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EX-32.1 - EXHIBIT 32.1 - ITEX CORPv395417_ex32-1.htm
EX-31.1 - EXHIBIT 31.1 - ITEX CORPv395417_ex31-1.htm
EX-32.2 - EXHIBIT 32.2 - ITEX CORPv395417_ex32-2.htm
EX-31.2 - EXHIBIT 31.2 - ITEX CORPv395417_ex31-2.htm
EXCEL - IDEA: XBRL DOCUMENT - ITEX CORPFinancial_Report.xls

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

 

FORM 10-Q

 

Mark One)

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended October 31, 2014.

 

OR

 

¨ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                                          to                                         

 

Commission File Number 0-18275

 

ITEX CORPORATION

(Exact name of registrant as specified in its charter)

 

Nevada   93-0922994

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

 

3326 160th Ave SE, Suite 100, Bellevue, WA 98008-6418
(Address of principal executive offices)

 

  (425) 463-4000  
(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 x  No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x  No ¨

 

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

 

  ¨ Large accelerated filer   ¨ Accelerated filer
  ¨ Non-accelerated filer   x Smaller reporting company
 

(Do not check if a smaller

reporting company)

 

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

Yes ¨ No x

 

As of October 31, 2014, we had 2,837,215 shares of common stock outstanding (including unvested restricted stock).

 

 
 

 

ITEX CORPORATION

FORM 10-Q

 

INDEX

 

    Page(s)
     
PART  I. Financial Information  
     
ITEM 1. Financial Statements  
     
  Consolidated Balance Sheets as of October 31, 2014 (unaudited) and July 31, 2014 1
     
  Consolidated Statements of Income for the Three-Months Ended October 31, 2014 and 2013 (unaudited) 2
     
  Consolidated Statement of Stockholders’ Equity for the Three-Months Ended October 31, 2014 (unaudited) 3
     
  Consolidated Statements of Cash Flows for the Three-Months Ended October 31, 2014 and 2013 (unaudited) 4
     
  Notes to Consolidated Financial Statements (unaudited) 5
     
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 9
     
ITEM 4. Controls and Procedures 30
     
PART II. Other Information 30
     
ITEM 1. Legal Proceedings 30
     
ITEM 2. Unregistered Sales of Equity Securities 31
     
ITEM 6. Exhibits 31
     
  Signatures 32

 

 
 

 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

ITEX CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands)

 

   October 31, 2014   July 31, 2014 
   (unaudited)     
ASSETS          
Current assets:          
Cash  $4,097   $3,673 
Accounts receivable, net of allowance of $402 and $357   655    658 
Prepaid expenses   84    104 
Loans and advances   20    15 
Deferred tax asset, net of allowance of $15   542    542 
Notes receivable   330    318 
Other current assets   33    30 
Total current assets   5,761    5,340 
           
Property and equipment, net of accumulated depreciation of $424 and $415   65    74 
Goodwill   3,191    3,191 
Deferred tax asset, net of allowance of $95 and net of current portion   3,413    3,492 
Intangible assets, net of accumulated amortization of $3,284 and $3,270   143    157 
Notes receivable, net of current portion   1,044    1,106 
Other long-term assets   9    11 
Total assets   13,626    13,371 
LIABILITIES AND STOCKHOLDERS' EQUITY          
Current liabilities:          
Accounts and other expenses payable   57    52 
Commissions payable to brokers   251    267 
Accrued commissions to brokers   883    728 
Accrued expenses   324    254 
Deferred revenue   24    32 
Advance payments   106    106 
Note payable, current portion   1    3 
Total current liabilities   1,646    1,442 
Total Liabilities   1,646    1,442 
           
Commitments and contingencies          
           
Stockholders’ equity:          
Common stock, $0.01 par value; 9,000 shares authorized; 2,605 shares and 2,602 shares issued and outstanding, respectively   26    26 
Additional paid-in capital   25,243    25,222 
Stockholder notes receivable   (143)   (161)
Accumulated deficit   (13,146)   (13,158)
Total stockholders' equity   11,980    11,929 
Total liabilities and stockholders’ equity  $13,626   $13,371 

 

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

 

1
 

 

ITEX CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share amounts)

 

   Three-months ended
October 31,
 
   2014   2013 
   (unaudited) 
Revenue:          
Marketplace revenue and other revenue  $3,117   $3,426 
           
Costs and expenses:          
Cost of marketplace revenue   1,923    2,137 
Corporate salaries, wages and employee benefits   445    521 
Selling, general and administrative   516    496 
Depreciation and amortization   23    42 
    2,907    3,196 
           
Income from operations   210    230 
           
Other income:          
Interest, net   24    31 
Other income, net   -    - 
    24    31 
           
Income before income taxes   234    261 
           
Income tax expense   79    85 
           
Net income  $155   $176 
           
Net income per common share:          
Basic  $0.06   $0.07 
Diluted  $0.06   $0.07 
           
Weighted average shares outstanding:          
Basic   2,607    2,602 
Diluted   2,611    2,613 

 

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

 

2
 

 

ITEX CORPORATION

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE THREE-MONTHS ENDED OCTOBER 31, 2014

(In thousands)

(Unaudited)

 

   Common Stock   Additional
Paid-in
   Stockholder
Note
   Accumulated     
   Shares   Amount   Capital   Receivable   Deficit   Total 
                         
Balance at July 31, 2014   2,602   $26   $25,222   $(161)  $(13,158)  $11,929 
                               
Common stock repurchased and retired   (14)   -    (42)   -    -    (42)
                               
Payments on stockholder notes receivable   -    -    -    18    -    18 
                               
Cancellation of broker stock purchase   (1)   -    (4)   -    -    (4)
                               
Stock based compensation expense   18    -    67    -    -    67 
                               
Dividend payment   -    -    -    -    (143)   (143)
                               
