to educate our key managers on matters related to the Exchange Act reporting and disclosure requirements.





2.
We did not have in place information and communication structures that were sufficient to ensure that reportable events regarding our business operations were communicated completely, accurately and timely as required by the Exchange Act.





Disclosure Controls and Procedures and Material Weaknesses Remediation Initiatives





The material weaknesses in our internal control over financial reporting and weaknesses in our disclosure controls and procedures were identified during the restatement of our prior period financial statements which was completed in June 2011. Our remediation efforts were commenced after the identification of the weaknesses, which were generally subsequent to June 30, 2011.





With respect to our training of management personnel, our remediation efforts will include, but not be limited to, the implementation of training programs for the appropriate key managers who are integral to our disclosure controls.  This training will include initial management training as well as on-going education on the reporting requirements of the Exchange Act.





With respect to improving our disclosure reporting structure and internal communication, our remediation efforts will include, but will not be limited to, designing, documenting and implementing processes to internally report, both on a periodic and routine on-going basis, items that could impact disclosure and reporting requirements that will keep management apprised of key events that may impact our reporting under the Exchange Act.





In light of the ineffectiveness of our disclosure controls and procedures described above, we performed additional procedures to ensure that our disclosures are presented in accordance with the requirements of the Exchange Act.  Accordingly, we believe that the information included in this report meets the requirements set forth in the Exchange Act.




The following material weaknesses in our system of internal controls over financial reporting were identified by management:





Revenue Accounting





As a result of our previously announced restatements, we identified the following material weaknesses with respect to our revenue accounting:





1.
We did not employ sufficiently qualified staff, and did not design sufficient documentation and review procedures to appropriately apply Accounting Standards Codification (“ASC”) 605-25 Revenue Recognition, Multiple-Element Arrangements, previously referred to as Emerging Issues Task Force (“EITF”) No. 00-21, Revenue Arrangements with Multiple Deliverables.





2.
We did not have sufficient procedures with respect to contract reviews to appropriately assess the impact of customer acceptance provisions when determining if delivery had occurred in order to recognize revenue.





3.
We did not have sufficient procedures to identify and assess product sales that should be accounted for on a net presentation basis in accordance with EITF 99-19, now ASC 605-45.  In addition, we lacked sufficient controls over our products database to monitor the appropriateness of any changes related to net/gross presentation.





4.
We did not have sufficient policies, procedures, training, or staffing criteria, with respect to our sales order entry process to correctly capture the applicable shipping terms for our sales transactions.





5.
We did not have sufficient policies and procedures, training, or staffing criteria, with respect to linking customer orders into arrangements when negotiated as a package and requiring, collecting and maintaining sufficient written documentation when consummating a customer order and proceeding with the sales order entry process.





6.
We did not effectively operate our control associated with the review of the service revenue accrual, resulting in computational errors.





In the 2010 Form 10-K filing and in the contemporaneously filed Form 10-Q’s for the first three quarters of 2010, we restated our financial statements for the 2008 quarterly and annual periods and the first three quarters of 2009.  With respect to the efforts we undertook to perform the revenue restatement we identified the following material weaknesses:





1.
We did not have sufficient procedures to test the software code we developed to perform certain calculations.





2.
We did not have sufficient procedures to control the accuracy and completeness of data uploaded into our database for calculation purposes.





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3.
We did not have sufficiently assess and apply certain aspects of EITF 00-21 to the particular facts and circumstances of our revenue arrangements.





Technical Accounting and Other





We identified the following additional material weaknesses.





Contingent Consideration Related to Business Acquisitions





We did not maintain effective internal controls to ensure the appropriate recording and reporting of certain business acquisition related payments. Specifically, our controls were not designed to ensure that the redistribution of such contingent acquisition-related payments from the selling shareholders to certain of our employees was correctly accounted for in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  In addition we did not adequately assess this GAAP accounting requirement. As a consequence, we did not correctly recognize non-cash expense for certain redistributed contingent acquisition-related payments which had already been correctly recognized as additional goodwill at the time of the payments.





Income Tax Valuation Allowance





We did not have sufficiently qualified staff to properly assess releasing the income tax valuation allowance.  We originally determined to maintain a full income tax valuation allowance against our net deferred tax assets based on our three year cumulative losses before taxes.  We did not adequately assess the other stronger evidence which when considered with the positive evidence  indicated a release of the valuation allowance was appropriate, including: (a) the realization of all net operating loss carry forwards, (b) the current period tax liability and (c) our expectations of future earnings.





Goodwill and Other Long-Lived Asset Valuations





We did not sufficiently design our internal controls to ensure that our goodwill and other long-lived asset valuation calculations were correct, as follows:





1.
We did not adequately document the assumptions used for our internal projections.





2.
Our internal financial model was not reviewed in detail by someone other than the preparer.





3.
We did not establish review procedures to adequately supervise and review the work of the outside valuation firm we hired to prepare the valuations.





