UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-Q





(Mark One)





x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934





For the quarterly period ended March 31, 2011





 ̈
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT OF 1934





For the transition period from _______ to _______





Commission file number 000-51720





InferX Corporation


(Exact name of registrant as specified in its charter)





Delaware

54-1614664(State or other jurisdiction of incorporation or

organization)

(I.R.S. Employer Identification No.)





46950 Jennings Farm DriveSuite 290Sterling, Virginia

20164-8679(Address of principal executive offices)

(Zip Code)





(703) 444-6030


(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 x




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.




Large accelerated filer o

Accelerated filer oNon-accelerated filer o

Smaller reporting company x(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 Act). Yes  ̈No x




As of May 11, 2011 there were 17,669,383 outstanding shares of the registrant’s common stock, $.0001 par value.







INFERX CORPORATION


CONDENSED CONSOLIDATED BALANCE SHEETS


MARCH 31, 2011 (UNAUDITED) AND DECEMBER 31, 2010




MARCH 31,


DECEMBER 31,2011


2010(UNAUDITED)ASSETSCURRENT ASSETSCash

$
61,148


$
32,828Accounts receivable


605,444



534,720Total current assets


666,592



567,548Fixed assets, net of depreciation


17,092



22,606Other AssetsOther assets


6,000



6,000Computer software development costs, net of amortization


-



-Total other asset


6,000



6,000TOTAL ASSETS

$
689,684


$
596,154LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)CURRENT LIABILITIESAccounts payable and accrued expenses

$
2,722,279


$
2,528,497Line of credit


341,587



341,587Related party payable


725,000



725,000Current portion of notes payable, related party


50,600



50,600Current portion of convertible notes payable


50,000



30,000Convertible debenture


240,000



260,000Derivative liability


120,000



414,000Liability for stock to be issued - common stock


76,455



44,750Current portion of notes payable


28,050



63,250Total current liabilities


4,353,971



4,457,684Long-term LiabilitiesNotes payable, net of current portion


334,689



341,357TOTAL LIABILITIES


4,688,660



4,799,041STOCKHOLDERS' EQUITY (DEFICIT)Preferred stock, par value $0.0001 per share, 10,000,000 shares authorized andno shares issued and outstanding


-



-Common stock, par value $0.0001 per share, 400,000,000 shares authorized and17,669,383 and 17,292,996 shares issued and outstanding, respectively


1,767



1,729Additional paid-in capital


708,541



534,188Retained earnings (defict)


(4,709,284
)


(4,738,804
)Total stockholders' equity (deficit)


(3,998,976
)


(4,202,887
)TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

$
689,684


$
596,154





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




2




INFERX CORPORATION


CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)


FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010




THREE MONTHS ENDEDMARCH 31,2011


2010REVENUE

$
1,031,336


$
1,392,058COST OF REVENUESDirect labor and other finges


147,709



296,564Subcontractor


510,534



994,602Other direct costs


16,684



21,977Amortization of computer software development costs


-



16,222Total costs of revenues


674,927



1,329,365GROSS PROFIT


356,409



62,693OPERATING EXPENSESIndirect and overhead labor and fringes


367,311



374,527Professional fees


73,954



108,790Business development costs


1,409



11,357Rent


22,446



25,350Advertising and promotion


6,776



25,165General and administrative


28,239



37,343Stock based compensation


99,641



-Depreciation


5,514



8,415Total operating expenses


605,290



590,947NET LOSS FROM OPERATIONS BEFORE OTHER EXPENSE ANDPROVISION FOR INCOME TAXES


(248,881
)


(528,254
)OTHER INCOME (EXPENSE)Amortization of debt discount


-



(41,497
)Fair value adjustment on derivative liability


294,000



(112,500
)Interest expense, net of interest income


(15,599
)


(9,489
)Total other income (expense)


278,401



(163,486
)NET INCOME (LOSS) FROM OPERATIONS BEFORE PROVISIONFOR INCOME TAXES


29,520



(691,740
)Provision for income taxes


-



-NET INCOME (LOSS) APPLICABLE TO SHARES

$
29,520


$
(691,740
)NET EARNINGS (LOSS) PER SHARE - BASIC

$
0.00


$
(0.18
)NET EARNINGS (LOSS) PER SHARE - DILUTED

$
-


$
(0.18
)WEIGHTED AVERAGE NUMBER OFSHARES OUTSTANDING


17,496,831



3,920,645





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




3




INFERX CORPORATION


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)


FOR THE THREE MONTHS ENDED MARCH 31, 2011 AND 2010




THREE MONTHS ENDEDMARCH 31,2011


2010CASH FLOWS FROM OPERATING ACTIVITIES:Net income (loss)

$
29,520


$
(691,740
)Adjustments to reconcile net income (loss)to net cash (used in) operating activities:Services rendered for promissory note


-



40,000Stock based compensation


99,641



-Fair value adjustment for derivative liability


(294,000
)


112,500Amortization of debt discount


-



41,497Amortization of computer software development costs


-



16,222Depreciation


5,514



8,415Change in assets and liabilities(Increase) decrease in accounts receivable


(70,724
)


(111,349
)(Increase) decrease in other current assets


-



(750
)Increase in accounts payable and accrued expenses


212,237



551,719Total adjustments


(47,332
)


658,254Net cash (used in) operating activities


(17,812
)


(33,486
)CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds received for shares of common stock and stock liability


68,000



-Proceeds received from note payable, net


(21,868
)


-(Repayment) of line of credit, net


-



(7,500
)Net cash provided by (used in) financing activities


46,132



(7,500
)NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS


28,320



(40,986
)CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD


32,828



49,989CASH AND CASH EQUIVALENTS - END OF PERIOD

$
61,148


$
9,003SUPPLEMENTAL INFORMATION OF CASH FLOW ACTIVITYCash paid during the year for interest

$
6,167


$
-Cash paid during the year for income taxes

$
-


$
-SUPPLEMENTAL INFORMATION OF NONCASH ACTIVITYConversion of accounts payable and accrued expenses for common stockand additional paid in capital or stock liability

$
5,600


$
-Conversion of convertible debentures and accrued interest for common stockand additional paid in capital or stock liability

$
32,855


$
-





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




4


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010





NOTE 1-
ORGANIZATION AND BASIS OF PRESENTATION




The unaudited condensed consolidated financial statements included herein have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  The condensed consolidated financial statements and notes are presented as permitted on Form 10-Q and do not contain information included in the Company’s annual statements and notes.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading.  It is suggested that these condensed consolidated financial statements be read in conjunction with the December 31, 2010 audited financial statements and the accompanying notes thereto.  While management believes the procedures followed in preparing these condensed consolidated financial statements are reasonable, the accuracy of the amounts are in some respects dependent upon the facts that will exist, and procedures that will be accomplished by the Company later in the year.




These unaudited condensed consolidated financial statements reflect all adjustments, including normal recurring adjustments which, in the opinion of management, are necessary to present fairly the consolidated operations and cash flows for the periods presented.




Black Nickel Acquisition Corporation I was incorporated in Delaware on May 26, 2005, and was formed as a vehicle to pursue a business combination. From inception through October 24, 2006, Black Nickel Acquisition Corporation I, was engaged in organizational efforts and obtaining initial financing.




On May 17, 2006, Black Nickel Acquisition Corporation I entered into a letter of intent with InferX Corporation, a privately-held Virginia corporation (“InferX Virginia”), with respect to entering into a merger transaction relating to bridge financing for InferX Virginia and the acquisition of and merger with InferX Virginia.  The transaction closed on October 24, 2006.  Following the merger, Black Nickel Acquisition Corporation I effected a short-form merger of InferX Virginia with and into Black Nickel Acquisition Corporation I, pursuant to which the separate existence of InferX Virginia terminated and Black Nickel Acquisition Corporation I changed its name to InferX Corporation (“InferX” or the “Company”).




The transaction was recorded as a recapitalization under the purchase method of accounting, as InferX became the accounting acquirer.  The reported amounts and disclosures contained in the consolidated financial statements are those of InferX Corporation, the operating company.




InferX was incorporated under the laws of Delaware in 1999.  On December 31, 2005, InferX and Datamat Systems Research, Inc. (“Datamat”), a company incorporated in 1992 under the corporate laws of the Commonwealth of Virginia executed an Agreement and Plan of Merger (the “Merger”).  InferX and Datamat had common majority directors.  The financial statements herein reflect the combined entity, and all intercompany transactions and accounts have been eliminated.  As a result of the Merger, InferX merged with and into Datamat, the surviving entity.  Upon completion, Datamat changed its name to InferX Corporation.




InferX was formed to develop and commercially market computer applications software systems that were initially developed by Datamat with grants from the Missile Defense Agency.  Datamat was formed as a professional services research and development firm, specializing in the Department of Defense.  The Company provided services and software to the United States government and to commercial entities as well.




On March 16, 2009, the Company entered into an agreement and plan of reorganization (the “Merger Agreement”) with the Irus Group, Inc. (“Irus”) under which it effected a reverse triangular merger between Irus and the Company’s wholly-owned subsidiary, Irus Acquisition Corp. (formed for the purse of completing this transaction).  The Merger Agreement was then amended on June 15, 2009 (the “First Amended and Restated Agreement”) to reflect the change in the amount of the shares issued to Irus in the transaction.




5


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010





NOTE 1-
ORGANIZATION AND BASIS OF PRESENTATION(CONTINUED)




Under the terms of the First Amended and Restated Agreement, the issued and outstanding shares of Irus common stock was automatically converted into the right to receive 56% of the issued and outstanding shares of the Company’s common stock.




The Merger Agreement also provides that, at the effective time of the Merger, the Company’s Board of Directors agreed to appoint Vijay Suri, President and CEO of the Company and have Vijay Suri fill a vacancy on its Board of Directors.  In addition, effectiveness of the Merger Agreement is conditional upon (i) the Company restructuring existing debt by converting the existing debt and warrants to common stock with the intention of having no more than 57-60 million shares of its common stock outstanding prior to a reverse split of not less than 1:10; (ii) the Company using its best efforts to reduce its accounts payable by 70%, (iii) Vijay Suri, President and CEO of The Irus Group executing an employment agreement with the Company, and (iv) additional customary closing conditions relating to delivery of financial statements, closing certificates as to representations and warranties, and the delivery of any required consents or government approvals.




In accordance with the merger, the Company on July 27, 2009 filed a Schedule 14C with the Securities and Exchange Commission.  The Schedule 14C, contained 2 proposals; to increase the authorized common shares from 75,000,000 to 400,000,000 and to reverse split the common stock on a 1:20 basis.  All share and per share amounts have been presented on a post-split basis.




