##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2005
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from January 1, 2005 to September 30, 2005
 Commission file number: 1-31949
 I-Sector Corporation
  Delaware
    
    76-0515249(State of incorporation)
    
    (I.R.S. Employer Identification Number)
 6401 Southwest Freeway
Houston, Texas 77074
 (713) 795-2000
 þ o
 o þ
 o þ




---



I-Sector Corporation
 FORM 10-Q for the Quarter Ended September 30, 2005
INDEX
 Part I. Financial InformationItem 1. Financial Statements (Unaudited):Condensed Consolidated Statements of Operations for the three months ended September 30, 2004 and 2005Condensed Consolidated Statements of Operations for the nine months ended September 30, 2004 and 2005Condensed Consolidated Balance Sheets at December 31, 2004 and September 30, 2005Condensed Consolidated Statement of Stockholders Equity for the nine months ended September 30, 2005Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2005Notes to Condensed Consolidated Financial StatementsItem 2. Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3. Quantitative and Qualitative Disclosures about Market RiskItem 4. Controls and ProceduresPart II. Other InformationItem 1. Legal ProceedingsItem 6. ExhibitsSignatureCertification of PEO Pursuant to Rule 13a-14(a)Certification of PFO Pursuant to Rule 13a-14(a)Certification of PEO Pursuant to Section 1350Certification of PFO Pursuant to Section 1350
  2




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PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements (Unaudited):
  
    Three months ended September 30,2004
    
    
    2005Revenue:Products
    
    $
    27,255
    
    
    $
    32,802Services
    
    
    2,826
    
    
    
    5,495Custom projects
    
    
    2,531
    
    
    
    860Total revenue
    
    
    32,612
    
    
    
    39,157Cost of goods and services:Products
    
    
    23,331
    
    
    
    28,676Services
    
    
    1,849
    
    
    
    3,654Custom projects
    
    
    1,323
    
    
    
    526Total cost of goods and services
    
    
    26,503
    
    
    
    32,856Gross profit
    
    
    6,109
    
    
    
    6,301Selling, general and administrative expenses
    
    
    5,456
    
    
    
    6,321Operating income (loss)
    
    
    653
    
    
    
    (20
    )Interest and other income (expense), net
    
    
    17
    
    
    
    (180
    )Income (loss) from continuing operations before income taxes
    
    
    670
    
    
    
    (200
    )Income tax expense
    
    
    2
    
    
    
    29Net income (loss) from continuing operations before minority interest
    
    
    668
    
    
    
    (229
    )Minority interest
    
    
    (50
    )
    
    
    Net income (loss) from continuing operations
    
    
    618
    
    
    
    (229
    )Discontinued operations:Loss on disposal of discontinued operations, net of taxes
    
    
    
    
    
    
    (6
    )Net income (loss)
    
    $
    618
    
    
    $
    (235
    )Net income (loss) per share:Basic:Income (loss) from continuing operations before minority interest
    
    $
    0.13
    
    
    $
    (0.04
    )Minority interest
    
    
    (0.01
    )
    
    
    Loss on disposal of discontinued operations, net of taxes
    
    
    
    
    
    
    Net income (loss) per share
    
    $
    0.12
    
    
    $
    (0.04
    )Diluted:Income (loss) from continuing operations before minority interest
    
    $
    0.12
    
    
    $
    (0.04
    )Minority interest
    
    
    (0.01
    )
    
    
    Loss on disposal of discontinued operations, net of taxes
    
    
    
    
    
    
    Net income (loss) per share
    
    $
    0.11
    
    
    $
    (0.04
    )Shares used in computing net income (loss) per share:Basic
    
    
    5,148,837
    
    
    
    5,975,392Diluted
    
    
    5,547,912
    
    
    
    5,975,392
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Nine months ended September 30,2004
    
    
    2005Revenue:Products
    
    $
    54,058
    
    
    $
    84,728Services
    
    
    7,879
    
    
    
    12,301Custom projects
    
    
    6,837
    
    
    
    4,244Total revenue
    
    
    68,774
    
    
    
    101,273Cost of goods and services:Products
    
    
    46,472
    
    
    
    73,784Services
    
    
    5,187
    
    
    
    8,169Custom projects
    
    
    3,171
    
    
    
    2,247Total cost of goods and services
    
    
    54,830
    
    
    
    84,200Gross profit
    
    
    13,944
    
    
    
    17,073Selling, general and administrative expenses
    
    
    13,191
    
    
    
    23,452Operating income (loss)
    
    
    753
    
    
    
    (6,379
    )Interest and other income (expense), net
    
    
    10
    
    
    
    (255
    )Income (loss) from continuing operations before income taxes
    
    
    763
    
    
    
    (6,634
    )Income tax benefit
    
    
    
    
    
    
    4Net income (loss) from continuing operations before minority interest
    
    
    763
    
    
    
    (6,630
    )Minority interest
    
    
    (56
    )
    
    
    (23
    )Net income (loss) from continuing operations
    
    
    707
    
    
    
    (6,653
    )Discontinued operations:Gain on disposal of discontinued operations, net of taxes
    
    
    1
    
    
    
    58Net income (loss) before cumulative effect of change in accounting method
    
    
    708
    
    
    
    (6,595
    )Cumulative effect of change in application of percentage of completion method
    
    
    
    
    
    
    (566
    )Net income (loss)
    
    $
    708
    
    
    $
    (7,161
    )Net income (loss) per share:Basic:Income (loss) from continuing operations before minority interest
    
    $
    0.16
    
    
    $
    (1.19
    )Minority interest
    
    
    (0.01
    )
    
    
    Gain on disposal of discontinued operations, net of taxes
    
    
    
    
    
    
    0.01Cumulative effect of change in accounting method
    
    
    
    
    
    
    (0.10
    )Net income (loss) per share
    
    $
    0.15
    
    
    $
    (1.28
    )Diluted:Income (loss) from continuing operations before minority interest
    
    $
    0.15
    
    
    $
    (1.19
    )Minority interest
    
    
    (0.01
    )
    
    
    Gain on disposal of discontinued operations, net of taxes
    
    
    
    
    
    
    0.01Cumulative effect of change in accounting method
    
    
    
    
    
    
    (0.10
    )Net income (loss) per share
    
    $
    0.14
    
    
    $
    (1.28
    )Shares used in computing net income (loss) per share:Basic
    
    
    4,572,124
    
    
    
    5,613,614Diluted
    
    
    5,014,378
    
    
    
    5,613,614
  4




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December 31,
    
    
    September 30,2004
    
    
    2005(Unaudited)ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    4,773
    
    
    $
    1,091Accounts and notes receivable, net of allowance of $2,146 and $992
    
    
    30,127
    
    
    
    37,136Inventory
    
    
    1,159
    
    
    
    879Cost and estimated earnings in excess of billings
    
    
    1,663
    
    
    
    1,019Other current assets
    
    
    310
    
    
    
    282Total current assets
    
    
    38,032
    
    
    
    40,407Property and equipment, net of accumulated depreciation of $2,397 and $2,801
    
    
    1,787
    
    
    
    2,532Notes receivable, long-term, net of allowance of $250 and $0
    
    
    207
    
    
    
    56Goodwill
    
    
    
    
    
    
    7,136Intangible assets, net of accumulated amortization of $1,005 and $1,362
    
    
    1,113
    
    
    