Net income   -    -    -    -    155    155 
                               
Balance at October 31, 2014   2,605   $26   $25,243   $(143)  $(13,146)  $11,980 

 

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

 

3
 

 

ITEX CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

(Unaudited)

 

   Three-months ended October 31, 
   2014   2013 
     
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net income  $155   $176 
Items to reconcile to net cash provided by operations:          
Depreciation and amortization   24    42 
Stock based compensation   67    69 
Increase (decrease) in allowance for uncollectible receivables   45    (16)
Change in deferred income taxes   79    92 
Changes in operating assets and liabilities:          
Accounts receivable   (42)   30 
Prepaid expenses   20    26 
Loans and advances   (5)   (11)
Other assets   (3)   (10)
Accounts payable and other expenses payable   5    71 
Commissions payable to brokers   (16)   (37)
Accrued commissions to brokers   155    153 
Accrued expenses   70    31 
Deferred revenue   (8)   (6)
Advance payments   -    (12)
Long-term liabilities   -    (3)
Net cash provided by operating activities   546    595 
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Purchase of property and equipment   (1)   (1)
Payments on notes payables   (2)   - 
Payments received from notes receivable   65    171 
Advances on notes receivable   (15)   (338)
           
Net cash provided by (used in) investing activities   47    (168)
           
CASH FLOWS FROM FINANCING ACTIVITIES:          
Principal payments on stockholder notes receivable   16    16 
Repurchase of common stock   (42)   (19)
Cash dividend paid to Common Shareholders   (143)   (145)
Net cash used in financing activities   (169)   (148)
           
Net increase in cash   424    279 
Cash at beginning of period   3,673    3,352 
Cash at end of period  $4,097   $3,631 
           
Supplemental cash flow information:          
Cash paid for taxes  $2   $25 

 

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

 

4
 

 

ITEX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

NOTE 1 – DESCRIPTION OF OUR COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (In thousands, except per share amounts)

 

Description of the Company

 

ITEX Corporation (“ITEX”, “Company”, “we” or “us”) was incorporated in October 1985 in the State of Nevada. Through our independent licensed broker and franchise network, corporate and corporate-owned offices (individually, “broker,” and together the “Broker Network”) in the United States and Canada, we operate a marketplace (the “Marketplace”) in which products and services are exchanged by Marketplace members utilizing our “virtual currency” (“ITEX dollars”). Our virtual currency is only usable in the Marketplace and allows thousands of member businesses (our “members”) to acquire products and services without exchanging cash. We administer the Marketplace and provide record-keeping and payment transaction processing services for our members.

 

Unaudited Interim Financial Information

 

We have prepared the accompanying consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial reporting. These consolidated financial statements are unaudited and, in our opinion, include all adjustments, consisting of normal recurring adjustments and accruals necessary for a fair presentation of our consolidated balance sheets, operating results, and cash flows for the periods presented. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) have been omitted in accordance with the rules and regulations of the SEC. The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amount of assets and liabilities and the disclosure of contingent liabilities as of the date of the financial statements and the reported amount of revenue and expenses during the reporting period. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes in Item 8 of Part II, “Financial Statements and Supplementary Data,” of our 2014 Annual Report on Form 10-K filed with the SEC on October 15, 2014.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of ITEX Corporation and its wholly-owned subsidiaries, BXI Exchange, Inc. and Virtual Currency Systems Corp. All inter-company accounts and transactions have been eliminated in consolidation.

 

Use of Estimates

 

Management has made a number of estimates and assumptions relating to the reporting of revenues, expenses, assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements. Actual results could differ from these estimates.

 

5
 

 

Income Per Share

 

We prepare our financial statements using both basic and diluted earnings per share. Basic earnings per share excludes potential dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. As of October 31, 2014, we had no contracts to issue common stock, but we did have 20 warrants outstanding that were anti-dilutive. The Company also had 232 unvested shares of restricted stock. All of these shares were dilutive and resulted in an additional 4,000 shares being included in dilutive earnings per share as of October 31, 2014.

 

The following table presents a reconciliation of the denominators used in the computation of net income per common share basic and net income per common share – diluted for the three-month period ended October 31, 2014 (in thousands, except per share data) (unaudited):

 

   Three-months Ended
October 31,
 
   2014   2013 
         
Net income available for shareholders  $155   $176 
           
Weighted avg. outstanding shares of common stock   2,607    2,602 
Dilutive effect of restricted shares   4    11 
Common stock and equivalents   2,611    2,613 
Earnings per share:          
Basic  $0.06   $0.07 
Diluted  $0.06   $0.07 

 

Recent Accounting Pronouncements

 

There have been no recent accounting pronouncements or changes in accounting pronouncements during the three-months ended October 31, 2014, as compared to the recent accounting pronouncements described in the Company’s Annual Report on Form 10-K, that are of significance, or potential significance to the Company.

 

NOTE 2 – COMMITMENTS

 

The Company leases office space under an operating lease. The lease commitment is for the Company’s corporate headquarters in Bellevue, Washington. The corporate headquarters lease expires on April 30, 2015.

 

6
 

 

Future minimum payments at October 31, 2014 under the operating lease for office space is as follows (in thousands):

 

   Executive office 

Lease commitment

for the year ending

July 31,

     
      
2015(1)  $84 

 

(1)   The expected payments for 2015 reflect future minimum payments for the nine-month period from November 1, 2014 to July 31, 2015.

 

Rent expense, including utilities and common area charges, was $40 and $40, respectively for the three-months ended October 31, 2014 and 2013.

 

In addition to the foregoing lease commitments, the Company is a party to several non-cancelable and non-refundable purchase commitments. Those purchase obligations consist primarily of arrangements for telecommunications and co-location services for the Company’s network operations.

 

There are no future minimum payments at October 31, 2014 under any non-cancelable commitments.