On October 27, 2009, the Company and Irus completed the Merger.  As consideration for the Merger, the Company issued 9,089,768 shares of common stock to Vijay Suri, the sole stockholder of Irus.  As part of their employment agreements signed on 27 October 2009, both Vijay Suri and B.K. Gogia, each were issued 1,000,000 shares of preferred stock.  On June 2, 2010, the Board rescinded the 1,000,000 shares of preferred stock and issued Vijay Suri and B.K. Gogia 1,000,000 shares of common stock in recognition of their personal guarantee of certain corporate debt of the Company.




Irus was a consulting firm advising on the planning, implementation and development of complex business intelligence and corporate performance management systems.  Irus has successfully implemented projects across a broad cross-section of clients in the government, financial services, retail, manufacturing, and telecommunications markets.  Irus has provided business solutions for many large clients, including MasterCard, JP Morgan Chase, ConAgra, and the US Navy, and collaborated with a wide range of technology partners including Oracle, IBM/Cognos and Microsoft.




The Merger with Irus was accounted for as a recapitalization under the purchase method of accounting, as Irus became the accounting acquirer.  The reported amounts and disclosures contained in the consolidated financial statements are those of Irus, the operating company.  In the transaction, Irus did assume the technology of the Company as well as the liabilities.




Effective July 1, 2009, the Company adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 105-10, Generally Accepted Accounting Principles – Overall (“ASC 105-10”). ASC 105-10 establishes the FASB Accounting Standards Codification (the “Codification”) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with U.S. GAAP. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority. The Codification superseded all existing non-SEC accounting and reporting standards. All other non-grandfathered, non-SEC accounting literature not included in the Codification is non-authoritative. The FASB will not issue new standards in the form of Statements, FASB Positions or Emerging Issue Task Force Abstracts. Instead, it will issue Accounting Standards Updates (“ASUs”).




6


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010





NOTE 1-
ORGANIZATION AND BASIS OF PRESENTATION(CONTINUED)




The FASB will not consider ASUs as authoritative in their own right. ASUs will serve only to update the Codification, provide background information about the guidance and provide the bases for conclusions on the change(s) in the Codification. References made to FASB guidance throughout this document have been updated for the Codification.




Going Concern




As shown in the accompanying condensed consolidated financial statements the Company has incurred a gain of $29,520 for the three months ended March 31, 2011, and has a working capital deficiency of $3,687,379 as of March 31, 2011.  The Company’s loss from operations has seen a significant improvement on a quarter over quarter basis due to improved expense control, less use of subcontractors as a percentage of revenue, and improved debt position.  The principal reasons for the recurring losses and working capital deficiency relates to the Company’s continued focus on consolidating operations directly related to the merger, as well as refining its products and search for profitable government contracts and the continued uncertainty in the commercial market due to the recent national down-turn in business and available capital to the firm.  The Company expects the negative cash flow from operations to continue its trend through the next twelve months, however the Company continues to expand the pipeline of contracts.  These factors continue to raise doubt about the ability of the Company to continue as a going concern.




Management’s plans to address these conditions include continued efforts to expand the firm’s current business backlog, by obtaining new government contracts, as well as commercial contracts through expanding sources and new technology, and the raising of additional capital through the sale of the Company’s stock.  Additionally, the executive management team has put into place an aggressive cost and expense savings spending plan to identify and eliminate costs which are directly impacting profitability.




The Company’s long-term success is dependent upon the obtainment of sufficient capital to fund its operations; development of its products; and launching its products to the worldwide market.  These factors will contribute to the Company’s obtaining sufficient sales volume to be profitable.  To achieve these objectives, the Company may be required to raise additional capital through public or private financings or other arrangements.




It cannot be assured that such financings will be available on terms attractive to the Company, if at all.  Such financings may be dilutive to existing stockholders and may contain restrictive covenants.




The Company is subject to certain risks common to technology-based companies in similar stages of development.  Principal risks to the Company include uncertainty of growth in market acceptance for its products; history of losses in recent years; ability to remain competitive in response to new technologies; costs to defend, as well as risks of losing patent and intellectual property rights; reliance on limited number of suppliers; reliance on outsourced manufacture of its products for quality control and product availability; uncertainty of demand for its products in certain markets; ability to manage growth effectively; dependence on key members of its management; and its ability to obtain adequate capital to fund future operations.




The condensed consolidated financial statements do not include any adjustments relating to the carrying amounts of recorded assets or the carrying amounts and classification of recorded liabilities that may be required should the Company be unable to continue as a going concern.




7


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010





NOTE 2-
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Principles of Consolidation




The condensed consolidated financial statements include those of the Company




Use of Estimates




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




Cash and Cash Equivalents




The Company considers all highly liquid debt instruments and other short-term investments with a maturity of three months or less, when purchased, to be cash equivalents.




The Company maintains cash and cash equivalent balances at one financial institution that is insured by the Federal Deposit Insurance Corporation up to $250,000.




Allowance for Doubtful Accounts




The Company provides an allowance for doubtful accounts, which is based upon a review of outstanding receivables as well as historical collection information.  Credit is granted to substantially all customers on an unsecured basis.  In determining the amount of the allowance, management is required to make certain estimates and assumptions.  Management has determined that as of March 31, 2011, no allowance for doubtful accounts is required.




Fixed Assets




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




Computer Software Development Costs




During 2009, the Company capitalized certain software development costs.  The Company capitalizes the cost of software in accordance with ASC 985-20 once technological feasibility has been demonstrated, as the Company has in the past sold, leased or otherwise marketed their software, and plans on doing so in the future.  The Company capitalizes costs incurred to develop and market their privacy preserving software during the development process, including payroll costs for employees who are directly associated with the development process and services performed by consultants.  Amortization of such costs is based on the greater of (i) the ratio of current gross revenues to the sum of current and anticipated gross revenues, or (ii) the straight-line method over the remaining economic life of the software, typically five years. It is possible that those anticipated gross revenues, the remaining economic life of the products, or both, may be reduced as a result of future events.  The Company has not developed any software for internal use.




For the three months ended March 31, 2011 and 2010, the Company recognized $0 and $16,222 of amortization expense on its capitalized software costs, respectively.




8


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010




NOTE 2-
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(CONTINUED)




Recoverability of Long-Lived Assets




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




Revenue Recognition




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




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




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




Stock-Based Compensation




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




9


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010




NOTE 2-
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(CONTINUED)




Stock-Based Compensation(continued)




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




The Company measures compensation expense for non-employee stock-based compensation under ASC 505-50, “Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services".  The fair value of the option issued is used to measure the transaction, as this is more reliable than the fair value of the services received.  The fair value is measured at the value of the Company’s common stock on the date that the commitment for performance by the counterparty has been reached or the counterparty’s performance is complete.  The fair value of the equity instrument is charged directly to compensation expense and additional paid-in capital.




Concentrations




For the three months ended March 31, 2011 the Company has derived 82% of its revenue from two customers.  These customers are considered major customers as they represent 10% or more of total revenue.




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




Segment Reporting




The Company follows the provisions of ASC 280-10, "Disclosures about Segments of an Enterprise and Related Information”.This standard requires that companies disclose operating segments based on the manner in which management disaggregates the Company in making internal operating decisions. The Company only operates in one reporting segment as of March 31, 2011 and for the three months ended March 31, 2011 and 2010.




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




The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, and accounts payable approximate fair value because of the immediate or short-term maturity of these financial instruments.  For the notes payable, the carrying amount reported is based upon the incremental borrowing rates otherwise available to us for similar borrowings.  For the warrants that are classified as derivatives, fair values were calculated at net present value using our weighted average borrowing rate for debt instruments without conversion features applied to total future cash flows of the instruments.




10


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010




NOTE 2-
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(CONTINUED)




Convertible Instruments




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




Income Taxes




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




Uncertainty in Income Taxes




Under ASC 740-10-25 recognition and measurement of uncertain income tax positions is required using a “more-likely-than-not” approach. The Company evaluates their tax positions on an annual and quarterly basis, and has determined that as of March 31, 2011 no additional accrual for income taxes is necessary.




Earnings (Loss) Per Share of Common Stock




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




11


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010




NOTE 2-
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(CONTINUED)





Earnings (Loss) Per Share of Common Stock(continued)





The following is a reconciliation of the computation for basic and diluted EPS:





Three Months EndedMarch 31,


March 31,2011


2010Net income (loss)

$
29,520



(691,740
)Weighted-average common shares outstanding:Basic


17,496,831



3,920,645Convertible debentures/notes


2,083,333



750,000Warrants


6,004,000



435,000
-Options


5,679,500



3,270,000Diluted


31,263,664



8,375,645Basic net income (loss) per share

$
0.00



(0.18
)Diluted net income (loss) per share

$
0.00



(0.18
)




Research and Development




Research and development expenses include payroll, employee benefits, equity compensation, and other headcount-related costs associated with product development.  The Company has determined that technological feasibility for the software products is reached shortly before the products are released to manufacturing. Costs incurred after technological feasibility is established are not material, and accordingly, the Company expenses all research and development costs when incurred.  In addition, research and development costs have been included in the condensed consolidated statements of operations for the three months ended March 31, 2010 and 2010, respectively.




Recent Issued Accounting Standards




In September 2006, ASC issued 820, Fair Value Measurements.ASC 820 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosure about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. Early adoption is encouraged. The adoption of ASC 820 is not expected to have a material impact on the financial statements.




12


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010




NOTE 2-
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(CONTINUED)




Recent Issued Accounting Standards(continued)




In February 2007, ASC issued 825-10, The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of ASC 320-10, (“ASC 825-10”) which permits entities to choose to measure many financial instruments and certain other items at fair value at specified election dates. A business entity is required to report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. This statement is expected to expand the use of fair value measurement. ASC 825-10 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.




In December 2007, ASC 810-10-65, “Noncontrolling Interests in Consolidated Financial Statements,” (ASC 810-10-65), was issued. ASC 810-10-65 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, changes in a parent’s ownership of a noncontrolling interest, calculation and disclosure of the consolidated net income attributable to the parent and the noncontrolling interest, changes in a parent’s ownership interest while the parent retains its controlling financial interest and fair value measurement of any retained noncontrolling equity investment.




ASC 810-10-65 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. Management is determining the impact that the adoption of ASC 810-10-65 will have on the Company’s financial position, results of operations or cash flows.




In December 2007, the Company adopted ASC 805, Business Combinations (ASC 805). ASC 805 retains the fundamental requirements that the acquisition method of accounting be used for all business combinations and for an acquirer to be identified for each business combination. ASC 805 defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control.  ASC 805 will require an entity to record separately from the business combination the direct costs, where previously these costs were included in the total allocated cost of the acquisition.  ASC 805 will require an entity to recognize the assets acquired, liabilities assumed, and any non-controlling interest in the acquired at the acquisition date, at their fair values as of that date.