    1,131Total Assets
    
    $
    41,139
    
    
    $
    51,262LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Notes payable and current portion of long-term debt
    
    $
    8,220
    
    
    $
    9,112Accounts payable
    
    
    10,675
    
    
    
    16,034Billings in excess of cost and estimated earnings
    
    
    63
    
    
    
    261Other current liabilities
    
    
    5,931
    
    
    
    7,094Total current liabilities
    
    
    24,889
    
    
    
    32,501Long-term debt
    
    
    122
    
    
    
    35Minority interest
    
    
    279
    
    
    
    Commitments and contingenciesStockholders Equity:Preferred stock, $.01 par value, 5,000,000 shares authorized, no shares issued
    
    
    
    
    
    
    Common stock, $.01 par value, 15,000,000 shares authorized, 5,201,354 and
5,976,926 shares issued
    
    
    52
    
    
    
    60Additional paid in capital
    
    
    17,513
    
    
    
    27,543Retained deficit
    
    
    (1,716
    )
    
    
    (8,877
    )Total stockholders equity
    
    
    15,849
    
    
    
    18,726Total Liabilities and Stockholders Equity
    
    $
    41,139
    
    
    $
    51,262
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$.01 par value
    
    
    AdditionalCommon Stock
    
    
    Paid-In
    
    
    RetainedShares
    
    
    Amount
    
    
    Capital
    
    
    Deficit
    
    
    TotalBalance at December 31, 2004
    
    
    5,201,354
    
    
    $
    52
    
    
    $
    17,513
    
    
    $
    (1,716
    )
    
    $
    15,849Exercise of common stock options
    
    
    157,414
    
    
    
    2
    
    
    
    207
    
    
    
    
    
    
    
    209Exchange of INX and I-Sector options
    
    
    
    
    
    
    
    
    
    
    5,729
    
    
    
    
    
    
    
    5,729Exchange of INX and I-Sector common stock
    
    
    244,890
    
    
    
    2
    
    
    
    1,528
    
    
    
    
    
    
    
    1,530Issuance of shares for Network Architects acquisition
    
    
    308,166
    
    
    
    3
    
    
    
    1,997
    
    
    
    
    
    
    
    2,000Issuance of shares for InfoGroup Northwest acquisition
    
    
    65,102
    
    
    
    1
    
    
    
    512
    
    
    
    
    
    
    
    513Issuance of stock options
    
    
    
    
    
    
    
    
    
    
    57
    
    
    
    
    
    
    
    57Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,161
    )
    
    
    (7,161
    )Balance at September 30, 2005
    
    
    5,976,926
    
    
    $
    60
    
    
    $
    27,543
    
    
    $
    (8,877
    )
    
    $
    18,726
  6




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Nine months ended September 30,2004
    
    
    2005CASH FLOWS FROM OPERATING ACTIVITIES:Net income (loss)
    
    $
    708
    
    
    $
    (7,161
    )Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:Net (gain) loss from discontinued operations
    
    
    2
    
    
    
    (58
    )Tax benefit from discontinued operations
    
    
    (1
    )
    
    
    (39
    )Minority interest
    
    
    56
    
    
    
    23Depreciation and amortization
    
    
    667
    
    
    
    800Loss on retirement of assets
    
    
    24
    
    
    
    31Bad debt expense
    
    
    164
    
    
    
    481Exchange of INX and I-Sector options
    
    
    
    
    
    
    5,729Issuance of stock options
    
    
    
    
    
    
    57Changes in operating assets and liabilities:Accounts and notes receivable
    
    
    (18,922
    )
    
    
    (7,339
    )Inventory
    
    
    138
    
    
    
    280Accounts payable
    
    
    5,651
    
    
    
    5,359Other assets and liabilities
    
    
    2,697
    
    
    
    2,130Net cash provided by (used in) operating activities
    
    
    (8,816
    )
    
    
    293CASH FLOWS FROM INVESTING ACTIVITIES:Acquisition of Network Architects, Corp.
    
    
    
    
    
    
    (2,300
    )Acquisition of InfoGroup Northwest, Inc.
    
    
    
    
    
    
    (1,900
    )Capital expenditures
    
    
    (912
    )
    
    
    (421
    )Net cash used in investing activities
    
    
    (912
    )
    
    
    (4,621
    )CASH FLOWS FROM FINANCING ACTIVITIES:Exercise of stock options
    
    
    86
    
    
    
    209Transaction costs paid for acquisitions
    
    
    
    
    
    
    (368
    )Proceeds from Unit offering
    
    
    7,547
    
    
    
    Payments on notes payable
    
    
    (2,972
    )
    
    
    (87
    )Notes payable  interest bearing borrowings on credit line
    
    
    7,319
    
    
    
    892Net cash provided by financing activities
    
    
    11,980
    
    
    
    646NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    2,252
    
    
    
    (3,682
    )CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    
    
    2,172
    
    
    
    4,773CASH AND CASH EQUIVALENTS AT END OF PERIOD
    
    $
    4,424
    
    
    $
    1,091SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:Cash paid for interest
    
    $
    55
    
    
    $
    274SUPPLEMENTAL NONCASH INVESTING AND FINANCING ACTIVITIES:Acquisition of INX minority interest:Issuance of common stock
    
    
    
    
    
    
    1,530Minority interest acquired
    
    
    
    
    
    
    (302
    )Acquisition of Network Architects, Corp.:Fair value of assets acquired
    
    
    
    
    
    
    4,300Common stock issued
    
    
    
    
    
    
    (2,000
    )Acquisition of InfoGroup Northwest, Inc.:Fair value of assets acquired
    
    
    
    
    
    
    2,400Common stock issued
    
    
    
    
    
    
    (500
    )Revaluation of options granted to consultants
    
    
    (200
    )
    
    
    Recognition of additional purchase price on Digital
Precision acquisition through issuance of INX common
stock
    
    
    234
    
    
    
    
  7




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##### Table of Contents



1. DESCRIPTION OF BUSINESS
  2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 Basis of Presentation
   Revenue Recognition
  Products Revenue.
 Services Revenue.
  8




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##### Table of Contents



Custom Project Revenue.
 December 31,
    
    
    September 30,2004
    
    
    2005Costs incurred on uncompleted contracts
    
    $
    1,675
    
    
    $
    1,748Estimated earnings
    
    
    4,862
    
    
    
    2,996Less: billings to date
    
    
    (4,937
    )
    
    
    (3,986
    )Total
    
    $
    1,600
    
    
    $
    758Included in accompanying balance sheets under the following captions:Cost and estimated earnings in excess of billings
    
    $
    1,663
    
    
    $
    1,019Billings in excess of cost and estimated earnings
    
    
    (63
    )
    
    
    (261
    )Total
    
    $
    1,600
    
    
    $
    758
 Vendor Incentives
  Stock-Based Compensation
   9




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##### Table of Contents



Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2004
    
    
    2005
    
    
    2004
    
    
    2005Compensation cost recognized in reported net income (loss), net of tax
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    5,786Basic and diluted:Net income (loss) as reported
    
    $
    618
    
    
    $
    (235
    )
    
    $
    708
    
    
    $
    (7,161
    )Deduct: total stock-based employee compensation determined under
fair value based method for all awards, net of related tax effects
    