 

NOTE 3 – LEGAL PROCEEDINGS AND LITIGATION CONTINGENCIES

 

From time to time we are subject to a variety of claims and litigation incurred in the ordinary course of business. In our opinion, the outcome of our pending legal proceedings, individually or in the aggregate, will not have a material adverse effect on our business operations, results of operations, cash flows or financial condition.

 

Management has regular litigation reviews, including updates from outside counsel, to assess the need for accounting recognition or disclosure of contingencies relating to pending lawsuits. The Company accrues an undiscounted liability for those contingencies where the incurrence of a loss is probable, and the amount can be reasonably estimated. The Company does not record liabilities when the likelihood that the liability has been incurred is probable but the amount cannot be reasonably estimated or when the liability is believed to be only reasonably possible or remote. For contingencies where an unfavorable outcome is reasonably possible and which are significant, the Company discloses the nature of the contingency and, where feasible, an estimate of the possible loss. For purposes of our litigation contingency disclosures, “significant” includes material matters as well as other items which management believes should be disclosed.

 

Management judgment is required related to contingent liabilities and the outcome of litigation because both are difficult to predict. Litigation is subject to inherent uncertainties and unfavorable rulings could occur. Although management currently does not believe resolving any pending proceeding will have a material adverse impact on our financial statements, management’s view of these matters may change in the future. A material adverse impact on our financial statements could occur for the period in which the effect of an unfavorable final outcome becomes probable and reasonably estimable.

 

7
 

 

NOTE 4 – INCOME TAXES

 

Income tax expense during interim periods is based on applying an estimated annual effective income tax rate to year-to-date income, plus any significant unusual or infrequently occurring items which are recorded in the interim period. 

 

The Federal effective tax rate related to our provision for income taxes in the three-months ended October 31, 2014 is similar to that used in the period ended October 31, 2013. The State effective tax rate related to our provision for income taxes in the three-months ended October 31, 2014 differs slightly from that used in the three-month periods ending October 31, 2013, due to a reduction in the accrued expenses on our consolidated balance sheet for uncertain tax positions related primarily to state jurisdictions.

 

The computation of the annual estimated effective tax rate at each interim period requires certain estimates and significant judgment including, but not limited to, the expected operating income for the year, projections of the proportion of income earned and taxed in various jurisdictions, permanent and temporary differences, and the likelihood of recovering deferred tax assets generated in the current year. The accounting estimates used to compute the provision for income taxes may change as new events occur, more experience is obtained, additional information becomes known or as the tax environment changes.

 

As of October 31, 2014 we have recognized a net income tax expense of $79 which is our estimated federal and state income tax liability for the three-months ended October 31, 2014. Realization of our deferred tax asset is dependent upon future earnings in specific tax jurisdictions, the timing and amount of which are uncertain.  As of October 31, 2014 the net deferred tax asset was $3,955.

 

We account for any uncertainty in income taxes by recognizing the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. We measure the tax benefits recognized in the financial statements from such a position based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. The application of income tax law is inherently complex. As such, we are required to make subjective assumptions and judgments regarding income tax exposures. The result of the reassessment of our tax positions did not have an impact on the consolidated financial statements.

 

NOTE 5 – STOCKHOLDERS’ EQUITY (in thousands, except per share amounts)

 

The Company has 5,000 shares of preferred stock authorized at $0.01 par value. No preferred shares were issued or outstanding as of October 31, 2014.

 

On March 9, 2010, the Company announced a $2,000 stock repurchase program, authorized by the Board of Directors. The program authorizes the repurchase of shares in open market purchases or privately negotiated transactions, has no expiration date and may be modified or discontinued by the Board of Directors at any time. During the three-month period ended October 31, 2014, the Company repurchased 14 shares of common stock for $42. There were 4 shares of common stock for $19 purchased during the three-month period ended October 31, 2013.

 

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NOTE 6 – STOCK-BASED PAYMENTS (in thousands)

 

We account for stock-based compensation in accordance with the related guidance. Under the fair value recognition provisions, we estimate stock-based compensation cost at the grant date based on the fair value of the award. We recognize that expense ratably over the requisite service period of the award and recognized $67 and $69 of stock based compensation expense for the periods ending October 31, 2014 and 2013, respectively.

 

At October 31, 2014, 213 shares of common stock granted under the 2004 Plan remained unvested and 19 under the 2014 plan. At October 31, 2014, the Company had $761 of unrecognized compensation expense, expected to be recognized over a weighted-average period of approximately six years.

 

NOTE 7 – SUBSEQUENT EVENTS

 

On November 20, 2014, the Board of Directors declared a cash dividend in the amount of $0.05 per share, payable on December 19, 2014 to stockholders of record as of the close of business on December 9, 2014.

 

On November 30, 2014, the Company and U.S. Bank entered into an Amendment to its Credit Agreement and Note to extend the maturity date to November 30, 2015, with a maximum loan amount of $1.0 million. There is no current outstanding balance on the line of credit.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands, except per share amounts)

 

In addition to current and historical information, this Quarterly Report on Form 10-Q contains forward-looking statements. These statements relate to our future operations, prospects, potential products, services, developments, business strategies or our future financial performance. Forward-looking statements reflect our expectations and assumptions only as of the date of this report and are subject to risks and uncertainties. Actual events or results may differ materially. We have included a detailed discussion of certain risks and uncertainties that could cause actual results and events to differ materially from our forward-looking statements in the section titled “Risk Factors” below. We undertake no obligation to update or revise publicly any forward-looking statement after the date of this report, whether as a result of new information, future events or otherwise.