ASC 805 will require an entity to recognize as an asset or liability at fair value for certain contingencies, either contractual or non-contractual, if certain criteria are met.  Finally, ASC 805 will require an entity to recognize contingent consideration at the date of acquisition, based on the fair value at that date.  This will be effective for business combinations completed on or after the first annual reporting period beginning on or after December 15, 2008.  Early adoption is not permitted and the ASC is to be applied prospectively only. Upon adoption of this ASC, there would be no impact to the Company’s results of operations and financial condition for acquisitions previously completed. The adoption of ASC 805 is not expected to have a material effect on the Company’s financial position, results of operations or cash flows.




In March 2008, ASC issued ASC 815, Disclosures about Derivative Instruments and Hedging Activities, (ASC 815). ASC 815 requires enhanced disclosures about an entity’s derivative and hedging activities. These enhanced disclosures will discuss: how and why an entity uses derivative instruments; how derivative instruments and related hedged items are accounted for and its related interpretations; and how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. ASC 815 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company does not believe that ASC 815 will have an impact on their results of operations or financial position.




13


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010




NOTE 2-
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(CONTINUED)




Recent Issued Accounting Standards(continued)




In April 2008, ASC issued ASC 350, “Determination of the Useful Life of Intangible Assets”. This amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under ASC 350. The guidance is used for determining the useful life of a recognized intangible asset shall be applied prospectively to intangible assets acquired after adoption, and the disclosure requirements shall be applied prospectively to all intangible assets recognized as of, and subsequent to, adoption. The Company does not believe ASC 350 will materially impact their financial position, results of operations or cash flows.




In May 2008, ASC 470-20, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (ASC 470-20), was issued. ASC 470-20 requires the issuer of certain convertible debt instruments that may be settled in cash (or other assets) on conversion to separately account for the liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuer’s non-convertible debt borrowing rate.  ASC 470-20 is effective for fiscal years beginning after December 15, 2008 on a retroactive basis.  The Company does not believe that the adoption of ASC 470-20 will have a material effect on its financial position, results of operations or cash flows.




In June 2008, ASC 815-40, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” (ASC 815-40), was issued.  ASC 815-40 provides guidance for determining whether an equity-linked financial instrument (or embedded feature) is indexed to an entity’s own stock and it applies to any freestanding financial instrument or embedded feature that has all the characteristics of a derivative.  ASC 815-40 also applies to any freestanding financial instrument that is potentially settled in an entity’s own stock.  The Company is determining what impact, if any, ASC 815-40 will have on its financial position, results of operations and cash flows.




In June 2008, ASC 470-20-65, “Transition Guidance for Conforming Changes to, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios”, (“ASC 470-20-65”), was issued. ASC 470-20-65 is effective for years ending after December 15, 2008.  The overall objective of ASC 470-20-65 is to provide for consistency in application of the standard.  The Company has computed and recorded a beneficial conversion feature in connection with certain of their prior financing arrangements and does not believe that ASC 470-20-65 will have a material effect on that accounting.




In May 2009, ASC 855, “Subsequent Events”, (SFAS 165), was published. ASC 855 requires the Company to disclose the date through which subsequent events have been evaluated and whether that date is the date the financial statements were issued or the date the financial statements were available to be issued. ASC 855 is effective for financial periods ending after June 15, 2009.




Effective July 1, 2009, the Company adopted FASB ASU No. 2009-05, Fair Value Measurement and Disclosures (Topic 820) (ASU 2009-05). ASU 2009-05 provided amendments to ASC 820-10, Fair Value Measurements and Disclosures – Overall, for the fair value measurement of liabilities. ASU 2009-05 provides clarification that in circumstances in which a quoted market price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using certain techniques. ASU 2009-05 also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of a liability.




14


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010




NOTE 2-
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(CONTINUED)




Recent Issued Accounting Standards(continued)




ASU 2009-05 also clarifies that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required for Level 1 fair value measurements. Adoption of ASU 2009-05 did not have a material impact on the Company’s results of operations or financial condition.




In January 2010, the Company adopted FASB ASU No. 2010-06, Fair Value Measurement and Disclosures (Topic 820) - Improving Disclosures about Fair Value Measurements (ASU 2010-06). These standards require new disclosures on the amount and reason for transfers in and out of Level 1 and 2 fair value measurements. The standards also require new disclosures of activities, including purchases, sales, issuances, and settlements within the Level 3 fair value measurements. The standard also clarifies existing disclosure requirements on levels of disaggregation and disclosures about inputs and valuation techniques. These new disclosures are effective beginning with the first interim filing in 2010.




The disclosures about the roll forward of information in Level 3 are required for the Company with its first interim filing in 211.  The Company does not believe this standard will impact their financial statements.




In February 2010, the FASB issued ASU 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements”. This update addresses both the interaction of the requirements of Topic 855, “Subsequent Events”, with the SEC’s reporting requirements and the intended breadth of the reissuance disclosures provision related to subsequent events (paragraph 855-10-50-4). The amendments in this update have the potential to change reporting by both private and public entities, however, the nature of the change may vary depending on facts and circumstances. Adoption of ASU 2010-09 did not have a material impact on the Company’s results of operations or financial condition.




Other ASU’s that have been issued or proposed by the FASB ASC that do not require adoption until a future date and are not expected to have a material impact on the financial statements upon adoption.





NOTE 3-
FIXED ASSETS




Fixed assets consist of the following as of March 31, 2011 (unaudited) and December 31, 2010, respectively:




Estimated Useful


March 31,


December 31Lives (Years)


2011


2010Computer equipment


5


$
299,915


$
299,915Office machinery and equipment


5



15,099



15,099Furniture  and fixtures


5



86,934



86,934Computer software


3



14,895



14,895Automobile


5



50,914



50,914467,757



467,757Less: Accumulated depreciation






(450,665
)


(445,151
)Total, net





$
17,092


$
22,606





Depreciation expense was $5,514 and $8,415 for the three months ended March 31, 2011 and 2010, respectively.




15


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010




NOTE 4-
COMPUTER SOFTWARE DEVELOPMENT COSTS





Computer software development costs consist of the following as of March 31, 2011 (unaudited) and December 31, 2010, respectively:




Estimated Useful


March 31,


December 31,Lives (Years)


2011


2010Computer software development costs


5


$
986,724


$
986,724Less: Accumulated amortization






(986,724
)


(986,724
)Total, net





$
0


$
0





Amortization expense was $0 and $16,222 for the three months ended March 31, 2011 and 2010, respectively.





NOTE 5-
NOTES PAYABLE




SBA Loan




On July 22, 2003, the Company and the U.S. Small Business Administration (“SBA”) entered into a Note (the “Note”) under the SBA’s Secured Disaster Loan program in the amount of $377,100.




Under the Note, the Company agreed to pay principal and interest at an annual rate of 4% per annum, of $1,868 every month commencing twenty-five (25) months from the date of the Note (commencing August 2005).  The Note matures July 2034.




The Company must comply with the default provisions contained in the Note.  The Company is in default under the Note if it does not make a payment under the Note, or if it: a) fails to comply with any provision of the Note, the Loan Authorization and Agreement, or other Loan documents; b) defaults on any other SBA loan; c) sells or otherwise transfers, or does not preserve or account to SBA’s satisfaction for, any of the collateral (as defined therein) or its proceeds; d) does not disclose, or anyone acting on their behalf does not disclose, any material fact to the SBA; e) makes, or anyone acting on their behalf makes, a materially false or misleading representation to the SBA; f) defaults on any loan or agreement with another creditor, if the SBA believes the default may materially affect the Company’s ability to pay this Note; g) fails to pay any taxes when due; h) becomes the subject of a proceeding under any bankruptcy or insolvency law; i) has a receiver or liquidator appointed for any part of their business or property; j) makes an assignment for the benefit of creditors; k) has any adverse change in financial condition or business operation that the SBA believes may materially affect the Company’s ability to pay this Note; l) dies; m) reorganizes, merges, consolidates, or otherwise changes ownership or business structure without the SBA’s prior written consent; or n) becomes the subject of a civil or criminal action that the SBA believes may materially affect the Company’s ability to pay this Note.  The Company is not in default and current on its obligation.  The Company has accrued interest at a rate of $38.90 per day.




As of March 31, 2011, the Company has an outstanding principal balance of $347,739.  Interest expense on the SBA loan for the three months ended March 31, 2011 and 2010 respectively was $ 3,430 and $ 3,501.




16


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010





NOTE 5-
NOTES PAYABLE(CONTINUED)




Tangiers Investors, LP




On February 26, 2010, the Company entered into a Promissory Note with Tangiers Investors, LP in the amount of $40,000.  The $40,000 was the value of services performed for the Company and not for cash paid.  The Company has agreed to repay the note in two tranches of $20,000.  The initial payment was due April 30, 2010 and the final payment was due June 30, 2010. Interest is calculated at 5% per annum.  The note was repaid in February 2011.




In August 2010, upon failure of the Company to pay either of the agreed upon payments, the Company and Tangiers Investors, LP entered into a Forbearance Agreement, which gave the company the option to either repay the entire $40,000 plus interest by October 15, 2010 and issue 50,000 common shares, repay $15,000 plus interest by October 15, 2010 and issue 50,000 common shares with the remaining $25,000 plus interest due by December 31, 2010 or repay the entire $40,000 plus interest by December 31, 2010 and issue 100,000 common shares.  As a result of the Company’s failure to comply with the terms of the original forbearance agreement, they entered into a second forbearance agreement, which further extended the time for the Company to pay the $40,000 note.  The Company again failed to repay the note by the extended date, and was forced to issue additional shares in December 2010, in accordance with the agreements.  Additionally, the Company accrued shares for an additional penalty.  Tangiers issued a default notice to the Company on January 20, 2011.  During negotiations for settlement the Company agreed to pay the outstanding debt in full plus outstanding interest.  As a result of the additional shares the Company was forced to issue to Tangiers due to the non-compliance of the forbearance agreements, the modifications made to the debt instrument, constituted a material modification and as a result, the original debt instrument was extinguished and the new debt instrument was recorded, with the resulting value of the penalty shares reflected as a loss on extinguishment.




Interest expense for the three months ended March 31, 2011 and 2010 respectively was $148 and $181.  There is no accrued interest as of March 31, 2011.  The Company issued all of the shares required and repaid the debt in February 2011.




Other




The Company has four notes payable, three are convertible into shares of common stock at $0.06 per share at 8% interest, and one note is for $15,000 at 5% interest.  All notes mature during 2011.  Interest expense for the three months ended March 31, 2011 on these notes is $1,141.