    
    22
    
    
    
    67
    
    
    
    67
    
    
    
    607Pro forma net income (loss), basic
    
    
    596
    
    
    
    (302
    )
    
    
    641
    
    
    
    (7,768
    )Deduct: adjustment for subsidiary dilution
    
    
    41
    
    
    
    
    
    
    
    32
    
    
    
    Pro forma net income (loss), diluted
    
    $
    555
    
    
    $
    (302
    )
    
    $
    609
    
    
    $
    (7,768
    )Earnings
(loss) per share:Basic  as reported
    
    $
    0.12
    
    
    $
    (0.04
    )
    
    $
    0.15
    
    
    $
    (1.28
    )Basic  pro forma
    
    $
    0.12
    
    
    $
    (0.05
    )
    
    $
    0.14
    
    
    $
    (1.33
    )Diluted  as reported
    
    $
    0.11
    
    
    $
    (0.04
    )
    
    $
    0.14
    
    
    $
    (1.28
    )Diluted  pro forma
    
    $
    0.10
    
    
    $
    (0.05
    )
    
    $
    0.12
    
    
    $
    (1.33
    )
   
    
    The modified prospective method, which results in the recognition of
compensation expense using SFAS No. 123(R) for all share-based awards
granted after the effective date and the recognition of compensation
expense using SFAS No. 123 for all previously granted share-based
awards that remain unvested at the effective date; or
    
    The modified retrospective method, which results in applying the
modified prospective method and restating prior periods by recognizing
the financial statement impact of share-based payments in a manner
consistent with the pro forma disclosure requirements of SFAS No. 123.
The modified retrospective method may be applied to all prior periods
presented or previously reported interim periods of the year of
adoption.
   3. ACQUISITIONS
  Network Architects, Corp.
  10




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##### Table of Contents



InfoGroup Northwest, Inc.
    Network
    
    
    InfoGroupArchitects,
    
    
    Northwest,Corp.
    
    
    Inc.Allocated acquisition cost:Intangibles  customer relationships and noncompete agreements amortized over 3 years
    
    $
    241
    
    
    $
    134Fixed assets
    
    
    500
    
    
    
    297Transaction costs
    
    
    66
    
    
    
    135Goodwill
    
    
    3,559
    
    
    
    1,969Total acquisition cost
    
    $
    4,366
    
    
    $
    2,535
  Pro Forma Summary (Unaudited)
  11




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##### Table of Contents



Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2004
    
    
    2005
    
    
    2004
    
    
    2005Revenues
    
    $
    41,846
    
    
    $
    39,157
    
    
    $
    90,284
    
    
    $
    115,195Net income (loss) before cumulative effect
of change in accounting method
    
    $
    1,093
    
    
    $
    (235
    )
    
    $
    1,437
    
    
    $
    (6,029
    )Net income (loss)
    
    $
    1,093
    
    
    $
    (235
    )
    
    $
    1,437
    
    
    $
    (6,595
    )Earnings per share:Basic:Net income (loss) before cumulative
effect of change in accounting method
    
    $
    0.20
    
    
    $
    (0.04
    )
    
    $
    0.29
    
    
    $
    (1.01
    )Net income (loss)
    
    $
    0.20
    
    
    $
    (0.04
    )
    
    $
    0.29
    
    
    $
    (1.10
    )Diluted:Net income (loss) before cumulative
effect of change in accounting method
    
    $
    0.18
    
    
    $
    (0.04
    )
    
    $
    0.27
    
    
    $
    (1.01
    )Net income (loss)
    
    $
    0.18
    
    
    $
    (0.04
    )
    
    $
    0.27
    
    
    $
    (1.10
    )Weighted average shares used in calculation:Basic
    
    
    5,520,519
    
    
    
    6,347,074
    
    
    
    4,943,806
    
    
    
    5,985,296Diluted
    
    
    5,919,594
    
    
    
    6,347,074
    
    
    
    5,386,060
    
    
    
    5,985,296
 4. SEGMENT INFORMATION
   INX
    
    
    Stratasoft
    
    
    Valerent
    
    
    Corporate
    
    
    Eliminations
    
    
    ConsolidatedRevenue:Products
    
    $
    32,228
    
    
    $
    
    
    
    $
    576
    
    
    $
    
    
    
    $
    (2
    )
    
    $
    32,802Services
    
    
    4,241
    
    
    
    
    
    
    
    1,254
    
    
    
    
    
    
    
    
    
    
    
    5,495Custom projects
    
    
    
    
    
    
    860
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    860Total revenue
    
    
    36,469
    
    
    
    860
    
    
    
    1,830
    
    
    
    
    
    
    
    (2
    )
    
    
    39,157Gross profit:Products
    
    
    4,106
    
    
    
    
    
    
    
    20
    
    
    
    
    
    
    
    
    
    
    
    4,126Services
    
    
    1,349
    
    
    
    
    
    
    
    492
    
    
    
    
    
    
    
    
    
    
    
    1,841Custom projects
    
    
    
    
    
    
    334
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    334Total gross profit
    
    
    5,455
    
    
    
    334
    
    
    
    512
    
    
    
    
    
    
    
    
    
    
    
    6,301Selling, general and administrative expenses
    
    
    4,326
    
    
    
    1,224
    
    
    
    552
    
    
    
    219
    
    
    
    
    
    
    
    6,321Operating income (loss)
    
    $
    1,129
    
    
    $
    (890
    )
    
    $
    (40
    )
    
    $
    (219
    )
    
    $
    
    
    
    
    (20
    )Interest and other income (expense), net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (180
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29Net loss on disposal of discontinued
operations, net of taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (235
    )
  INX
    
    
    Stratasoft
    
    
    Valerent
    
    
    Corporate
    
    
    Eliminations
    
    
    ConsolidatedRevenue:Products
    
    $
    27,179
    
    
    $
    
    
    
    $
    288
    
    
    $
    
    
    
    $
    (212
    )
    
    $
    27,255Services
    
    
    1,516
    
    
    
    
    
    
    
    1,310
    
    
    
    
    
    
    
    
    
    
    
    2,826Custom projects
    
    
    
    
    
    
    2,531
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,531Total revenue
    
    
    28,695
    
    
    
    2,531
    
    
    
    1,598
    
    
    
    
    
    
    
    (212
    )
    
    
    32,612Gross profit:Products
    
    
    3,928
    
    
    
    
    
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    3,924Services
    
    
    417
    
    
    
    
    
    
    
    560
    
    
    
    
    
    
    
    
    
    
    
    977Custom projects
    
    
    
    
    
    
    1,208
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,208Total gross profit
    
    
    4,345
    
    
    
    1,208
    
    
    
    556
    
    
    
    
    
    
    
    
    
    
    
    6,109
 12




---



##### Table of Contents



INX
    
    
    Stratasoft
    
    
    Valerent
    
    
    Corporate
    
    
    Eliminations
    
    
    ConsolidatedSelling, general and administrative expenses
    
    
    3,332
    
    
    
    1,419
    
    
    
    522
    
    
    
    183
    
    
    
    
    
    
    
    5,456Operating income (loss)
    
    $
    1,013
    
    
    $
    (211
    )
    
    $
    34
    
    
    $
    (183
    )
    
    $
    
    
    