 

Overview

 

ITEX operates a marketplace (the “Marketplace”) in which products and services are exchanged by Marketplace members utilizing our “virtual currency” (“ITEX dollars”). Our virtual currency is only usable in the Marketplace and allows thousands of member businesses (our “members”) to acquire products and services without exchanging cash. We service our member businesses through our independent licensed brokers and franchise network (individually, “broker” and together, the “Broker Network”) in the United States and Canada. We administer the Marketplace and provide record-keeping and payment transaction processing services for our members. We generate revenue by charging members percentage-based transaction fees, association fees, and other fees assessed in United States dollars and Canadian dollars where applicable (collectively and as reported on our financial statements, “USD” or “Cash”).

 

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For each calendar year, we divide our operations into 13 four-week billing and commission cycles always ending on a Thursday (“operating cycle”). For financial statement purposes, our fiscal year is from August 1 to July 31 (“year”, “2015” for August 1, 2014 to July 31, 2015, “2014” for August 1, 2013 to July 31, 2014). Our first quarter is the three-month period from August 1, 2014 to October 31, 2014 (“three-month period ended October 31”). We report our results as of the last day of each calendar month (“accounting cycle”). The timing of billing and collection activities after the end of the billing cycle does not correspond with the end of the accounting period, therefore this timing difference results in the fluctuations of the balances of cash, accounts receivable, commissions payable and accrued commissions on the consolidated balance sheets and consolidated statements of cash flows.

 

Each operating cycle we generally charge our members association fees of $20 USD ($260 USD annually) and $10 ITEX dollars ($130 ITEX dollars annually). We also charge transaction fees in USD from both the buyer and seller computed as a percentage of the ITEX dollar value of the transaction.

 

The following summarizes our operational and financial highlights for the quarter and our outlook (in thousands except per share data):

 

·Comparative Results. For the three-months ended October 31, 2014, as compared to the three-months ended October 31, 2013, our revenue decreased by $309, or 9%, from $3,426 to $3,117. Our income from operations decreased by $20, or 9%, from $230 to $210. Net income decreased by $21, or 12%, from $176 to $155.

 

·Revenue Sources. Our decrease in revenues for the three-months ended October 31, 2014 reflects a reduction in our transaction volume and a reduction in our membership base. Association revenue decreased $62, or 6% from $1,110 to $1,048 and our transaction revenue decreased $248, or 11% from $2,204 to $1,956.

 

·Internet Applications and Web Services. We continually enhance our internet applications and web services to make our online services more user friendly to our employees, brokers and members, and to create confidence in the Marketplace. In 2014 we upgraded our payment processing and team software with .NET technologies. We refresh the content at our website www.itex.com to better tell our story and make it more community driven. We are seeking potential additional revenue opportunities which may be derived from licensing our virtual currency platform to third parties.

 

·Smart Phone technology. We seek to provide useful tools to members to enable them to expand their trading community, find local customers and instantly complete transactions through a mobile device. During this quarter we launched a Smart Phone application, ITEX MobileSM with ITEXpaySM which enables our members to easily register new prospects into our Marketplace, complete transactions and search for other members.

 

·Revenue Trends. Our reduction in revenue this quarter was due to a reduction in members and a corresponding reduction in transaction and association fees generated from our members. We believe the reduction in members and transaction volume is attributed in part to the prolonged weak economic climate for small businesses (our primary clientele) and increased competition from pricing and convenience of big box stores and Internet outlets. Although we seek to increase revenues through organic growth and the development of new revenue sources, the primary driver of revenue growth in past years has been through our business acquisitions. These acquisitions are intermittent and cannot be relied upon as a future source of revenue growth, because of the absence of acquisition candidates, lack of financing, or unacceptable terms. We have approximately 30% recurring revenues from association fees. Approximately two-thirds of our revenues each year come from transactions fees assessed during that year. We believe the expansion of our membership base will increase our recurring revenues. We continue to seek to increase our revenue by:

 

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oenhancing our internet applications;

 

ooffering expanded tools and features with ITEX MobileSM;

 

omarketing the benefits of participation in the Marketplace;

 

oexpanding Marketplace offerings of goods and services;

 

oAdding new brokers.

 

In order to add new brokers we are sustaining our broker recruiting incentives. Through our Broker Mentor program, existing brokers recruit prospective brokers and provide ongoing training to the prospective broker until certain performance thresholds are met. Upon meeting the performance thresholds, the prospective broker is offered a franchise for a reduced fee of $5 from our standard fee of $20. The mentoring broker receives a 5% commission override on the cash collected per cycle by the new broker.

 

·Financial Position. At October 31, 2014, we had a cash balance of $4,097, compared to a balance of $3,673 at July 31, 2014. Our net cash flows provided by operating activities were $546 for the three-month period ended October 31, 2014, compared to $595 for the corresponding period the previous year. Our business model has demonstrated the ability to generate consistent cash flows, which have historically supplied us with our primary source of liquidity. We seek to maintain a liquidity cushion sufficient to fund our business activity and handle contingencies, while preserving the ability to return cash to our stockholders through dividends and share buybacks. However, our Board of Directors may decide to use capital for acquisitions, revenue generating opportunities or other corporate purposes. See Risk Factor below “Our ability to pay dividends on our common stock is subject to the discretion of our Board of Directors and may be limited by our lack of liquidity or access to capital.

 

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RESULTS OF OPERATIONS

 

Condensed Results (in thousands, except per share data):

 

   Three Months Ended 
October 31,
 
   2014   2013 
   (unaudited) 
Marketplace revenue and other revenue  $3,117   $3,426 
           
Cost of marketplace revenue   1,923    2,137 
Operating expenses   984    1,059 
Income from operations   210    230 
           
Other income, net   24    31 
Income before income taxes   234    261 
           
Provision for income taxes   79    85 
           
Net income  $155   $176 
           
Net income per common share:          
Basic  $0.06   $0.07 
Diluted  $0.06   $0.07 
           
Average common and equivalent shares:          
Basic   2,607    2,602 
Diluted   2,611    2,613 

 

Revenue for the three-months ended October 31, 2014, as compared to the corresponding three-months ended October 31, 2013, decreased by $309, or 9%. The decrease in revenues during the three-months ended October 31, 2014 was from a reduction in members and a reduction in transaction and association fees generated from our members.