The following represent the maturities of the notes payable for the next five years – 2012 - $78,050; 2013- $8,795; 2014 - $9,100; 2015 - $9,465; 2016 - $10,250; and thereafter - $297,079.




NOTE 6-
NOTE PAYABLE – RELATED PARTY




In April 2010, the Company entered into two separate promissory notes with the Company’s President who loaned the Company a total of $26,000 on April 16, 2010 and $24,600 on April 30, 2010.  Payments of $1,000 per month commence July 1, 2010 for five months and the balance due on December 1, 2010.  Interest is calculated at 1.5% per month; escalating to 2.5% per month should the monthly $1,000 payments not be made timely.  The Company has not made the required $1,000 payments, thus the interest, effective July 1, 2010 on these notes has been accrued at 2.5% per month in accordance with the note agreements.  These notes originally due on December 1, 2010 have been extended through June 30, 2011; and the Company agreed to increase the interest rate to 5%.  Interest expense for the three months ended March 31,2011 and accrued interest at March 31, 2011 related to these notes are $624 and $1,499 respectively.




17


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010




NOTE 7-
LINE OF CREDIT




The Company has a line of credit with a bank in the amount of $850,000 as of March 31, 2011.  The Company has an outstanding balance of $341,587 as of March 31, 2011.




The loan accrues interest at annual interest rates of prime plus 1⁄4 %.  Interest expense for the three months ended March 31, 2011 and 2010 respectively was $2,737 and $2,881.  The line of credit is secured by the Company’s accounts receivables and personally guaranteed by the Company’s President.




NOTE 8-
CONVERTIBLE DEBENTURES




On December 23, 2009, the Company entered into a Debenture and Warrant Purchase Agreement pursuant to which Street Capital, LLC, the placement agent, agreed to use its best efforts to provide bridge financing through unnamed prospective purchasers in return for an 8% secured convertible debenture (“Debenture”) in the principal amount of $300,000 at a conversion price of $0.20 per share of the Company’s common stock and equity participation in the form of a class A common stock purchase warrant to purchase an aggregate of up to 450,000 shares of the Company’s common stock with an exercise price of $0.20, and a class B common stock purchase warrant to purchase an aggregate of up to 120,000 shares of the Company’s common stock, with an exercise price per share equal to $0.50. On July 9, 2010, the exercise price was changed to $0.20 as the Company failed to convert or repay the instrument by the due date of June 23, 2010.  The Company received $150,000 of the $300,000 total principal on December 23, 2009 and entered into two additional debentures for $100,000 and $10,000 for a total of $110,000 in April 2010.  In March 2011, the Company received notice to convert $20,000 into common stock.  The shares had not been issued as of March 31, 2011, and the $20,000 is reflected in the liability for stock to be issued. This brought the total balance of convertible debentures down to $240,000 as of March 31, 2011.




The Company also entered into a Security Agreement pursuant to which it granted to the Debenture holders a first lien against all of its assets, including its software, as security for repayment of the Debenture.  As a result of the Company raising $260,000 of the $300,000 in proceeds, they issued a total of 390,000 class A and 104,000 class B warrants to the respective parties.  In accordance with ASC 470-20, the Company separately accounted for the conversion feature and recognized each component of the transaction separately.  As a result, the Company recognized a discount on the convertible debenture in the amount of $170,125 that was amortized over the life of the convertible debentures which was six-months on each debenture.




The Company recognized the discount as a derivative liability, and in accordance with the ASC, values the derivative liability each reporting period to market as a result of the debentures reaching maturity with no repayment or conversion.  The Company had recognized a loss of $121,953 and $121,922 in the years ended December 31, 2010 and 2009 due to the beneficial conversion of the various instruments and a gain of $294,000 in the three months ended March 31,2011.  The convertible debentures were to mature from June 2010 to October 2010.  The Company entered into an Amendment to Debenture and Warrants which extended the due date of the original $150,000 debenture from June 2010 to August 31, 2010 and amended the exercise price of the Class B warrants from $0.50 to $0.20 on July 9, 2010.




The Company is in continuing discussions with the Debenture Holders to extend the amended due date of the remaining $150,000 debenture from August 31, 2010 to a future date to be acceptable to all parties.  The Company entered into a Second Amendment on September 1, 2010, that further extended the repayment date of the $150,000 Convertible Debenture to October 31, 2010 and issued 150,000 shares of common stock and 150,000 Class C Warrants as a penalty.  The Company failed to comply with the new maturity date of October 31, 2010 and as a result agreed to issue 25,000 shares of common stock for each month that the debenture remains unpaid.  The Debenture Holders converted $20,000 of principle for shares of common stock January 19, 2011 and was paid accrued interest in shares of common stock.




18




NOTE 8-
CONVERTIBLE DEBENTURES (CONTINUED)




As of March 31, 2011, the Company has accrued an additional 150,000 shares of common stock as a penalty.  The Company also extended the other two convertible debentures issuing the debenture holders each Class C warrants 100,000 and 10,000 respectively, and accruing penalty shares 100,000 and 10,000 shares, respectively.  The Company was forced to issue the Class C warrants in addition to the shares of common stock, due to the non-compliance of the agreements.  The modifications made to the debt instruments, constituted a material modification and as a result, the original debt instrument was extinguished and the new debt instrument was recorded, with the resulting value of the penalty shares and warrants reflected as a loss on extinguishment.




Interest expense for the three months ended March 31, 2011 and 2010 were $4,818 and $2,926, respectively.  As of March 31, 2011, accrued interest on the convertible debentures is $10,428.




NOTE 9-
STOCKHOLDERS’ EQUITY (DEFICIT)




Preferred Stock




The Company was incorporated on May 26, 2005, and the Board of Directors authorized 10,000,000 shares of preferred stock with a par value of $0.0001.  The Company as of December 31, 2009 has authorized the issuance of 2,000,000 shares of preferred stock. 1,000,000 of the shares were authorized to be issued to Vijay Suri in connection with the Merger Agreement, and 1,000,000 shares of preferred stock were authorized to be issued to B.K. Gogia the former CEO upon his resignation as CEO.  The Company and Vijay Suri and B.K. Gogia on June 2, 2010, agreed to rescind the issuance of the preferred stock.  As a result of the recession, the Company and its officers agreed to issue them each 1,000,000 shares of common stock for their personal guarantees of certain debt of the Company.




Common Stock




The Company was incorporated on May 26, 2005, and since then the Board of Directors authorized 75,000,000 shares of common stock with a par value of $0.0001.  On March 13, 2009, the Company’s Board of Directors approved the increase of the authorized shares of common stock to 400,000,000.




The Company as of March 31, 2011 had 17,669,383 shares of common stock issued and outstanding.




During the three months ended March 31, 2011 the Company has issued 376,387 shares of common stock.  Shares of common stock issued and outstanding are as follows:  The Board of Directors authorized a common stock sale in the amount of $75,000 to a small number of Accredited Investors acceptable to the Company, there were 333,333 shares authorized for sale; of which 302,222 were purchased and on March 31, 2011 288,887 shares have been issued; 75,000 shares of the Company’s common stock as payment for of Tangiers Investors LP’s forbearance; the Company issue 2,500 shares of the Company's common stock to a vendor for the conversion of outstanding debt; 10,000 shares to a consultant in exchange for services.  The Company has an outstanding liability for stock to be issued, net of issuances of shares, of $76,455 at March 31, 2011.  The Company recorded an additional $99,641 in stock based compensation.




During the year ended December 31, 2010 the Company has issued 13,372,351 shares of common stock as follows: 9,089,768 shares that were issued for the 100% exchange in the Irus transaction; 300,000 shares for services rendered that were also previously recorded as a liability for stock to be issued; 142,500 shares under a pledge agreement with Tangiers L.P.; and 5,000 shares for services rendered that were previously recorded as a liability for stock to be issued; and the Company cancelled a net of 5,000 shares (issued 45,000 shares and cancelled 50,000 shares); 90,083 shares to pay an existing accounts payable, 2,300,000 shares recorded as a liability for stock to be issued; 350,000 shares for late fees associated with missed payments; 1,000,000 shares for cash in the amount of $2,000; and 100,000 shares for late fees associated with missed payments.  The Company has an outstanding liability for stock to be issued, net of issuances of shares that reduced the liability of $44,750 at December 31, 2010. The Company recorded an additional $289,835 in stock based compensation, which includes $25,491 related to the Class C warrants that were reclassified as loss on extinguishment of debt.




19


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010




NOTE 9-
STOCKHOLDERS’ EQUITY (DEFICIT)(CONTINUED)




From January 1, 2009 through October 27, 2009, the period prior to the reverse merger with Irus Group, the following transactions occurred:




·
The Company effectuated a reverse 1:20 stock split. All shares of common stock have been reflected with the 1:20 reverse split, retroactively in accordance with SAB Topic 14C;


·
1,875,000 shares of common stock were issued in conversion of $393,500 in convertible notes, interest and warrants that were issued with the convertible notes;


·
617,500 shares of common stock were issued for cash in the amount of $135,000;


·
187.500 shares of common stock were issued for services rendered valued at $53,000;


·
232,940 shares of common stock were issued in connection with the exercise of warrants issued in the prior financing that InferX completed in 2007.  The Company valued these warrants at $2,236,224, which is what the exercise price would have been had the warrants been exercised for cash.  The Company provided the warrant holders a cashless exercise as a result of the Merger; and


·
100,750 shares of common stock were issued in the exercise of stock options for $0, as a result of the Merger, no cash was required.




The transactions resulted in the Company going from 886,955 shares issued and outstanding to 3,920,645 shares.




Additional items impacting equity prior to the reverse merger were:




·
Conversion of accrued interest to additional paid in capital in the amount of $45,913; and


·
Conversion of accrued compensation to related parties to additional paid in capital, as a result of their forgiveness of the accrued compensation in the amount of $524,226.




The Merger Agreement called for the Company to issue 9,089,768 shares of common stock in exchange for 100% of the shares of Irus Group.




For the three months ending March 31, 2011, the Company recorded $99,641 in stock based compensation.




Warrants




The Company prior to the reverse merger with Irus Group, converted all of their previous issued and outstanding warrants from the private placement completed in 2007 as well as the warrants issued with the convertible notes.




The Company issued 225,000 Class A warrants and 60,000 Class B warrants in connection with the convertible debenture on December 23, 2009.  The Class A warrants have an exercise price of $0.20 per share and the Class B warrants have an exercise price of $0.50 per share.  All warrants have a term of 5 years.  The value of the warrants at inception was $98,130 which represented the debt discount.  The Class B warrants exercise price was amended on July 9, 2010 to a price of $0.20 due to the Company’s failure to convert or repay the instrument by June 23, 2010.