    
    653Interest and other income, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2Minority interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (50
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    618
  INX
    
    
    Stratasoft
    
    
    Valerent
    
    
    Corporate
    
    
    Eliminations
    
    
    ConsolidatedRevenue:Products
    
    $
    83,376
    
    
    $
    
    
    
    $
    1,376
    
    
    $
    
    
    
    $
    (24
    )
    
    $
    84,728Services
    
    
    8,571
    
    
    
    
    
    
    
    3,730
    
    
    
    
    
    
    
    
    
    
    
    12,301Custom projects
    
    
    
    
    
    
    4,244
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,244Total revenue
    
    
    91,947
    
    
    
    4,244
    
    
    
    5,106
    
    
    
    
    
    
    
    (24
    )
    
    
    101,273Gross profit:Products
    
    
    10,923
    
    
    
    
    
    
    
    21
    
    
    
    
    
    
    
    
    
    
    
    10,944Services
    
    
    2,649
    
    
    
    
    
    
    
    1,483
    
    
    
    
    
    
    
    
    
    
    
    4,132Custom projects
    
    
    
    
    
    
    1,997
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,997Total gross profit
    
    
    13,572
    
    
    
    1,997
    
    
    
    1,504
    
    
    
    
    
    
    
    
    
    
    
    17,073Selling, general and administrative expenses
    
    
    10,937
    
    
    
    4,181
    
    
    
    1,672
    
    
    
    6,662
    
    
    
    
    
    
    
    23,452Operating income (loss)
    
    $
    2,635
    
    
    $
    (2,184
    )
    
    $
    (168
    )
    
    $
    (6,662
    )
    
    $
    
    
    
    
    (6,379
    )Interest and other income (expense), net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (255
    )Income tax benefit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4Minority interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (23
    )Net gain on disposal of discontinued
operations, net of taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    58Cumulative effect of change in application
of percentage of completion method
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (566
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (7,161
    )
  INX
    
    
    Stratasoft
    
    
    Valerent
    
    
    Corporate
    
    
    Eliminations
    
    
    ConsolidatedRevenue:Products
    
    $
    53,594
    
    
    $
    
    
    
    $
    1,127
    
    
    $
    
    
    
    $
    (663
    )
    
    $
    54,058Services
    
    
    4,054
    
    
    
    
    
    
    
    3,825
    
    
    
    
    
    
    
    
    
    
    
    7,879Custom projects
    
    
    
    
    
    
    6,837
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,837Total revenue
    
    
    57,648
    
    
    
    6,837
    
    
    
    4,952
    
    
    
    
    
    
    
    (663
    )
    
    
    68,774Gross profit:Products
    
    
    7,521
    
    
    
    
    
    
    
    65
    
    
    
    
    
    
    
    
    
    
    
    7,586Services
    
    
    1,221
    
    
    
    
    
    
    
    1,471
    
    
    
    
    
    
    
    
    
    
    
    2,692Custom projects
    
    
    
    
    
    
    3,666
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,666Total gross profit
    
    
    8,742
    
    
    
    3,666
    
    
    
    1,536
    
    
    
    
    
    
    
    
    
    
    
    13,944Selling, general and administrative expenses
    
    
    7,534
    
    
    
    3,570
    
    
    
    1,398
    
    
    
    689
    
    
    
    
    
    
    
    13,191Operating income (loss)
    
    $
    1,208
    
    
    $
    96
    
    
    $
    138
    
    
    $
    (689
    )
    
    $
    
    
    
    
    753Interest and other income, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10Minority interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (56
    )Net gain on disposal of discontinued
operations, net of taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    708
 5. CHANGE IN APPLICATION OF ACCOUNTING METHOD
  13




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##### Table of Contents



6. EARNINGS PER SHARE
   Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2004
    
    
    2005
    
    
    2004
    
    
    2005Numerator
for basic earnings (loss) per share:Net income (loss) from continuing operations before minority interest
    
    $
    668
    
    
    $
    (229
    )
    
    $
    763
    
    
    $
    (6,630
    )Minority interest
    
    
    (50
    )
    
    
    
    
    
    
    (56
    )
    
    
    (23
    )Gain (loss) on disposal of discontinued operations, net of taxes
    
    
    
    
    
    
    (6
    )
    
    
    1
    
    
    
    58Cumulative effect of change in accounting method
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (566
    )Net income (loss)
    
    $
    618
    
    
    $
    (235
    )
    
    $
    708
    
    
    $
    (7,161
    )Numerator for diluted earnings per share:Net income (loss) from continuing operations before minority interest
    
    $
    668
    
    
    $
    (229
    )
    
    $
    763
    
    
    $
    (6,630
    )Minority interest
    
    
    (50
    )
    
    
    
    
    
    
    (56
    )
    
    
    (23
    )INX income attributable to potential
minority interest net loss from continuing operations used in computing loss per share
    
    
    (41
    )
    
    
    
    
    
    
    (32
    )
    
    
    Gain (loss) on disposal of discontinued operations, net of taxes
    
    
    
    
    
    
    (6
    )
    
    
    1
    
    
    
    58Cumulative effect of change in accounting method
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (566
    )Net income (loss)
    
    $
    577
    
    
    $
    (235
    )
    
    $
    676
    
    
    $
    (7,161
    )Denominator for basic earnings per share  weighted-average shares
outstanding
    
    
    5,148,837
    
    
    
    5,975,392
    
    
    
    4,572,124
    
    
    
    5,613,614Effect of dilutive securities  shares issuable from assumed
conversion of common stock options and restricted stock
    
    
    399,075
    
    
    
    
    
    
    
    442,254
    
    
    
    Denominator for diluted earnings per share  weighted-average
shares outstanding
    
    
    5,547,912
    
    
    
    5,975,392
    
    
    
    5,014,378
    
    
    
    5,613,614
 14




---



##### Table of Contents



7. STOCKHOLDERS EQUITY
 Elimination of Minority Interest in INX
  Common Stock Repurchase Plan
  Warrants
   8. STOCK OPTION PLANS
   15




---



##### Table of Contents



Weighted AveShares
    
    
    Exercise PriceOptions outstanding at beginning of the period
    
    
    652,921
    
    
    $
    3.37Granted during the period
    
    
    218,500
    
    
    $
    6.25INX options assumed at conversion rate
    
    
    1,123,103
    
    
    $
    1.15Exercised during the period
    
    
    (157,414
    )
    
    $
    1.31Cancelled during the period
    
    
    (20,000
    )
    
    $
    7.86Options outstanding at end of period
    
    
    1,817,110
    
    
    $
    2.52Options exercisable at end of period
    
    
    1,569,912
    
    
    $
    1.89Options outstanding price range
    
    $
    0.01 to $7.76Weighted average fair value of options granted during the period
    
    $
    6.25Options weighted average remaining life
    
    7.06 Years
 Outstanding
    
    
    ExercisableWeightedAverage
    
    
    Weighted
    
    
    
    
    
    
    WeightedRemaining
    
    
    Average
    
    
    
    
    
    
    AverageOutstanding
    
    
    Contractual
    
    
    Exercise
    
    
    Exercisable
    
    
    ExerciseShares
    
    
    Life
    
    
    Price
    
    
    Shares
    
    
    Price$0.01 to $0.99
    
    
    98,747
    
    
    