 

Cost of marketplace revenue which includes association and transaction commissions paid to brokers, corporate-owned office expense and other marketplace-related expenses decreased by $214, or 10% for the three-month period ended October 31, 2014, as compared to the corresponding three-months ended October 31, 2013.

 

Operating expenses which include corporate salaries, wages and employee benefits, selling, general and administrative, depreciation and amortization decreased by $75, or 7% for the three-months ended October 31, 2014, compared to the corresponding period of fiscal 2014.

 

Income from operations for the three-months ended October 31, 2014, as compared to the corresponding three-months ended October 31, 2013, decreased by $20 or 9%. This net decrease is primarily the result of the decrease in marketplace revenue for the period ended October 31, 2014.

 

Net income for the three-months ended October 31, 2014, as compared to the corresponding three-months ended October 31, 2013, decreased by $21 or 12% primarily as a result of the $309 decrease in revenues, offset by a $214 reduction in cost of marketplace and a $75 reduction in operating expenses in the three-months ended October 31, 2014, as compared to the corresponding three-months ended October 31, 2013.

 

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Earnings per share, both basic and diluted, decreased by $0.01 to $0.06 per share in the three-months ended October 31, 2014 compared to the three-months ended October 31, 2013.

 

Revenue, Costs and Expenses

 

The following table sets forth our selected consolidated financial information for the three-months ended October 31, 2014 and 2013 with amounts expressed as a percentage of total revenues (in thousands) (unaudited):

 

   Three-months ended October 31, 
   2014   2013 
   Amount   Percent   Amount   Percent 
Revenue:                    
Marketplace revenue and other revenue  $3,117    100%  $3,426    100%
                     
Costs and expenses:                    
Cost of marketplace revenue   1,923    62%   2,137    63%
Salaries, wages and employee benefits   445    14%   521    15%
Selling, general and administrative   516    16%   496    14%
Depreciation and amortization   23    1%   42    1%
    2,907    93%   3,196    93%
                     
Income from operations   210    7%   230    7%
                     
Other Income, net   24    1%   31    1%
                     
Income before income taxes   234    8%   261    8%
                     
Provision for income taxes   79    3%   85    3%
                     
Net income  $155    5%  $176    5%

 

Marketplace revenue

 

Marketplace revenue consists of transaction fees, association fees and other revenues net. Revenue also includes a nominal amount of ITEX dollars (non-cash). The following are the components of Marketplace revenue that are included in the consolidated statements of income (in thousands) (unaudited):

 

   Three-months ended October 31,   Percent
increase
 
   2014   2013   (decrease) 
   (unaudited)     
             
Transaction fees  $1,956   $2,204    -11%
Association fees   1,048    1,110    -6%
Other revenue   113    112    1%
   $3,117   $3,426    -9%

 

Marketplace revenue for the three-months ended October 31, 2014 decreased by $309, or 9% to $3,117 as compared to $3,426 for the three-months ended October 31, 2013.

 

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Transaction fees for the three-months ended October 31, 2014 decreased by $248, or 11%, to $1,956 from $2,204 for the three-months ended October 31, 2013. The decrease in transaction fees was due to lower transaction volume for the three-months ended October 31, 2014, as compared to the three-months ended October 31, 2013.

 

Association fees for the three-months ended October 31, 2014 decreased by $62, or 6%, to $1,048 from $1,110 for the three-months ended October 31, 2013. The decrease in association fees is due to a decrease in net active membership accounts for the comparable periods.

 

Other revenue for the three-months ended October 31, 2014 increased by $1, or 1% to $113 as compared to $112 for the three-months ended October 31, 2013.

 

ITEX Dollar Revenue

 

As described in notes to our consolidated financial statements, we receive ITEX dollars from members’ transaction and association fees, and, to a lesser extent, from other member fees. ITEX dollars earned from members are later used by us as a method of payment in revenue sharing and incentive arrangements with our Broker Network, including co-op advertising, as well as for certain general corporate expenses. ITEX dollars are only usable in our Marketplace.

 

We take extensive measures to maintain the integrity of our role in the Marketplace economy, and to protect against the misuse or misappropriation of ITEX dollars. For example:

 

·All ITEX dollar purchases for corporate and Marketplace purposes are approved by senior management.

 

·We do not sell or purchase ITEX dollars for USD.

 

Occasionally we spend ITEX dollars in the Marketplace for our corporate needs. As discussed in the notes to our consolidated financial statements, we record ITEX dollar revenue in the amounts ultimately equal to expenses we incurred and paid for in ITEX dollars, resulting in an overall net effect of $0 on the operating and net income lines. We recorded $49 and $42 as ITEX dollar revenue for the three-months ended October 31, 2014 and 2013, respectively.

 

The corresponding ITEX dollar expenses in the period ended October 31, 2014 was for equipment, legal services, printing, outside services and miscellaneous expenses. We plan to continue to utilize ITEX dollars for our corporate purposes in future periods.

 

Cost of Marketplace Revenue

 

Cost of marketplace revenue consists of commissions paid to brokers, salaries and employee benefits of our corporate-owned offices, payment of processing fees and other expenses directly correlated to marketplace revenue. The following are the main components of cost of marketplace revenue that are included in the consolidated statements of income (in thousands)(unaudited):

 

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   Three-months ended October 31,   Percent
increase
 
   2014   2013   (decrease) 
   (unaudited)     
             
Transaction fee commissions  $1,461   $1,662    -12%
Association fee commissions   371    397    -7%
Other costs of revenue   91    78    17%
   $1,923   $2,137    -10%
                
Costs of marketplace revenue
as percentage of total revenue
   62%   62%     

 

Cost of marketplace revenue for the three-months ended October 31, 2014 was $1,923 as compared to $2,137 for the three-months ended October 31, 2013, a decrease of $214, or 10%. The overall cost of Marketplace as a percentage of revenue remained the same at 62% for both periods.