The Company issued 15,000 Class A warrants and 4,000 Class B warrants to an individual investor in connection with the convertible debenture first entered into on April 1, 2010.  The Class A warrants have an exercise price of $0.20 per share and the Class B warrants have an exercise price of $0.50 per share.  All warrants have a term of 5 years.  The value of the warrants at inception was $8,855 which represented the debt discount.




20


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010




NOTE 9-
STOCKHOLDERS’ EQUITY (DEFICIT)(CONTINUED)




The Company issued 150,000 Class A warrants and 40,000 Class B warrants to an individual investor in connection with the convertible debenture first entered into on April 19, 2010.  The Class A warrants have an exercise price of $0.20 per share and the Class B warrants have an exercise price of $0.50 per share.  All warrants have a term of 5 years.  The value of the warrants at inception was $63,140 which represented the debt discount.




The Company issued 150,000 warrants to an investment banker as part of their overall compensation package to raise funds for the Company.  The warrants have an exercise price of $0.20 per share and expire in 5 years.  These warrants have vested as of December 31, 2010, and have recorded $28,402 as of December 31, 2010 in stock-based compensation.




The Company issued 900,000 warrants to an investment consultant as part of their overall compensation package to raise funds for the Company.  These warrants have an exercise price of $0.20 per share and expire in 5 years.  These warrants vest with 400,000 over one year beginning in July 2010, and the balance of 500,000 warrants vest based upon achievement of performance objectives mutually agreed between the Company and the Consultant.  The Company incurred $26,933 in stock-based compensation expense to record the first two scheduled vesting’s of 100,000 warrants in July 2010 and October 2010.  The third scheduled vesting occurred in January 2011 and the $18,997 was recorded as stock based compensation in the three months ended March 31, 2011. The contract was terminated on February 25, 2011 and 300,000 warrants are vested and the remaining 600,000 warrants are forfeited.




The Company issued 4,500,000 warrants to B.K. Gogia as part of his overall compensation package.  These warrants have an exercise price of $0.20 per share and expire in 5 years.  These warrants vest based upon achievement of performance objectives mutually agreed between the Company and the Employee and the stock price being not less than $0.50 per share.  None of these warrants have vested as of March 31, 2011.




The Company issued 300,000 warrants to an individual in exchange for services previously rendered and recorded.  These warrants have an exercise price of $0.20 per share, expire in five years and became fully vested in April 2010. The values of these warrants were $104,736.




As a result of the Company’s failure to comply with the repayment terms of the three convertible debentures, the Company issued Class C Warrants to the three debenture holders.  The Company issued a total of 260,000 Class C Warrants with an exercise price of $0.40 and a 5 year term.  The value of these warrants has been expensed and classified as a loss on extinguishment of debt due to the fact that it was considered a material modification of the debt instrument.  This value is $25,491 on the Class C Warrants.




21


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010




NOTE 9-
STOCKHOLDERS’ EQUITY (DEFICIT)(CONTINUED)




The following is a breakdown of the warrants:




Exercise

DateWarrants


Price

Issued

Term225,000


$
0.20

12/23/2009

5 years60,000


$
0.50

12/23/2009

5 years150,000


$
0.20

1/26/2010

5 years15,000


$
0.20

4/1/2010

5 years4,000


$
0.50

4/1/2010

5 years300,000


$
0.20

4/6/2010

5 years4,500,000


$
0.20

4/6/2010

5 years300,000


$
0.20

4/6/2010

5 years150,000


$
0.20

4/19/2010

5 years40,000


$
0.50

4/19/2010

5 years150,000


$
0.40

11/30/2010

5 years110,000


$
0.40

12/29/2010

5 years6,004,000




The warrants have a weighted average price of $0.21.




The warrants were valued utilizing the same Black – Scholes criteria as the options below:




Options




Since October 2007, the Company’s Board of Directors and Shareholders approved the adoption of an option plan for a total of 5,000,000.  The Company prior to the reverse merger with Irus exercised all of the options that were outstanding at the time.  Subsequent to the reverse merger, the Company issued stock options in connection with certain employment agreements.  The Company granted 3,250,000 options, 2,950,000 are vested, and none of which have been exercised as of December 31, 2009.  As of December 31, 2010, an additional 150,000 became vested, and still none were exercised.  Of the 3,250,000 that were granted only 150,000 remain unvested, and these vest on December 15, 2011.




The total options granted as of December 31, 2010 were 5,134,500, of which 4,439,500 are vested and none have been exercised.




During the three months ended March 31, 2011, the Company granted an additional 545,000 options to purchase shares of common stock.  Of this amount, 195,000 vested as of March 31, 2011.  None of these options have been exercised as of March 31, 2011.




The total options granted as of March 31, 2011 were 5,679,500, of which 4,634,500 are vested and none have been exercised.




22




INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010




NOTE 9-
STOCKHOLDERS’ EQUITY (DEFICIT)(CONTINUED)




These options have exercise prices that range from $0.06 to $0.50 and were valued based on the black-scholes model with the following criteria:




Strike Price

$
0.06 – 0.50Expected Life of Option

3 - 5 yr.Annualized Volatility


261.60-340.19
%Discount Rate


1.25
%Annual Rate of Quarterly Dividends

None




The value attributable to these options that vested for the three months ended March 31, 2011 is $73,143 and is reflected in the consolidated statements of operations as stock based compensation.




NOTE 10-
COMMITMENTS




Office Lease




The Company leases office space in Sterling, Virginia pursuant to a lease with a related party through common ownership which expires in 2013.  The lease provides for an annual rental of approximately $78,000.




Rent expense for the three months ended March 31, 2011 and 2010 was $22,446 and $25,350, respectively.




Board of Advisors Agreements




The Company’s board of directors on May 1, 2010, approved the addition of two members to its Board of Advisors.  Each of these members provide assistance to the Company with respect to their healthcare solution and predictive technology to prospective banking, insurance and healthcare customers.  As consideration for the placement on the Board of Advisors, the Company has, in addition to quarterly cash payments, granted those options under their 2007 Stock Incentive Plan that vest over a two-year period of time commencing in May 2010.  The Company has included these fees in their consolidated statements of operations for the three months ended March 31, 2011 and 2010.


23


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010




NOTE 10-
COMMITMENTS (CONTINUED)




Consulting Agreements




The Company has entered into consulting agreements with marketing and strategic consulting groups with terms that do not exceed one year.  These companies are to be paid fees for the services they perform.  The Company has included these fees in their consolidated statements of operations for the year ended December 31, 2010.




On January 26, 2010, the Company entered into an agreement with Coady Diemar Partners, LLC, an investment banker in connection with investment banking services. Pursuant to the agreement, Coady Diemar Partners, LLC received a retainer of $30,000 payable in two tranches of $15,000 and receive 150,000 warrants as well as receive an 8% fee on amounts raised. The term of the agreement is one-year. The warrants did not vest until June 2010.




In June 2010, the Company entered into a consulting agreement with a company to provide financial services and locate potential investment opportunities.  The term of the agreement is for one-year, and the consultant will receive monthly payments of $7,500 as well as be issued 300,000 shares of restricted common stock, and 900,000 warrants that vest over the one-year period and upon certain financing criteria being met.  As of March 31, 2011, 300,000 of the warrants have vested.  The Company has included these fees in their consolidated statements of operations for the three months ended March 31, 2011. The agreement terminated in February 2011, and the remaining 600,000 unvested warrants have been cancelled.




In December 2010, the Company entered into an agreement with Strategic Global Advisors, LLC, a firm that provides investment and public relations consulting firm services.  Pursuant to the agreement, Strategic Global Advisors, LLC will receive a retainer of $30,000 payable in four monthly payments of $7,500 and receive 500,000 options to purchase the Company's common stock that vest on the date of grant.  The options were valued at $34,994.  The Company has included these fees in their consolidated statements of operations for the three months ended March 31, 2011.




On March 2, 2011, The Board of Directors entered into an agreement with Assured Value Advisors, Inc., a merchant and investment banking services consultant in connection with investment banking services.  Pursuant to the agreement, Assured Value Advisors, Inc. will receive 500,000 options to purchase shares of the Company's common stock; of which 150,000 ($59,773 in stock based compensation) of these options are to vest immediately, with the remainder to be vested based on performance milestones.




Employment Agreements




During the year ended December 31, 2009, the Company entered into four separate employment agreements with their key executives.  The employment agreements range in years from 3 to 5, and require the Company to compensate the key executives for a base salary, as well as provide for incentive compensation.  In addition, the executives were granted in total 3,250,000 stock options that vest through December 2011.  The Company also entered into another employment agreement in January 2010 which granted an additional 20,000 options to an employee.  This agreement was for a period of two years.




NOTE 11-
PROVISION FOR INCOME TAXES




Deferred income taxes will be determined using the liability method for the temporary differences between the financial reporting basis and income tax basis of the Company’s assets and liabilities.  Deferred income taxes are measured based on the tax rates expected to be in effect when the temporary differences are included in the Company’s tax return.  Deferred tax assets and liabilities are recognized based on anticipated future tax consequences attributable to differences between financial statement carrying amounts of assets and liabilities and their respective tax bases.


24




INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010




NOTE 11-
PROVISION FOR INCOME TAXES (continued)




At March 31, 2011, deferred tax assets consist of the following:





Net operating losses

$
1,156,335Valuation allowance


(1,156,335
)$
-




At March 31, 2011, the Company had net operating loss carry forward in the approximate amount of $3,400,985, available to offset future taxable income through 2031.  The Company established valuation allowances equal to the full amount of the deferred tax assets due to the uncertainty of the utilization of the operating losses in future periods.




A reconciliation of the Company’s effective tax rate as a percentage of income before taxes and federal statutory rate for the three months ended March, 31, 2011 and 2010 is summarized below.




2011


2010Federal statutory rate


(34.0
)%


(34.0
)%State income taxes, net of federal benefits


6.0



6.0Valuation allowance


28.0



28.00
%


0
%




NOTE 12-
RELATED PARTY TRANSACTIONS




The Company has a rent expense in the amount for the three months ended March 31, 2011 and 2010 of $22,446 and $25,350, respectively, to a company owned by a relative of an officer of the Company.  In addition, the Company has outstanding fees due the President & CEO of $725,000 as of March 31, 2011 relating to past due distributions prior to the reverse merger.  Further, the Company entered into two separate promissory notes with Vijay Suri during April 2010, in which Mr. Suri loaned the Company a total of $26,000 on April 16, 2010 and $24,600 on April 30, 2010.  The notes were due on December 1, 2010, however, have been extended through June 30, 2011.