    5.34
    
    
    $
    0.10
    
    
    
    98,747
    
    
    $
    0.10$1.00 to $1.99
    
    
    1,165,730
    
    
    
    6.52
    
    
    
    1.33
    
    
    
    1,152,497
    
    
    
    1.33$2.00 to $3.99
    
    
    97,200
    
    
    
    7.34
    
    
    
    2.61
    
    
    
    97,200
    
    
    
    2.61$4.00 to $6.99
    
    
    231,933
    
    
    
    8.26
    
    
    
    4.62
    
    
    
    179,801
    
    
    
    4.75$7.00 to $7.76
    
    
    233,500
    
    
    
    9.28
    
    
    
    7.59
    
    
    
    41,667
    
    
    
    7.55Total
    
    
    1,817,110
    
    
    
    7.06
    
    
    $
    2.52
    
    
    
    1,569,912
    
    
    $
    1.89
 9. FLOORPLAN LINE OF CREDIT
  
    
    Extends the term of the $25 million floorplan line of credit facility to September 9,
2007, unless terminated earlier as provided in the Amendment. Inventory and accounts
receivable for the Dallas Independent School District (DISD) are excluded from the
availability calculation under the facility except as provided under the multiple advance
working capital credit facility.
    
    Provides a working capital revolving line of credit under the above floorplan facility
with an aggregate outstanding principal sublimit of $10 million.
    
    Provides a multiple advance working capital credit facility under the floorplan line in
the maximum amount of $4 million for a term of 60 days with the outstanding principal
balance not to exceed 30% of eligible DISD receivables.
    
    Charges interest payable monthly at the rate of prime plus .5% on revolving credit loans
and prime plus 2.5% on multiple advance working capital loans.
    
    Amends certain restrictive covenants.
  16




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##### Table of Contents



10. DISCONTINUED OPERATIONS
 Telecom and Computer Products Divisions
  Stratasoft and Valerent Subsidiaries
   Pro FormaLess
    
    
    Less
    
    
    AdjustmentsActual
    
    
    Stratasoft
    
    
    Valerent
    
    
    (a)
    
    
    Pro FormaRevenue
    
    $
    39,157
    
    
    $
    (860
    )
    
    $
    (1,830
    )
    
    $
    
    
    
    $
    36,467Cost of goods and services
    
    
    32,856
    
    
    
    (526
    )
    
    
    (1,318
    )
    
    
    
    
    
    
    31,012Gross profit
    
    
    6,301
    
    
    
    (334
    )
    
    
    (512
    )
    
    
    
    
    
    
    5,455Selling, general and administrative expenses
    
    
    6,321
    
    
    
    (1,224
    )
    
    
    (552
    )
    
    
    257
    
    
    
    4,802Operating income (loss)
    
    
    (20
    )
    
    
    890
    
    
    
    40
    
    
    
    (257
    )
    
    
    653Interest and other income, net
    
    
    (180
    )
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    (178
    )Income (loss) from continuing operations before income taxes
    
    
    (200
    )
    
    
    892
    
    
    
    40
    
    
    
    (257
    )
    
    
    475Income tax expense
    
    
    29
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29Net income (loss) from continuing operations
    
    $
    (229
    )
    
    $
    892
    
    
    $
    40
    
    
    $
    (257
    )
    
    $
    446Net income (loss) from continuing operations per share:Basic
    
    $
    (0.04
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    0.07Diluted
    
    $
    (0.04
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    0.07Shares used in computing net income (loss) per share:Basic
    
    
    5,975,392
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,975,392Diluted
    
    
    5,975,392
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,975,392
 17




---



##### Table of Contents



Pro FormaLess
    
    
    Less
    
    
    AdjustmentsActual
    
    
    Stratasoft
    
    
    Valerent
    
    
    (a)
    
    
    Pro FormaRevenue
    
    $
    101,273
    
    
    $
    (4,244
    )
    
    $
    (5,106
    )
    
    $
    
    
    
    $
    91,923Cost of goods and services
    
    
    84,200
    
    
    
    (2,247
    )
    
    
    (3,602
    )
    
    
    
    
    
    
    78,351Gross profit
    
    
    17,073
    
    
    
    (1,997
    )
    
    
    (1,504
    )
    
    
    
    
    
    
    13,572Selling, general and administrative expenses
    
    
    23,452
    
    
    
    (4,181
    )
    
    
    (1,672
    )
    
    
    876
    
    
    
    18,475Operating income (loss)
    
    
    (6,379
    )
    
    
    2,184
    
    
    
    168
    
    
    
    (876
    )
    
    
    (4,903
    )Interest and other income, net
    
    
    (255
    )
    
    
    7
    
    
    
    
    
    
    
    
    
    
    
    (248
    )Income (loss) from continuing operations before income taxes
    
    
    (6,634
    )
    
    
    2,191
    
    
    
    168
    
    
    
    (876
    )
    
    
    (5,151
    )Income tax benefit
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )Minority interest
    
    
    (23
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (23
    )Net income (loss) from continuing operations
    
    $
    (6,653
    )
    
    $
    2,191
    
    
    $
    168
    
    
    $
    (876
    )
    
    $
    (5,170
    )Net loss from continuing operations per share:Basic
    
    $
    (1.19
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (0.92
    )Diluted
    
    $
    (1.19
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (0.92
    )Shares used in computing net
loss per share:Basic
    
    
    5,613,614
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,613,614Diluted
    
    
    5,613,614
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,613,614
  Pro FormaLess
    
    
    Less
    
    
    AdjustmentsActual
    
    
    Stratasoft
    
    
    Valerent
    
    
    (a)
    
    
    Pro FormaRevenue
    
    $
    93,069
    
    
    $
    (8,996
    )
    
    $
    (6,942
    )
    
    $
    
    
    
    $
    77,131Cost of goods and services
    
    
    73,117
    
    
    
    (4,150
    )
    
    
    (4,777
    )
    
    
    
    
    
    
    64,190Gross profit
    
    
    19,952
    
    
    
    (4,846
    )
    
    
    (2,165
    )
    
    
    
    
    
    
    12,941Selling, general and administrative expenses
    
    
    18,254
    
    
    
    (5,100
    )
    
    
    (1,886
    )
    
    
    894
    
    
    
    12,162Operating income (loss)
    
    
    1,698
    
    
    
    254
    
    
    
    (279
    )
    
    
    (894
    )
    
    
    779Interest and other income, net
    
    
    (108
    )
    
    
    12
    
    
    
    
    
    
    
    
    
    
    
    (96
    )Income (loss) from continuing operations before income taxes
    
    
    1,590
    
    
    
    266
    
    
    
    (279
    )
    
    
    (894
    )
    
    
    683Income tax benefit
    
    
    19
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19Minority interest
    
    
    (117
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (117
    )Net income (loss) from continuing operations
    
    $
    1,492
    
    
    $
    266
    
    
    $
    (279
    )
    
    $
    (894
    )
    
    $
    585Net income from continuing operations per share:Basic
    
    $
    0.33
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    0.13Diluted
    
    $
    0.30
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    0.12Shares used
in computing net income per share:Basic
    
    
    4,569,507
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,569,507Diluted
    
    
    5,004,393
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,004,393
 18




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##### Table of Contents



Pro FormaLess
    
    
    Less
    
    
    AdjustmentsActual
    
    
    Stratasoft
    
    
    Valerent
    
    