4.
We did not establish a procedure to determine if the outside valuation firm retained by us had adequate controls and review procedures to assess the quality and accuracy of their own work prior to delivering their reports to us.





Management’s Internal Control Over Financial Reporting Remediation Initiatives





The material weaknesses in our internal control over financial reporting were identified during the restatement of our prior period financial statements which was completed in June 2011. Our remediation efforts were commenced after the identification of the weaknesses, which were generally subsequent to June 30, 2011.





Revenue Accounting





To address the material weaknesses related to our revenue accounting, our remediation efforts will include, but will not be limited to, the following.





Our efforts to remediate our revenue accounting material weaknesses will involve a holistic restructuring of our entire revenue accounting process beginning with sales order entry through cash collection.  We will develop policies and procedures including documentation requirements, for the entire revenue process, addressing both technical accounting matters and the related business processes.  We will hire appropriate staff, develop and implement training, and conduct routine assessments of compliance with our new procedures.





We intend to implement a solution that leverages the use of our technology resources, beginning with the tracking of sales opportunities and will include a database system that facilitates the contract review process, enables linkage of multiple customer orders into arrangements when negotiated as a package and documents delivery of orders.





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With respect to the service revenue accrual material weakness, we will implement an additional follow-up procedure to confirm the control as designed was performed, and we will modify access to underlying project reports to implement a cut-off control and prevent data changes.





Technical Accounting and Other





Contingent Consideration Related to Business Acquisitions





To address the material weaknesses in our accounting for contingent consideration related to our business acquisitions, our remediation efforts will include, but will not be limited to, the following:





1.
We will include a provision in our future business combination agreements requiring selling shareholders to timely inform us if any contingent consideration is redistributed to our employees, including a certification document to be executed at the time contingent consideration is disbursed.





2.
We will enhance our accounting capabilities and knowledge with respect to accounting for contingent consideration as required by GAAP.





3.
In future employment agreements with individuals that become employees as a result of business acquisitions, we will include a provision requiring disclosure to us with respect to their receipt of any redistributed acquisition related payments.





Income Tax Valuation Allowance





To address our material weakness with respect to the accounting for our income tax valuation allowance we will provide additional training to our staff and implement a review procedure to be performed by someone with the necessary knowledge and experience to correctly conclude on the assessment of the need for a valuation allowance.





Goodwill and Other Long-Lived Asset Valuations





To address our material weaknesses in our goodwill and other long-lived asset valuation calculations our remediation efforts will include, but not be limited to, the following:





1.
We will develop and implement a comprehensive set of documentation requirements regarding our forecast assumptions.





2.
We will develop and implement a detailed financial model review and approval process.





3.
We will develop and implement a detailed set of review procedures to assess the work product provided by our external valuation services firm.





4.
We will develop and implement procedures to assess the quality and completeness of the internal controls performed by our external valuation services firm prior to their delivery of work product to us.





We anticipate these actions will improve our internal control over financial reporting and will address the related material weaknesses identified above.  We are currently planning and initiating efforts to implement these improvements in our internal control over financial reporting.  However, because the institutionalization of the internal control process requires repeatable process execution, the successful execution of these controls, for at least several periods, may be required prior to management being able to definitively conclude that the material weaknesses have been fully remediated.





In light of the material weaknesses described above related to our internal control over financial reporting, we performed significant additional analysis and other post-closing procedures to ensure that our financial statements were prepared in accordance with generally accepted accounting principles.  Accordingly, we believe that the financial statements included in this report fairly present in all material respects, our financial condition, results of operations, changes in shareholders' equity and cash flows for the periods presented.





Changes in Internal Control over Financial Reporting





During the second quarter of 2011, there have been no changes in our internal controls over financial reporting that has materially affected, or is reasonably likely to affect, our internal control over financial reporting.





The certifications of INX's Principal Executive Officer and Principal Financial Officer attached as Exhibits 31.1 and 31.2 to this Quarterly Report on Form 10-Q include, in paragraph 4 of such certifications, information concerning INX's disclosure controls and procedures and internal controls over financial reporting. Such certifications should be read in conjunction with the information contained in this Item 4 for a more complete understanding of the matters covered by such certifications.





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PART II. OTHER INFORMATION





Item 1. Legal Proceedings





See Note 10 to condensed financial statements in Part I, Item 1, which is incorporated herein by reference.





Item 6. Exhibits





See exhibit list in the Index to Exhibits, which is incorporated herein by reference as the list of exhibits required as part of this report.








SIGNATURE





Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.





INX Inc.Date: August 15, 2011
By:
/s/ JAMES H. LONGJames H. LongExecutive Chairman andChief Financial Officer




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Index to Exhibits





Exhibit

No.

Description

Filed Herewith or

Incorporated by

Reference From:31.1

Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer

Filed herewith.31.2

Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer

Filed herewith.32.1

Section 1350 Certification of Principal Executive Officer

Filed herewith.32.2

Section 1350 Certification of Principal Financial Officer

Filed herewith.