NOTE 13-
MAJOR CUSTOMERS




The Company has derived 82% of its revenue and accounts receivable for the three months ended March 31, 2011 from two customers.  A major customer is a customer that represents 10% of total revenues.


25


INFERX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31, 2011 AND 2010




NOTE 14-
FAIR VALUE MEASUREMENTS




The Company adopted certain provisions of ASC Topic 820. ASC 820 defines fair value, provides a consistent framework for measuring fair value under generally accepted accounting principles and expands fair value financial statement disclosure requirements. ASC 820’s valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect our market assumptions. ASC 820 classifies these inputs into the following hierarchy:




Level 1 inputs: Quoted prices for identical instruments in active markets.




Level 2 inputs: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.




Level 3 inputs: Instruments with primarily unobservable value drivers.




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




The information set forth and discussed in this Management’s Discussion and Analysis or Plan of Operation is derived from our financial statements and the related notes, which are included. The following information and discussion should be read in conjunction with those financial statements and notes, as well as the information provided in our Annual Report on Form 10-K for our fiscal year ended December 31,2010.




Overview




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




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




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


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




The Irus Group, Inc. (“Irus”), founded in 1996, has emerged as a star consulting firm specializing in bridging corporate performance management and business intelligence systems to help clients answer tough business questions.  Irus’ specific domain expertise revolved around the planning, consulting, implementation and development of complex business intelligence solutions.  Irus developed a deep understanding and breadth of knowledge in enterprise budgeting and planning systems, allowing Irus to provide their customers marry critical systems and processes for business intelligence into corporate performance management solutions.




Irus’ strategic approach, coupled with broad business understanding, and proven processes, tied to technical proficiency in major business intelligence, corporate performance management, and budgeting and planning applications, help improve client business performance.  Notably, Irus provided clients comprehensive support for their financial and operational management processes, which included: capture of critical business functional requirements; strategic planning for future growth and expansion; systems development and implementation; and training.  Irus successfully implemented projects across a broad cross-section of clients in the United States and Canada, which have included government, financial services, retail, manufacturing, and telecommunications.




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




We continue to enjoy a solid performance record for quality and on-time performance with our US Government clients.  Our services business consists of professional IT consulting focused on business intelligence and corporate performance management and predictive analytics support.  As a result of our merger with the Irus Group, we expanded and enhanced our customer base and services offerings, which we believe will increase our revenues and expenses in comparison to recent periods.  Our services business, which represented over 99% of our total revenues in fiscal 2010, has significantly lower margins than our software business.  The proportion of our services revenues relative to our total revenues in three months ending March 31, 2011 was affected by our continued focus on the PA software side of the business and the continued uncertainty of the US Government budget.




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


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Software Business:  Our software business, which represented less than 1%, of our total revenues in fiscal 2010, is comprised of two operating segments: (i) new software licenses and (ii) software license updates and product support.  The company made significant investment in developing new healthcare and financial services solutions working with partners as addressed in business section.  We expect that our software business’ total revenues in 2011 will increase due to the continued demand for our PA software products and software license updates and product support offerings.  We will continue to make further investments in research and development to meet customer demand and changing market conditions.  We believe that future software revenues will significantly increase as we bring to market our software-as-a-service (SaaS) and platform-as-a-service (PaaS) delivery models.




During this fiscal quarter, we continued to place great emphasis on the enhancement and development of our core technology products and the adaptation into market-sector specific solutions.  This concentration of effort resulted in higher overhead, on a year over year basis, consisting primarily of personnel related expenditures.  Key to our future, we intend to continue to invest significantly in our product research and development and market-driven technology solutions because they are essential to maintaining our competitive position.




Critical Accounting Policies




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




Principles of Consolidation




The consolidated financial statements include those of InferX Corporation.




Use of Estimates




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




Cash and Cash Equivalents




We consider all highly liquid debt instruments and other short-term investments with a maturity of six months or less, when purchased, to be cash equivalents.




We maintain cash and cash equivalent balances at one financial institution that is insured by the Federal Deposit Insurance Corporation up to $250,000.




Allowance for Doubtful Accounts




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


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Fixed Assets




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




Computer Software Development Costs




During 2009, the Company capitalized certain software development costs.  The Company capitalizes the cost of software in accordance with ASC 985-20 once technological feasibility has been demonstrated, as the Company has in the past sold, leased or otherwise marketed their software, and plans on doing so in the future.  The Company capitalizes costs incurred to develop and market their privacy preserving software during the development process, including payroll costs for employees who are directly associated with the development process and services performed by consultants.  Amortization of such costs is based on the greater of (i) the ratio of current gross revenues to the sum of current and anticipated gross revenues, or (ii) the straight-line method over the remaining economic life of the software, typically five years. It is possible that those anticipated gross revenues, the remaining economic life of the products, or both, may be reduced as a result of future events.  The Company has not developed any software for internal use.  During the period ending March 31, 2011, the Company did not capitalize any software development costs.




Recoverability of Long-Lived Assets




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




Revenue Recognition




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




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




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


29




Stock-Based Compensation




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




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




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




Concentrations




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




Segment Reporting




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




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




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




Convertible Instruments




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




Income Taxes




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


30




Uncertainty in Income Taxes




Under ASC 740-10-25 recognition and measurement of uncertain income tax positions is required using a “more-likely-than-not”approach.  We evaluate our tax positions on an annual basis, and have determined that no additional accrual for income taxes is necessary.




(Loss) Per Share of Common Stock




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




Research and Development




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




Recent Issued Accounting Standards




In September 2006, ASC 820, “Fair Value Measurements” (ASC 820) was issued. ASC 820 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosure about fair value measurements.  This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007.  Early adoption is encouraged.  The adoption of ASC 820 is not expected to have a material impact on the consolidated financial statements.




In February 2007, ASC 825-10, “The Fair Value Option for Financial Assets and Financial Liabilities” (ASC 825-10), was issued. This included an amendment of ASC 320-10, which permits entities to choose to measure many financial instruments and certain other items at fair value at specified election dates.  A business entity is required to report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date.  This statement is expected to expand the use of fair value measurement.  ASC 825-10 is effective for financial statements issued for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years.




In December 2007, ASC 810-10-65, “Noncontrolling Interests in Consolidated Financial Statements,” (ASC 810-10-65), was issued. ASC 810-10-65 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, changes in a parent’s ownership of a noncontrolling interest, calculation and disclosure of the consolidated net income attributable to the parent and the noncontrolling interest, changes in a parent’s ownership interest while the parent retains its controlling financial interest and fair value measurement of any retained noncontrolling equity investment.




ASC 810-10-65 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years.  Early adoption is prohibited. Management is determining the impact that the adoption of ASC 810-10-651 will have on our consolidated financial position, results of operations or cash flows.




In December 2007, the Company adopted ASC 805, “Business Combinations” (ASC 805).  ASC 805 has the fundamental requirements that the acquisition method of accounting be used for all business combinations and for an acquirer to be identified for each business combination.  ASC 805 defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control.  ASC 805 will require an entity to record separately from the business combination the direct costs, where previously these costs were included in the total allocated cost of the acquisition.  ASC 805 will require an entity to recognize the assets acquired, liabilities assumed, and any non-controlling interest in the acquired at the acquisition date, at their fair values as of that date.


31




ASC 805 will require an entity to recognize as an asset or liability at fair value for certain contingencies, either contractual or non-contractual, if certain criteria are met.  Finally, ASC 805 will require an entity to recognize contingent consideration at the date of acquisition, based on the fair value at that date.  This will be effective for business combinations completed on or after the first annual reporting period beginning on or after December 15, 2008.  Early adoption of this standard is not permitted and the standards are to be applied prospectively only.  Upon adoption of this standard, there would be no impact to our results of operations and financial condition for acquisitions previously completed.  The adoption of ASC 815 is not expected to have a material effect on our consolidated financial position, results of operations or cash flows.




In March 2008, ASC 815, Disclosures about Derivative Instruments and Hedging Activities” (ASC 815), was issued. ASC 815 requires enhanced disclosures about an entity’s derivative and hedging activities.  These enhanced disclosures will discuss: how and why an entity uses derivative instruments; how derivative instruments and related hedged items are accounted for and its related interpretations; and how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows.  ASC 815 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.  The Company does not believe that ASC 815 will have an impact on their results of operations or financial position.




In April 2008, ASC 350, “Determination of the Useful Life of Intangible Assets”, (ASC 350), was issued. ASC 350 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset.  The guidance is used for determining the useful life of a recognized intangible asset shall be applied prospectively to intangible assets acquired after adoption, and the disclosure requirements shall be applied prospectively to all intangible assets recognized as of, and subsequent to, adoption. The Company does not believe ASC 350 will materially impact our financial position, results of operations or cash flows.




In May 2008, ASC 470-20, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (ASC 470-20), was issued. ASC 470-20 requires the issuer of certain convertible debt instruments that may be settled in cash (or other assets) on conversion to separately account for the liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuer’s non-convertible debt borrowing rate.  ASC 470-20 is effective for fiscal years beginning after December 15, 2008 on a retroactive basis.  The Company does not believe that the adoption of ASC 470-20 will have a material effect on its financial position, results of operations or cash flows.




In June 2008, ASC 815-40, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” (ASC 815-40), was issued.  ASC 815-40 provides guidance for determining whether an equity-linked financial instrument (or embedded feature) is indexed to an entity’s own stock and it applies to any freestanding financial instrument or embedded feature that has all the characteristics of a derivative.  ASC 815-40 also applies to any freestanding financial instrument that is potentially settled in an entity’s own stock.  The Company is determining what impact, if any, ASC 815-40 will have on its financial position, results of operations and cash flows.




In June 2008, ASC 470-20-65, “Transition Guidance for Conforming Changes to, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios”, (ASC 470-20-65), was issued. ASC 470-20-65 is effective for years ending after December 15, 2008.  The overall objective of ASC 470-20-65 is to provide for consistency in application of the standard.  The Company has computed and recorded a beneficial conversion feature in connection with certain of their prior financing arrangements and does not believe that ASC 470-20-65 will have a material effect on that accounting.




In May 2009, ASC 855, “Subsequent Events”, (SFAS 165), was published. ASC 855 requires the Company to disclose the date through which subsequent events have been evaluated and whether that date is the date the financial statements were issued or the date the financial statements were available to be issued. ASC 855 is effective for financial periods ending after June 15, 2009.


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Effective July 1, 2009, the Company adopted FASB ASU No. 2009-05, “Fair Value Measurement and Disclosures (Topic 820)” (ASU 2009-05). ASU 2009-05 provided amendments to ASC 820-10, “Fair Value Measurements and Disclosures – Overall”, for the fair value measurement of liabilities. ASU 2009-05 provides clarification that in circumstances in which a quoted market price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using certain techniques.  ASU 2009-05 also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of a liability.  ASU 2009-05 also clarifies that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required for Level 1 fair value measurements.  Adoption of ASU 2009-05 did not have a material impact on the Company’s results of operations or financial condition.