(b)
    
    
    Pro FormaASSETSCurrent Assets:Cash and cash equivalents
    
    $
    1,091
    
    
    $
    40
    
    
    $
    46
    
    
    $
    
    
    
    $
    1,177Accounts and notes receivable
    
    
    37,136
    
    
    
    (537
    )
    
    
    (1,193
    )
    
    
    
    
    
    
    35,406Inventory
    
    
    879
    
    
    
    (459
    )
    
    
    (55
    )
    
    
    
    
    
    
    365Cost and estimated earnings in excess of billings
    
    
    1,019
    
    
    
    (629
    )
    
    
    
    
    
    
    
    
    
    
    390Investment in subsidiaries held for sale
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,044
    
    
    
    1,044Other current assets
    
    
    282
    
    
    
    (18
    )
    
    
    (6
    )
    
    
    
    
    
    
    258Total current assets
    
    
    40,407
    
    
    
    (1,603
    )
    
    
    (1,208
    )
    
    
    1,044
    
    
    
    38,640Property and equipment, net
    
    
    2,532
    
    
    
    (53
    )
    
    
    (12
    )
    
    
    (299
    )
    
    
    2,168Notes receivable, long-term, net
    
    
    56
    
    
    
    (61
    )
    
    
    
    
    
    
    5
    
    
    
    Goodwill
    
    
    7,136
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,136Intangible assets, net
    
    
    1,131
    
    
    
    (662
    )
    
    
    
    
    
    
    
    
    
    
    469Total Assets
    
    $
    51,262
    
    
    $
    (2,379
    )
    
    $
    (1,220
    )
    
    $
    750
    
    
    $
    48,413LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Notes payable and current portion of long-term debt
    
    $
    9,112
    
    
    $
    (91
    )
    
    $
    
    
    
    $
    
    
    
    $
    9,021Accounts payable
    
    
    16,034
    
    
    
    (192
    )
    
    
    (465
    )
    
    
    
    
    
    
    15,377Billings in excess of cost and estimated earnings
    
    
    261
    
    
    
    (196
    )
    
    
    
    
    
    
    
    
    
    
    65Other current liabilities
    
    
    7,094
    
    
    
    (1,340
    )
    
    
    (532
    )
    
    
    
    
    
    
    5,222Total current liabilities
    
    
    32,501
    
    
    
    (1,819
    )
    
    
    (997
    )
    
    
    
    
    
    
    29,685Long-term debt
    
    
    35
    
    
    
    (33
    )
    
    
    
    
    
    
    
    
    
    
    2Intercompany balances
    
    
    
    
    
    
    (6,322
    )
    
    
    (4,187
    )
    
    
    10,509
    
    
    
    Stockholders Equity:Common stock
    
    
    60
    
    
    
    (531
    )
    
    
    
    
    
    
    531
    
    
    
    60Additional paid in capital
    
    
    27,543
    
    
    
    (1
    )
    
    
    (201
    )
    
    
    202
    
    
    
    27,543Retained deficit
    
    
    (8,877
    )
    
    
    6,327
    
    
    
    4,165
    
    
    
    (10,492
    )
    
    
    (8,877
    )Total stockholders equity
    
    
    18,726
    
    
    
    5,795
    
    
    
    3,964
    
    
    
    (9,759
    )
    
    
    18,726Total Liabilities and Stockholders Equity
    
    $
    51,262
    
    
    $
    (2,379
    )
    
    $
    (1,220
    )
    
    $
    750
    
    
    $
    48,413
 
 (a)
    
    Pro Forma Condensed Consolidated Statements of Operations Adjustments:
 
    
    The adjustments to selling, general and administrative expenses for all periods
presented represent corporate expenses allocated to discontinued subsidiaries that are not
expected to be eliminated. The continuing corporate expenses are allocated accounting and
information systems department costs and allocated insurance premiums.
    
    Interest expense for discontinued operations represents interest on external debt
incurred specifically for such operations. No intercompany interest expense is reflected
in the pro forma presentation.
    
    Income tax expense is not charged to net income from continuing operations for all
periods presented due to the accumulated net operating loss carryforward for federal income
tax purposes of approximately $2.2 million at September 30, 2005.
    
    The pro forma presentation reflects the impact of the planned actions on the results
from continuing operations. The cumulative effect of the change in application of
accounting method discussed in Note 5 impacts only the discontinued Stratasoft subsidiary.
 (b)
    
    Pro Forma Condensed Consolidated Balance Sheet Adjustments:
 
    
    The pro forma adjustment transferring net property and equipment of $299 to investment
in subsidiaries held for sale represents computer equipment, furniture, and other equipment
solely used by the discontinued subsidiaries, maintained on the books of I-Sector.
    
    Pro forma adjustments to intercompany accounts, additional paid in capital, and retained
earnings represent the reclassification of the net I-Sector investment in subsidiaries held
for sale.
 19




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##### Table of Contents



11. RECLASSIFICATIONS
  
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
  Special notice regarding forward-looking statements
  General
   
    
    Planned sale of two business units
    
    Proposed name change and elimination of holding company structure
    
    Acquisitions completed during the second quarter of 2005
    
    Elimination of minority interest in INX
    
    Change in application of an accounting principle for the Stratasoft business unit that
was subsequently discontinued in the fourth quarter of 2005.
 Planned Sale of Two Business Units
   20




---



##### Table of Contents



Proposed Name Change and Elimination of Holding Company Structure
  Acquisitions
  Network Architects, Corp.
   InfoGroup Northwest, Inc.
   21




---



##### Table of Contents



Elimination of Minority Interest in INX
      Change in the Application of Accounting Method for Stratasoft Projects
   Results Of Operations
 Overview
 Sources of Revenue.
 22




---



##### Table of Contents



Gross Profit and Gross Profit Margin
 23




---



##### Table of Contents



Selling, General and Administrative Expenses
  Tax Loss Carryforward.
 Period Comparisons.
 24




---



##### Table of Contents



Three months ended September 30,2004
    
    
    2005Amount
    
    
    %
    
    
    Amount
    
    
    %(Dollars in thousands)RevenueINX product
    
    $
    27,179
    
    
    
    83.3
    
    
    $
    32,228
    
    
    
    82.3INX service
    
    
    1,516
    
    
    
    4.6
    
    
    
    4,241
    
    
    
    10.8Total INX revenue
    
    
    28,695
    
    
    
    87.9
    
    
    
    36,469
    
    
    
    93.1Stratasoft  Custom projects
    
    
    2,531
    
    
    
    7.8
    
    
    
    860
    
    
    
    2.2Valerent product
    
    
    288
    
    
    
    .9
    
    
    
    576
    
    
    
    1.5Valerent service
    
    
    1,310
    
    
    
    4.0
    
    
    
    1,254
    
    
    
    3.2Total Valerent revenue
    
    
    1,598
    
    
    
    4.9
    
    
    
    1,830
    
    
    
    4.7Eliminations revenue
    
    
    (212
    )
    
    
    (.6
    )
    
    
    (2
    )
    
    
    0.0Total revenue
    
    
    32,612
    
    
    
    100.0
    
    
    
    39,157
    
    
    
    100.0Gross profit:INX product
    
    
    3,928
    
    
    