 

Transaction fee commissions are paid to brokers upon the collection of the transaction revenue. Transaction fee commissions for the three-months ended October 31, 2014 decreased by $201 or 12% to $1,461 as compared to $1,662 for the three-months ended October 31, 2013. The decrease in transaction fee commissions is due to the reduction in transaction fee revenue which is similar to the 10% reduction is transaction fee revenues for the same comparable period.

 

Association fee commissions are paid to brokers upon the collection of the association revenue. Association fee commissions for the three-months ended October 31, 2014 decreased by $26, or 7% to $371 as compared to $397 for the three-months ended October 31, 2013. The decrease in association fee commissions is due to a similar reduction in association fee revenue.

 

Other costs of revenue consist of miscellaneous Marketplace-related expenses such as marketing and credit card processing fees along with other commissions not associated with association or transaction revenue. Other costs of revenue increased by $13 or 17% to $91 as compared to $78 for the three-months ended October 31, 2014.

 

Corporate Salaries, Wages and Employee Benefits

 

Salaries, wages and employee benefits include expenses for corporate employee salaries and wages, payroll taxes, payroll related insurance, healthcare benefits, stock-based compensation, recruiting costs and other personnel related items. Comparative results are as follows (in thousands) (unaudited):

 

   Three-months ended October 31,   Percent 
   2014   2013   decrease 
   (unaudited)     
             
Corporate salaries, wages and employee benefits  $445   $521    -15%
                
Corporate salaries, wages and employee benefits as percentage of total revenue   14%   15%     

 

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Corporate salaries, wages and employee benefits expenses for the three-months ended October 31, 2014, as compared to the three-months ended October 31, 2013, decreased by $76, or 15%. The decrease is primarily due to a reduction in headcount.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses include consulting, legal and professional services, as well as expenses for rent and utilities, marketing, business travel, insurance, bad debts, business taxes, and other expenses. As discussed above in “ITEX Dollar Revenue”, certain ITEX dollar expenses are also included. Comparative results are as follows (in thousands) (unaudited):

 

   Three-months ended October 31,   Percent 
   2014   2013   increase 
                
Selling, general and administrative expenses  $516   $496    4%
                
Selling, general and administrative expenses as percentage of total revenue   17%   14%     

  

Selling, general and administrative expenses for the three-months ended October 31, 2014, as compared to the three-months ended October 31, 2013, increased by $20, or 4%. Our selling general and administrative expenses also increased as a percentage of total revenues in the periods presented. The increase is due primarily to an increase foreign currency expense. Foreign currency expense for the three-months ended October 31, 2014 increased by $20, or 182% to $31 as compared to $11 for the three-months ended October 31, 2013. This was offset somewhat by a reduction in consulting fees which decreased by $20 or 59% to $14 as compared to $34 for the three-months ended October 31, 2013.

 

Depreciation and Amortization

 

Depreciation and amortization expenses include depreciation on our fixed assets and amortization of our intangible assets, including intangible assets obtained in business combinations. Comparative results are as follows (in thousands) (unaudited):

 

   Three-months ended October 31,   Percent 
   2014   2013   decrease 
             
Depreciation and amortization  $23   $42    -45%
                
Depreciation and amortization as percentage of total revenue   1%   1%     

 

Depreciation and amortization for the three-months ended October 31, 2014, as compared to the three-months ended October 31, 2013, decreased by $19, or 45%. The decrease is primarily related to the completion of the amortization of a non-compete agreement and membership lists associated with acquisition of certain assets.

 

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Other income

 

Other income includes interest received on notes receivable and promissory notes, and gains or losses on the sale of assets.

 

Comparative results are as follows (in thousands) (unaudited):

 

   Three-months ended
October 31,
   Percent 
   2014   2013   (decrease) 
             
Interest income  $24   $31    -23%
                
Other income  $24   $31    -23%
                
Other income, as percentage of total revenue   1%   1%     

 

Interest income is derived primarily from our notes receivable for corporate-owned office sales and general loans to brokers. As part of our initiative to support brokers and as a way to generate return on capital, we have outstanding loans to our brokers. Each loan is primarily secured by the broker’s ITEX office.

 

Income Taxes

 

Comparative results are as follows (in thousands) (unaudited):

 

   Three-months ended October 31 
   2014   2013 
   Amount   Rate   Amount   Rate 
Expected tax provison at federal statutory rate  $80    34%  $91    35%
State income benefit   (1)   0%   (6)   -2%
                     
Provision for income taxes  $79    34%  $85    33%

 

We recognized a $79 provision for income taxes, in the three-month period ended October 31, 2014, as compared to the $85 provision for income taxes in the three-month period ended October 31, 2013. Provision for income taxes decreased by $6 for the three-months ended October 31, 2014, as compared to the corresponding period of fiscal 2014. The decrease was primarily due to the decrease in taxable income in the three-months ended October 31, 2014.

 

The Federal effective tax rate related to our provision for income taxes in the three-month period ended October 31, 2014 is similar to that used in the period ended October 31, 2013. The State effective tax rate related to our provision for income taxes in the three-months ended October 31, 2014 is slightly different than that used in the three-month period ending October 31, 2013, due to the resolution of certain state tax positions which led to a reduction in the accrued expenses on our consolidated balance sheet for uncertain tax positions related primarily to state jurisdictions.