In January 2010, the Company adopted FASB ASU No. 2010-06, Fair Value Measurement and Disclosures (Topic 820)- Improving Disclosures about Fair Value Measurements (ASU 2010-06). These standards require new disclosures on the amount and reason for transfers in and out of Level 1 and 2 fair value measurements. The standards also require new disclosures of activities, including purchases, sales, issuances, and settlements within the Level 3 fair value measurements. The standard also clarifies existing disclosure requirements on levels of disaggregation and disclosures about inputs and valuation techniques. These new disclosures are effective beginning with the first interim filing in 2010.




The disclosures about the roll forward of information in Level 3 are required for the Company with its first interim filing in 2011.  The Company does not believe this standard will impact their financial statements.




In February 2010, the FASB issued ASU 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements”. This update addresses both the interaction of the requirements of Topic 855, “Subsequent Events”, with the SEC’s reporting requirements and the intended breadth of the reissuance disclosures provision related to subsequent events (paragraph 855-10-50-4). The amendments in this update have the potential to change reporting by both private and public entities, however, the nature of the change may vary depending on facts and circumstances. Adoption of ASU 2010-09 did not have a material impact on the Company’s results of operations or financial condition.




Other ASU’s that have been issued or proposed by the FASB ASC that do not require adoption until a future date and are not expected to have a material impact on the financial statements upon adoption.




Three Months Ended March 31, 2011 and 2010




Revenue




Revenue for the three months ended March 31, 2011 was $1,031,336, a decrease from $1,392,058 for the same period in 2010; a 26% decrease, reflecting what we believe to be a continuing uncertain economic environment across all of our focus market areas; and inability of the US Government to enact a budget, which directly impacts our revenue delivered from government contracts.  From a customer market perspective, we did not see a significant improvement in the business environment for capital expenditures across our enterprise, commercial, and government markets, during the first quarter of fiscal 2011.  In this same period, our net sales decreased on a quarter-over-quarter basis across all of our focus market areas, likewise our revenue from legacy professional services contracts decreased by 26%, compared with the corresponding periods of fiscal 2010.  In the first quarter of fiscal 2011 and 2010, we had no revenue from core PA technology products.




Cost of Revenues




Costs of revenues for the three months ended March 31, 2011 were $674,927, a 49% decrease from $1,329,365 for the same period in 2010.  The decrease resulted primarily from lower subcontractor costs attributable to lower revenue as well as benefits from our ongoing program to optimize efficiency and reduce costs.


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Gross Margin




In the first quarter of fiscal 2011, our gross margin percentage increased by approximately 469% compared with the corresponding period of fiscal 2010.  This increase in gross margin percentage for the first quarter of fiscal 2011 was the result of a substantial reduction in cost of goods sold.




Operating Expenses




For the first quarter operating expenses of fiscal 2011 increased by approximately 2% compared with the corresponding period of fiscal 2010.  The increase was attributable to higher stock based compensation-related expenses, however, all other aspects of our operating expenses enjoyed a significant decrease during this period.  Operating expenses for the three months ended March 31, 2011, which include indirect labor, professional fees, travel, rent, general and administrative, stock issued for services, stock based compensation, and depreciation, increased $14,343 to $605,290 from $590,947 for the same period in 2010.




Other Income (Expense)




Other income increased $441,887 in the three months ended March 31, 2011 compared to the same period in 2010.  The increase is attributable to the fair value increase in the derivative liability of $406,500, offset by the increase in the amortization of debt discount of $41,497 and an increase in interest expense of $6,110.




Contract Backlog




At March 31, 2011 and December 31, 2010, our estimated backlog was $6,102,000 million and $5,790,000 million, respectively, of which $4,440,000 million and $4,752,000 million, respectively, was funded.  We define backlog as our estimate of the remaining future revenue from existing signed contracts over the remaining base contract performance period and from the option periods of those contracts, assuming the exercise of all related options.  We define funded backlog as the portion of backlog for which funding currently is appropriated and obligated to us under a contract or other authorization for payment signed by an authorized purchasing agency, less the amount of revenue we have previously recognized.  Our backlog does not include any estimate of future potential delivery orders that might be awarded under our Government Wide Acquisition Contracts (GWAC) or other multiple-award contract vehicles.




Factors That May Impact Net Sales and Gross Margin




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




Liquidity and Capital Resources




We had cash of $61,148 and a working capital deficit of $3,687,379 as of March 31, 2011.  During the three months ended March 31, 2011, we used approximately $971,800 of cash from our operations.  Operations were funded primarily from the consulting revenue generated in this period.


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We will need to generate significant additional revenue to support our projected increases in staffing and other operating expenses in light of the requirements created by our business plan and enhancement of our core technology products and the adaptation of that technology into market-sector specific solutions.  We are currently expending approximately $409,000 per month to support our operations, and under our current business plan we anticipate expenditures of approximately $459,000 per month through the 3rd quarter of 2011.  We expect to raise additional financing through the sale of our common stock during the second or third  quarter of 2011 to supplement the cash generated from software license sales and the professional services that are provided through existing contracts that we believe will be sufficient to fund our operations until additional financing is procured  If we are unable to generate sufficient cash through the sale of our stock it will be necessary for us to significantly reduce expenses to manage our business.  Although we believe the additional capital required will be provided through one of these sources, we cannot assure you that we will be successful in these financing efforts or accepting financing at acceptable prices.  Our failure to generate such revenue, reduce expenses or obtain necessary financing could impair our ability to continue business operations and raises substantial doubt about our ability to remain as a going concern.





Item 3.   Quantitative and Qualitative Disclosures About Market Risk.





Not applicable





Item 4T.             Controls and Procedures.




Evaluation of disclosure controls and procedures.




Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of December 31, 2010.  Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are not effective due to the existence of material weaknesses in our internal control over financial reporting, discussed below.




Management’s Report on Internal Control Over Financial Reporting.




Internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act), is a process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, or persons performing similar functions, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, or persons performing similar functions, and in consultation with our board of directors, has established and maintained policies and procedures designed to maintain the adequacy of our internal control over financial reporting that it believes are appropriate in light of our limited activities, personnel and resources as a development stage company, and includes those policies and procedures that:




(1)  Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect transactions and dispositions of our assets;




(2)  Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of our management and directors; and




(3)  Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.




Our management has evaluated the effectiveness of our internal control over financial reporting as of March 31, 2011 based on the criteria established in a report entitled Internal Control—Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).


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Based on our assessment, management has concluded that our internal controls over financial reporting were not effective as of March 31, 2011 due to the existence of several material weaknesses in our internal control over financial reporting, discussed below.  Our Board of Directors has reviewed the results of management’s assessment. In addition, on a quarterly basis we will evaluate any changes to our internal control over financial reporting to determine if material changes occurred.




PART II — OTHER INFORMATION




Item 1.   Legal Proceedings.




Arnold Worldwide, Inc., the landlord of InferX at its former premises at 1600 International Drive, Suite 110, McLean, Virginia 22102, commenced an action against InferX in the General District Court of Fairfax County, on August 25, 2008, seeking (i) damages, including rent due under the sublease between InferX and Arnold Worldwide, late fees due under the sublease, attorney’s fees due under the sublease, and interest, for a total amount claimed of $180,066.53; and (ii) an order for possession of the Premises.  Though the Company disputes the amount outstanding, it has made a good faith gesture to resolve this matter by making a payment of $30,000 on September 12, 2008, and entered into good-faith discussions to resolve the issue with Arnold Worldwide.  The Company agreed to the entry of a Consent Order of Possession that allowed Arnold Worldwide to take possession of the premises.  The lease for the premises at 1600 International Drive terminated November 30, 2008.




Item 1A.            Risk Factors.




We face intense competition.




Our business is rapidly evolving and intensely competitive, and is subject to changing technology, shifting user needs, and frequent introductions of new products and services.  We have many competitors from different industries, including providers of online products and services.  Our current and potential competitors range from large and established companies to emerging start-ups.  Established companies have longer operating histories and more established relationships with customers and end users, and they can use their experience and resources against us in a variety of competitive ways, including by making acquisitions, investing aggressively in research and development, and competing aggressively for customers and market share.  Emerging start-ups may be able to innovate and provide products and services faster than we can.  If our competitors are more successful than we are in developing compelling products or in attracting and retaining clients, our revenues and growth rates could decline.




The market for our products and services is new and evolving and a viable market may never develop or may take longer to develop than we anticipate.




Our software and services represent what we believe is a novel entry in an emerging market, and we do not know the extent to which our targeted customers will want to purchase them.  The development of a viable market for our products may be impacted by many factors which are out of our control, including customer reluctance to try new products and services and the existence and emergence of products and services marketed by better-known competitors.




If a viable market fails to develop or develops more slowly than we anticipate, we may be unable to recover the losses we will have incurred to develop our products and services and may be unable to achieve profitability.




If we do not continue to innovate and provide products and services that are useful to users, we may not remain competitive, and our revenues and operating results could suffer.




Our success depends on providing products and services that make using our technology a more useful and business impactful experience for our customers.  Our competitors are constantly developing innovations in technology embedded in their products and services.  As a result, we must continue to invest significant resources in research and development in order to enhance our predictive analytics technology and our existing products and services and introduce new products and services solutions that people can easily and effectively use.  If we are unable to provide quality products and services, then our users may become dissatisfied and move to a competitor’s products and services.  In addition, these new products and services may present new and difficult technology challenges, and our operating results would also suffer if our innovations are not responsive to the needs of our users and or are not effectively brought to market.  This may force us to compete in different ways and expend significant resources in order to remain competitive.


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The industry in which we operate is characterized by rapid technological changes, and our continued success will depend upon our ability to react to such changes.




The markets for our products and services are characterized by rapidly changing technology.  The introduction of products or services embodying new technology can render our existing products and services obsolete and unmarketable and can exert price pressures on existing products and services.  It is critical to our success for us to be able to anticipate changes in technology and to successfully develop and introduce new, enhanced and competitive products and services on a timely basis.  We cannot assure you that we will successfully develop new products or services or introduce new applications for existing products and services, that new products and applications will achieve market acceptance or that the introduction of new products, services or technological developments by others will not render our products and services obsolete.  Our inability to develop products and services that are competitive in technology and price and meet customer needs could have a material adverse effect on our business, financial condition or results of operations.




Our management controls a substantial percentage of our stock and therefore has the ability to exercise substantial control over our affairs.