    14.5
    
    
    
    4,106
    
    
    
    12.7INX service
    
    
    417
    
    
    
    27.5
    
    
    
    1,349
    
    
    
    31.8Total INX gross profit
    
    
    4,345
    
    
    
    15.1
    
    
    
    5,455
    
    
    
    15.0Stratasoft  Custom projects
    
    
    1,208
    
    
    
    47.7
    
    
    
    334
    
    
    
    38.8Valerent product
    
    
    (4
    )
    
    
    (1.4
    )
    
    
    20
    
    
    
    3.5Valerent service
    
    
    560
    
    
    
    42.7
    
    
    
    492
    
    
    
    39.2Total Valerent gross profit
    
    
    556
    
    
    
    34.8
    
    
    
    512
    
    
    
    28.0Total gross profit
    
    
    6,109
    
    
    
    18.7
    
    
    
    6,301
    
    
    
    16.1Selling, general and administrative expenses:INX
    
    
    3,332
    
    
    
    11.6
    
    
    
    4,326
    
    
    
    11.9Stratasoft
    
    
    1,419
    
    
    
    56.1
    
    
    
    1,224
    
    
    
    142.3Valerent
    
    
    522
    
    
    
    32.7
    
    
    
    552
    
    
    
    30.2Corporate
    
    
    183
    
    
    
    N/A
    
    
    
    219
    
    
    
    N/ATotal selling, general and administrative expenses
    
    
    5,456
    
    
    
    16.7
    
    
    
    6,321
    
    
    
    16.1Operating income (loss):INX
    
    
    1,013
    
    
    
    3.5
    
    
    
    1,129
    
    
    
    3.1Stratasoft
    
    
    (211
    )
    
    
    (8.3
    )
    
    
    (890
    )
    
    
    (103.5
    )Valerent
    
    
    34
    
    
    
    2.1
    
    
    
    (40
    )
    
    
    (2.2
    )Corporate
    
    
    (183
    )
    
    
    N/A
    
    
    
    (219
    )
    
    
    N/ATotal operating (loss) income
    
    
    653
    
    
    
    2.0
    
    
    
    (20
    )
    
    
    (0.0
    )Interest and other income (expense), net
    
    
    17
    
    
    
    0.1
    
    
    
    (180
    )
    
    
    (0.5
    )Income (loss) from continuing operations before income taxes
    
    
    670
    
    
    
    2.1
    
    
    
    (200
    )
    
    
    (0.5
    )Income tax benefit
    
    
    2
    
    
    
    0.0
    
    
    
    29
    
    
    
    0.1Net income (loss) from continuing operations before minority interest
    
    
    668
    
    
    
    2.1
    
    
    
    (229
    )
    
    
    (0.6
    )Minority interest
    
    
    (50
    )
    
    
    (0.2
    )
    
    
    
    
    
    
    0.0Loss on disposal of discontinued operations, net of taxes
    
    
    
    
    
    
    0.0
    
    
    
    (6
    )
    
    
    0.0Net income (loss)
    
    $
    618
    
    
    
    1.9
    
    
    $
    (235
    )
    
    
    (0.6
    )
 Three Months Ended September 30, 2004 Compared To the Three Months Ended September 30, 2005
 Revenue
    25




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##### Table of Contents



Gross Profit
    Selling, General and Administrative Expenses
  Operating Profit (Loss)
 Interest and Other Income (Expense), Net
 Loss on disposal of discontinued operations, net of tax.
 Net income (loss)
 26




---



##### Table of Contents



Nine months ended September 30,2004
    
    
    2005Amount
    
    
    %
    
    
    Amount
    
    
    %(Dollars in thousands)RevenueINX product
    
    $
    53,594
    
    
    
    77.9
    
    
    $
    83,376
    
    
    
    82.3INX service
    
    
    4,054
    
    
    
    5.9
    
    
    
    8,571
    
    
    
    8.5Total INX revenue
    
    
    57,648
    
    
    
    83.8
    
    
    
    91,947
    
    
    
    90.8Stratasoft  Custom projects
    
    
    6,837
    
    
    
    9.9
    
    
    
    4,244
    
    
    
    4.2Valerent product
    
    
    1,127
    
    
    
    1.6
    
    
    
    1,376
    
    
    
    1.4Valerent service
    
    
    3,825
    
    
    
    5.6
    
    
    
    3,730
    
    
    
    3.6Total Valerent revenue
    
    
    4,952
    
    
    
    7.2
    
    
    
    5,106
    
    
    
    5.0Eliminations revenue
    
    
    (663
    )
    
    
    (0.9
    )
    
    
    (24
    )
    
    
    (0.0
    )Total revenue
    
    
    68,774
    
    
    
    100.0
    
    
    
    101,273
    
    
    
    100.0Gross profit:INX product
    
    
    7,521
    
    
    
    14.0
    
    
    
    10,923
    
    
    
    13.1INX service
    
    
    1,221
    
    
    
    30.1
    
    
    
    2,649
    
    
    
    30.9Total INX gross profit
    
    
    8,742
    
    
    
    15.2
    
    
    
    13,572
    
    
    
    14.8Stratasoft  Custom projects
    
    
    3,666
    
    
    
    53.6
    
    
    
    1,997
    
    
    
    47.1Valerent product
    
    
    65
    
    
    
    5.8
    
    
    
    21
    
    
    
    1.5Valerent service
    
    
    1,471
    
    
    
    38.5
    
    
    
    1,483
    
    
    
    39.8Total Valerent gross profit
    
    
    1,536
    
    
    
    31.0
    
    
    
    1,504
    
    
    
    29.5Total gross profit
    
    
    13,944
    
    
    
    20.3
    
    
    
    17,073
    
    
    
    16.9Selling, general and administrative expenses:INX
    
    
    7,534
    
    
    
    13.1
    
    
    
    10,937
    
    
    
    11.9Stratasoft
    
    
    3,570
    
    
    
    52.2
    
    
    
    4,181
    
    
    
    98.5Valerent
    
    
    1,398
    
    
    
    28.2
    
    
    
    1,672
    
    
    
    32.7Corporate
    
    
    689
    
    
    
    N/A
    
    
    
    6,662
    
    
    
    N/ATotal selling, general and administrative expenses
    
    
    13,191
    
    
    
    19.2
    
    
    
    23,452
    
    
    
    23.2Operating income (loss):INX
    
    
    1,208
    
    
    
    2.1
    
    
    
    2,635
    
    
    
    2.9Stratasoft
    
    
    96
    
    
    
    1.4
    
    
    
    (2,184
    )
    
    
    (51.5
    )Valerent
    
    
    138
    
    
    
    2.8
    
    
    
    (168
    )
    
    
    (3.3
    )Corporate
    
    
    (689
    )
    
    
    N/A
    
    
    
    (6,662
    )
    
    
    N/ATotal operating (loss) income
    
    
    753
    
    
    
    1.1
    
    
    
    (6,379
    )
    
    
    (6.3
    )Interest and other income (expense), net
    
    
    10
    
    
    
    0.0
    
    
    
    (255
    )
    
    
    (0.3
    )Income (loss) from continuing operations before income taxes
    
    
    763
    
    
    
    1.1
    
    
    
    (6,634
    )
    
    
    (6.6
    )Income tax benefit
    
    
    