 

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LIQUIDITY AND CAPITAL RESOURCES

 

We finance our ongoing operations primarily from existing cash, investing activities, and cash flows from operations. As of October 31, 2014, and July 31, 2014, we had $4,097 and $3,673, respectively, in cash. Additionally, we have a revolving credit agreement to establish a $1,000 line of credit facility from our primary banking institution, U.S. Bank (“line of credit”). The current line of credit agreement expires in November 2015. We had no outstanding balance on our line of credit as of October 31, 2014.

 

The following table presents a summary of our cash flows for the three-months ended October 31, 2014 and 2013 (in thousands) (unaudited):

 

   Three-months ended October 31, 
   2014   2013 
         
Cash provided by operating activities  $546   $595 
Cash provided by (used) in provided by investing activities   47    (168)
Cash used in financing activities   (169)   (148)
Increase in cash  $424   $279 

 

As part of our contemplated future expansion activities and our evaluation of strategic alternatives and opportunities, we may seek to acquire certain competitors or other business to business enterprises, or consider partnering or other collaboration agreements, or a merger or other strategic transaction. Such alliances, mergers or acquisitions or dispositions could result in potentially dilutive issuances of our equity securities, the expenditure of our cash or the incurrence of debt or contingent liabilities. We expect that our current working capital would be adequate for this purpose. However, we may seek to finance a portion of the acquisition cost subject to the consent of any secured creditors. We believe that our financial condition is stable and that our cash balances, other liquid assets, and cash flows from operating activities provide adequate resources to fund ongoing operating requirements.

 

Inflation has not had a material impact on our business. Inflation affecting the U.S. dollar is not expected to have a material effect on our operations in the foreseeable future.

 

Operating Activities

 

For the three-months ended October 31, 2014, net cash provided by operating activities was $546 compared with $595 in the three-months ended October 31, 2013 a decrease of $49, or 8%. The decrease in net cash provided by the operating activities is primarily a result of the $20 decrease in net income and an increase of $39 of accrued expenses in the three-month period ended October 31, 2014 as compared to the period ended October 31, 2013.

 

The difference between our net income and our net cash provided by operating activities was attributable to non-cash expenses included in net income, and changes in the operating assets and liabilities, as presented below (in thousands) (unaudited):

 

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   Three-months ended October 31, 
   2014   2013 
         
Net income  $155   $176 
Add: non-cash expenses   214    187 
Add: changes in operating assets and liabilities   177    232 
Net cash provided by operating activities  $546   $595 

 

Non-cash expenses are primarily associated with the amortization of intangible assets, depreciation and amortization of property and equipment, stock-based compensation expense, the changes in the deferred portion of the provision (benefit) for income taxes.  

 

Changes in operating assets and liabilities primarily reflect changes in working capital components of the balance sheet apart from cash and cash equivalents. Net cash provided by operating activities also reflects changes in some non-current components of the balance sheet, such as long-term deferred rent and non-current prepaid expenses and deposits.

 

As discussed earlier in the overview section of our Management’s Discussion and Analysis of Financial Condition and Results of Operations, for each calendar year, we divide our operations into 13 four-week billing and commission cycles always ending on a Thursday, while we report our financial results as of the last day of each calendar month. The timing of billing and collection activities after the end of the billing cycle does not correspond with the end of the accounting period, therefore this timing difference results in the fluctuations of the balances of cash, accounts receivable, commissions payable and accrued commissions.

 

Investing Activities

 

Net cash (used in) provided by investing activities was primarily the result of purchase of property and equipment and intangible assets, the collections on notes receivable from corporate office sales and advances on broker loans.

 

For the three-months ended October 31, 2014, net cash provided by investing activities was $47 compared with $168 used in investing activities in the three-months ended October 31, 2013, an increase of $215, or 128%. In the three-months ended October 31, 2014, the net cash provided by investing activities was primarily related to $65 in note receivable principal collections offset by $15 in advances on loans. In the three-months ended October 31, 2013, the net cash used in investing activities was primarily related to $338 in advances on loans offset by $171 in note receivable principal collections.

 

Financing Activities

 

Our net cash used in financing activities consists of cash dividends to stockholders, discretionary repurchases of our common stock and principal payments on stockholders’ notes receivable.

 

For the three-months ended October 31, 2014, net cash used in financing activities was $169 compared with $148 used in financing activities in the three-months ended October 31, 2013, an increase of cash used in financing activities of $21, or 14%. The increase is primarily due to additional shares purchased during the period ended October 31, 2014.

 

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In the three-months ended October 31, 2014, we declared and paid $143 in cash dividends to our stockholders.

 

Commitments

 

We lease office space under an operating lease. The lease commitment is for the Company’s corporate headquarters in Bellevue, Washington. The lease for the corporate headquarters expires on April 30, 2015.

 

In addition to the lease commitment, we are a party to several non-cancelable and non-refundable purchase commitments. Those purchase obligations consist primarily of arrangements for telecommunications and co-location services for our network operations. Our contractual commitments at October 31, 2014 are presented below (in thousands) (unaudited):

 

Year ending July 31,  Operating
lease
   Purchase
commitments
   Total 
             
2015 (1)  $84   $-   $84 

 

 

(1)   The expected payments for 2015 reflect future minimum payments for the nine-month period from November 1, 2014 to July 31, 2015.

 

Critical Accounting Policies and Estimates

 

Our discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate significant estimates used in preparing our financial statements, including those related to:

 

·revenue recognition, including allowances for uncollectible accounts;
·accounting for ITEX dollar activities;
·the allocation of purchase price in business combinations;
·valuation of notes receivable;
·accounting for goodwill and other long-lived intangible assets;
·accounting for income taxes;
·share-based compensation; and
·litigation matters

 

We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates if our assumptions change or if actual circumstances differ from those in our assumptions.

 

For a summary of all of our significant accounting policies, including the critical accounting policies discussed above, see Note 1, Summary of Significant Accounting Policies, to our consolidated financial statements filed with our 2014 annual report on Form 10-K.