As of the date of this filing, our directors and executive officers beneficially owned 11,806,152 shares, or approximately 66.8%, of our outstanding common stock in the aggregate.  Because of the large percentage of stock held by our directors and executive officers, these persons could influence the outcome of any matter submitted to a vote of our stockholders.




If we were to lose the services of Dr. Jerzy Bala, Ray Piluso, Vijay Suri , or B.K. Gogia, or other members of our senior management team, we may not be able to execute our business strategy.




Our future success depends in a large part upon the continued service of key members of our senior management team.  In particular, our CEO, Vijay Suri, and B.K. Gogia our Chairman, Dr. Jerzy Bala, our Chief Technology Officer, and Raimondo Piluso, Chief Operating Officer, are critical to the overall management of InferX Corporation as well as the development of our technology, our culture, and our strategic direction.  The loss of or unavailability of the services of any one of these individuals would have a material adverse effect on our business prospects and/or potential earning capacity.




We rely on highly skilled personnel and, if we are unable to retain or motivate key personnel, hire qualified personnel, or maintain our corporate culture, we may not be able to grow effectively.




Our performance largely depends on the talents and efforts of highly skilled individuals.  Our future success depends on our continuing ability to identify, hire, develop, motivate, and retain highly skilled personnel for all areas of our organization.  Competition in our industry for qualified employees is intense, and some of our competitors have directly targeted our employees.  In addition, our compensation arrangements, such as our equity award programs, may not always be successful in attracting new employees and retaining and motivating our existing employees.  Our continued ability to compete effectively depends on our ability to attract new employees and to retain and motivate our existing employees.




In addition, we believe that our corporate culture fosters innovation, creativity, and teamwork.  As our organization grows, and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the beneficial aspects of our corporate culture.  This could negatively impact our future success.


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We may not be able to protect important intellectual property, and we could incur substantial costs defending against claims that our products infringe on the proprietary rights of others.




We currently have received two patents and have filed four provisional patents, awaiting determination.  While we believe that we have a proprietary position in component technologies for our products, our ability to compete effectively will depend, in part, on our ability to protect our proprietary technologies, processes and designs, to secure patents for the applications we have pending and to protect those patents that we may secure.  We do not know whether any of our pending patent applications will be issued or, if issued, that the claims allowed are or will be sufficiently broad to protect our technology or processes.  Even if all of our patent applications are issued and are sufficiently broad, our patents may be challenged or invalidated.




We could incur substantial costs in prosecuting or defending patent infringement suits or otherwise protecting our intellectual property rights.  While we have attempted to safeguard and maintain our proprietary rights, we do not know whether we have been or will be completely successful in doing so.




We may face liability claims from future customers if our software malfunctions or contains undetected defects.




Our products have in the past contained, and may in the future contain, undetected or unresolved errors when first introduced, as new versions are released, or otherwise.  Despite extensive testing, errors, defects or failures may be found in our current or future products or enhancements after they have been installed by customers.  If this happens, we may experience delay in or loss of market acceptance and sales, diversion of development resources, injury to our reputation or increased service costs, any of which could have a material adverse effect on our business, financial condition and results of operations.  Moreover, because our products are designed to provide critical data analysis services, we may receive significant liability claims. Although we intend to obtain product liability insurance covering certain damages arising from implementation and use of our products, our insurance may not cover all claims sought against us.  Liability claims could require us to spend significant time and money in litigation or to pay significant damages.  As a result, any such claims, whether or not successful, could seriously damage our reputation and business.




We must ensure the protection and privacy of customer data.




We rely on complex encryption algorithms and technology to secure customer data.  We believe our products protect the security and privacy of customer data by transmitting encrypted pointers to customer data, rather than the data itself, across the Internet and existing dedicated transmission lines.  However, if customer data is misappropriated or unintentionally disclosed as a result of an actual or perceived failure of our software, our reputation, and ultimately our business, would be seriously harmed, and we could face liability claims.




We currently are dependent on contracts with the federal government for all of our revenues.




Revenues derived from federal government contracts accounted for 99% of our revenues in the first fiscal quarter 2011.  We expect that government contracts will continue to be a significant source of our revenues for the foreseeable future.  Our business generated from government contracts may be adversely affected if:




·
ability of the government to prepare, approve and execute a final federal fiscal budget;




·
levels of government expenditures and authorizations for national and homeland security related programs decrease, remain constant or shift to programs in areas where we do not provide products and services;




·
we are prevented from entering into new government contracts or extending existing government contracts based on violations or suspected violations of procurement laws or regulations;




·
we are not granted security clearances that are required to sell our products or services or such security clearances are revoked; or


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·
our reputation or relationship with government agencies is impaired.




Most of our contracts with the government contain standard provisions that provide for termination at the convenience of the government pursuant to which we are entitled to recover costs incurred, settlement expenses, and profit on work completed prior to termination.




If we fail to comply with complex procurement laws and regulations, we may be subject to civil and criminal penalties and administrative sanctions.




We must comply with laws and regulations relating to the formation, administration and performance of government contracts.  These laws and regulations affect how we do business with government agencies and may impose added costs on our business.  For example, we are subject to the Federal Acquisition Regulations, which comprehensively regulate the formation, administration and performance of federal government contracts, and to the Truth in Negotiations Act, which requires certification and disclosure of cost and pricing data in connection with contract negotiations.




If a government review or investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or debarment from doing business with government agencies, which could materially and adversely affect our business, financial condition and results of operations.  In addition, a government may reform its procurement practices or adopt new contracting rules and regulations that could be costly to satisfy or that could impair our ability to obtain new contracts.




Risks Related to Our Common Stock




Currently, there is a limited trading market for our common stock, which may adversely impact your ability to sell your shares and the price you receive.




There is currently a limited trading market for our common stock and a more active trading market for our common stock may never develop or be sustained.  The market price of our common stock may be significantly affected by factors such as actual or anticipated fluctuations in our operating results, general market conditions and other factors.  In addition, the stock market has from time to time experienced significant price and volume fluctuations that have particularly affected the market prices for the shares of developmental stage companies, which may materially adversely affect the market price of our common stock without regard to our operating performance. These fluctuations may also cause short sellers to enter the market from time to time in the belief that we will have poor results in the future.  We cannot predict the actions of market participants and, therefore, can offer no assurances that the market for our common stock will be stable or appreciate over time.  Furthermore, for companies such as us whose securities are quoted on the OTC Bulletin Board, it is more difficult (i) to obtain accurate quotations, (ii) to obtain coverage for significant news events because major wire services generally do not publish press releases about such companies, and (iii) to obtain needed capital.  These factors may negatively impact your ability to sell shares of our common stock and the price you receive.




Our common stock is deemed to be a “penny stock,” which may make it more difficult for you to sell your shares.




Our common stock is subject to the “penny stock” rules adopted under Section 15(g) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  The penny stock rules apply to companies whose common stock is not listed on the NASDAQ Stock Market or another national securities exchange and trades at less than $5.00 per share or that have tangible net worth of less than $5,000,000 ($2,000,000 if the company has been operating for three or more years).  These rules require, among other things, that brokers who trade penny stock to persons other than “established customers” complete certain documentation, make suitability inquiries of investors and provide investors with certain information concerning trading in the security, including a risk disclosure document and quote information under certain circumstances.  Many brokers have decided not to trade penny stocks because of the requirements of the penny stock rules and, as a result, the number of broker-dealers willing to act as market makers in such securities is limited.  Remaining subject to the penny stock rules should be expected to have an adverse effect on the market for our common stock by reducing the number of potential investors.  This may make it more difficult for investors in our common stock to sell shares to third parties or to otherwise dispose of them.  This could cause our stock price to decline.


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We need to raise additional capital, but that capital may not be available.




Our existing capital is insufficient to fund our operations beyond the second quarter of 2011.  We believe the anticipated revenues from potential customer contracts along with the sale of a limited amount of equity will enable us to meet our financial obligations as they become due.  However, we are not generating sufficient revenues to increase our working capital or to carry out our proposed business objectives and continue to operate as a going concern beyond the near term, and we need to obtain additional financing or reduce our expenses by curtailing our operations.




We cannot assure you that we will be successful or that our operations will generate sufficient revenues, if any, to meet the expenses of our operations.  Although we are seeking additional financing, such financing may not be available or, if available, may not be available on satisfactory terms.  Additionally, the nature of our business activities may require the availability of additional funds in the future due to more rapid growth than is forecast, and thus, we may need additional capital or credit lines to continue that rate of business growth.  We may encounter difficulty in obtaining these funds and/or credit lines. Moreover, even if additional financing or credit lines were to become available, it is possible that the cost of such funds or credit would be high and possibly prohibitive.




If we were to decide to obtain such additional funds by equity financing in one or more private or public offerings, current stockholders would experience a corresponding decrease in their percentage ownership.




Our independent registered public accounting firm has expressed doubt regarding our ability to continue as a going concern.




Our audited financial statements for the years ended December 31, 2010 and 2009 have been prepared under the assumption that we will continue as a going concern.  Our independent registered public accounting firms have issued their reports dated April 13, 2011 and May 20, 2010 in connection with the audits of our financial statements for the years ended December 31, 2010 and 2009 that included an explanatory paragraph describing the existence of conditions that raise doubt about our ability to continue as a going concern due to our having sustained operating losses and capital deficits from operations.  The fact that we have received this “going concern opinion” from our independent registered public accounting firm will likely make it difficult for us to raise capital on favorable terms and could hinder, to some extent, our operations.  Additionally, if we are not able to continue as a going concern, it is likely that stockholders will lose all of their investment.  Our financial statements do not include any adjustments that might result from the outcome of this uncertainty.




Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds.





None.





Item 3.   Defaults Upon Senior Securities.





None.





Item 4.   Submission of Matters to a Vote of Security Holders.





None.




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Item 5.   Other Information.




Except as otherwise noted, the securities described in this Item were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act of 1933 and/or Regulation D promulgated under the Securities Act. Each such issuance was made pursuant to individual contracts that are discrete from one another and are made only with persons who were sophisticated in such transactions and who had knowledge of and access to sufficient information about the Company to make an informed investment decision. Among this information was the fact that the securities were restricted securities.




Item 6.   Exhibits.





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Certification of the Principal Executive, Financial and Accounting Officer required by Rule 13a-14(a) or Rule 15d-14(a).32

Certification of the Chief Executive Officer and Chief Financial Officer required by Rule 13a-14(b) or Rule 15d-14(b) and 18 U.S.C. 1350.





SIGNATURES





In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.





Dated: May 13, 2011
InferX CorporationBy:
/s/ Vijay SuriVijay Suri, President, CEO and CFO(Principal Executive, Financial andAccounting Officer)


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