    
    
    
    0.0
    
    
    
    (4
    )
    
    
    (0.0
    )Net income (loss) from continuing operations before minority interest
    
    
    763
    
    
    
    1.1
    
    
    
    (6,630
    )
    
    
    (6.6
    )Minority interest
    
    
    (56
    )
    
    
    (0.1
    )
    
    
    (23
    )
    
    
    (0.0
    )Gain on disposal of discontinued operations, net of taxes
    
    
    1
    
    
    
    0.0
    
    
    
    58
    
    
    
    0.1Net income (loss) before change in accounting method
    
    
    708
    
    
    
    1.0
    
    
    
    (6,595
    )
    
    
    (6.5
    )Cumulative effect of change in application of percentage of completion method
    
    
    
    
    
    
    
    
    
    
    (566
    )
    
    
    (0.6
    )Net income (loss)
    
    $
    708
    
    
    
    1.0
    
    
    $
    (7,161
    )
    
    
    (7.1
    )
 Nine Months Ended September 30, 2004 Compared To the Nine Months Ended September 30, 2005
 Revenue
   27




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##### Table of Contents



Gross Profit
    Selling, General and Administrative Expenses
  
    
    Selling, general, and administrative expenses of locations acquired in the second quarter of 2005 were $1,226 and primarily consisted of sales and administrative wages, commissions, and related payroll taxes.
    
    Management and administrative compensation expense increased $6,682 exclusive of expenses at acquired locations due to the one-time noncash charge of $5,729 related to option remeasurement associated with the INX minority interest exchange, increased administrative and management salaries and wages of $890 related primarily to hiring additional personnel, acquisition related bonuses of $60, and nonqualified stock option expense of $57.
    
    Sales compensation increased $1,017 exclusive of expenses at acquired locations due to increased commissions generated from the increased gross profit dollars and additional personnel hired to generate continued revenue growth.
    
    General office expenses increased $384 exclusive of expenses at acquired locations due to increased printing, advertising, and office supplies costs directly related to the generally increased size of the organization.
    
    Rent, insurance, other occupancy costs, and telecommunications costs increased $252 exclusive of expenses at acquired locations primarily due to the relocation of our Dallas, Texas office facility and the addition of the San Antonio, Texas office in mid-2004 and INX growth.
    
    Bad debt expense increased $224 primarily due to an increase in the allowance in the Stratasoft segment.
    
    Professional fees increased $166 due to Sarbanes-Oxley consulting services.
    
    Travel increased $112 primarily due to increased INX travel related to acquisitions activity.
 28




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##### Table of Contents



Operating Profit (Loss)
 Interest and Other Income (Expense), Net
 Minority interest
 Gain on disposal of discontinued operations, net of tax.
 Cumulative Effect of Change in Accounting Method.
 Net income (loss)
 Liquidity and Capital Resources
 Sources of Liquidity
  Accounts and Notes Receivable.
  29




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##### Table of Contents



Inventory.
 Contractual Obligations
  Payments Due by PeriodLessThan
    
    
    13
    
    
    45Contractual Obligations
    
    Total
    
    
    1 Year
    
    
    Years
    
    
    Years(Dollars in thousands)Lease obligations
    
    $
    2,061
    
    
    $
    890
    
    
    $
    994
    
    
    $
    177Other debt obligations
    
    
    132
    
    
    
    91
    
    
    
    41
    
    
    
    Total contractual cash obligations
    
    $
    2,193
    
    
    $
    981
    
    
    $
    1,035
    
    
    $
    177
   Textron Facility.
   
    
    Extends the term of the $25 million floorplan line of credit facility to September 9,
2007, unless terminated earlier as provided in the Amendment. Inventory and accounts
receivable for the Dallas Independent School District (DISD) are excluded from the
availability calculation under the facility except as provided under the multiple advance
working capital credit facility.
    
    Provides a working capital revolving line of credit under the above floorplan facility
with an aggregate outstanding principal sublimit of $10 million.
 
 30




---



##### Table of Contents




    
    Provides a multiple advance working capital credit facility under the floorplan line in
the maximum amount of $4 million for a term of 60 days with the outstanding principal
balance not to exceed 30% of eligible DISD receivables.
    
    Charges interest payable monthly at the rate of prime plus .5% on revolving credit loans
and prime plus 2.5% on multiple advance working capital loans.
    
    Amends certain restrictive covenants.
    
    
    maintain Minimum Tangible Capital Funds of $10.5 million, which is defined to be the sum
of cash, receivables, inventory and fixed net assets, minus total liabilities, with total
liabilities being defined as accounts payable, accrued expenses and short- and long-term
notes payable;
    
    maintain a maximum Debt to Tangible Capital Funds ratio of 4.0 to 1;
    
    maintain Minimum Working Capital of not less than $8.0 million;
    
    maintain a Current Ratio at September 30, 2005 of not less than 1.15 to 1.0 and not less than 1.25 to 1.0 thereafter; and
    
    achieve Earnings before Interest Expense, Taxes, Depreciation and Amortization (EBITDA)
exceeding $100,000 for the quarter ended September 30, 2005 and exceeding $300,000 quarterly
thereafter.
  Cash Flows.
 Operating Activities.
  
    
    Increase in accounts payable of $5,359 and decrease in inventory of $280, which related
primarily to increased purchases of Cisco products for sales by INX, was offset by the
$7,339 increase in accounts receivable. Although overall receivables increased due to
increased sales, the days in sales outstanding decreased by 20 days from 108 days at
December 31, 2004 (using the exhaustive method of calculation) to 88 days at September 30,
2005 primarily due to collections of amounts related to an INX E-Rate program funded project
relating to a school district.
 31




---



##### Table of Contents




    
    Contracts in progress which, decreased $842 due to a $644 decrease in the cost and
estimated earnings in excess of billings and an $198 increase in billings in excess of cost
and estimated earnings, which was primarily due to the lower Stratasoft revenues discussed
above .
    
    The $1,337 increase in accrued expense is primarily related to accruing for sales
commissions, wages and bonuses; third party commissions and professional fees, which
increased consistent with the increase in sales.
 Investing Activities.
 Financing Activities.
 Related Party Transactions
   
 Item 3. Quantitative and Qualitative Disclosures about Market Risk
   
 Item 4. Controls and Procedures
    32




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##### Table of Contents




    
    Performed a review at September 30, 2005 and will review at the end of
each future accounting period all open projects to ensure all significant contractor
liabilities are accrued.
    
    Modified our timekeeping system procedures to input time of all
individual outside contractors paid based on time.
    
    Modified our purchase order procedures to input outside contractor
commitments paid based on fixed rates.
    
 PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
   
 Item 6. Exhibits
 31.1
    
    Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer31.2
    
    Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer32.1
    
    Section 1350 Certification of Principal Executive Officer32.2
    
    Section 1350 Certification of Principal Financial Officer
 
   I-Sector Corporation.Date: November 14, 2005
    
    By:
    
    /s/ BRIAN FONTANABrian Fontana, Vice Presidentand Chief Financial Officer
 
 33




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##### Table of Contents



Index to Exhibits
 31.1
    
    Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer31.2
    
    Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer32.1
    
    Section 1350 Certification of Principal Executive Officer32.2
    
    Section 1350 Certification of Principal Financial Officer
 34