 

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Recent Accounting Pronouncements

 

For a discussion of new accounting pronouncements and their impact on the Company, see Note 1 of the Notes to Consolidated Financial Statements included in this Form 10-Q.

 

FACTORS THAT MAY AFFECT FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q contains statements that are forward-looking such as estimates, projections, statements relating to our business plans, objectives and expected operating results. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. All statements that express expectations and projections with respect to future matters may be affected by changes in our strategic direction, as well as developments beyond our control. We cannot assure you that our expectations will necessarily come to pass. Actual results could differ materially because of issues and uncertainties such as those listed below, in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, ITEM 2 and elsewhere in this report. These factors, among others, may adversely impact and impair our business and should be considered in evaluating our financial outlook.

 

Our revenue growth and success is tied to the operations of our independent Broker Network, and as a result the loss of our brokers or the financial performance of our brokers can negatively impact our business

 

We service our member businesses primarily through our independent licensed broker and franchise network (individually, “broker”, together, the “Broker Network”) as well as through any corporate-owned offices we may operate from time to time. Our financial success primarily depends on our brokers and the manner in which they operate and develop their offices. We depend on the ability of our brokers to enroll new members, train them in the use of the Marketplace, grow our transactional volume by facilitating business among members, manage member relationships, provide members with information about ITEX products and services, and assure the payment of our fees. Brokers are independently owned and operated and have a contractual relationship with ITEX, typically for a renewable five-year term. Our inability to renew a significant portion of these agreements on terms satisfactory to our brokers and us could have a material adverse effect on our business, financial condition and results of operations. Further, our brokers may not be successful in increasing the level of revenues generated compared to prior years, or even sustaining their own business activities, which depends on many factors, including industry trends, the strength of the local economy, the success of their marketing activities, control of expense levels, the employment and management of personnel, and being able to secure adequate financing to operate their businesses. There can be no assurance that our brokers will be successful in adding members or increasing the volume of transactions through the Marketplace, or that if they do not renew their agreements or terminate operations we will be able to attract new brokers at rates sufficient to maintain a stable or growing revenue base. If our brokers are unsuccessful in generating revenue, enrolling new members to equalize the attrition of members leaving the Marketplace, or if a significant number of brokers become financially distressed and terminate operations, our revenues could be reduced and our business operating results and financial condition may be materially adversely affected.

 

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Future revenue growth remains uncertain and our operating results and profitability may decline

 

Marketplace revenue decreased 9% for the year ended July 31, 2014, compared to the previous year ended July 31, 2013 and decreased 9% for the three-months ended October 31, 2014 compared same period ending October 31, 2013. Although we seek to increase revenues through organic growth and the development of new revenue streams, we cannot assure you that our revenues will increase in future quarters or future years. We may be unable to add revenue through acquisitions, either because of the absence of acquisition candidates, lack of financing, or unacceptable terms. We have approximately 30% recurring revenues. We do not have an order backlog, and approximately two-thirds of our revenues each quarter come from variable transaction fees computed as a percentage of the ITEX dollar value of the transactions occurring during that quarter. Our operating results in one or more future quarters may fall below the expectations of investors.

 

We cannot assure you that we can continue to be operated profitably, which depends on many factors, including the overall development and expansion of our industry, our success in expanding our member base, the control of our expense levels and the success of our business activities. We may make investments in marketing, broker and member support, technology and further development of our operating infrastructure which entail long-term commitments. Our industry as a whole may be adversely affected by industry trends and economic factors. Despite our efforts to expand our revenues, we may not be successful. We experience a certain amount of attrition from members leaving the Marketplace. If new member enrollments do not continue or are insufficient to offset attrition, we will increasingly need to focus on keeping existing members active and increasing their activity level in order to maintain or grow our business. We cannot assure you that this strategy would be successful to offset declining revenues or profits.

 

Our ability to pay dividends on our common stock is subject to the discretion of our Board of Directors and may be limited by our lack of liquidity or access to capital.

 

Our dividend policy is subject to the discretion of our Board of Directors and depends upon a number of factors, including our earnings, financial condition, cash and capital needs and general economic or business conditions. Although we are currently declaring cash dividends on our common stock as a way to return value to our stockholders, we are not required to do so and we cannot assure you that we will continue to pay dividends in the future. We have sought to maintain a liquidity cushion sufficient to fund our business activities and handle contingencies, while preserving the ability to return cash to our stockholders through dividends and share buybacks. However, our Board of Directors may decide to use capital for acquisitions, revenue generating opportunities or other corporate purposes. If liquidity from our cash flow is inadequate or unavailable, we may be required to scale back or eliminate the dividends we pay to our stockholders. Any reduction of, or the elimination of, our common stock dividend in the future could adversely affect the market price of our common stock.

 

Our brokers could take actions that could harm our business, our reputation and adversely affect the ITEX Marketplace

 

Our agreements with our brokers require that they understand and comply with all laws and regulations applicable to their businesses, and operate in compliance with our Marketplace Rules. Brokers are independently owned and operated and are not our employees, partners, or affiliates. We set forth operational standards and guidelines; however, we have limited control over how our broker businesses are run. Our brokers have individual business strategies and objectives, and may not operate their offices in a manner consistent with our philosophy and standards. We cannot assure that our brokers will avoid actions that adversely affect the reputation of ITEX or the Marketplace. Improper activity stemming from one broker can generate negative publicity which could adversely affect our entire Broker Network and the Marketplace. Our image and reputation and the image and reputation of other brokers may suffer materially, and system-wide sales could significantly decline if our brokers do not operate their businesses according to our standards. While we ultimately can take action to terminate brokers that do not comply with the standards contained in our agreements, and even though we may implement compliance and monitoring functions, we may not be able to identify problems and take action quickly enough and, as a result, our image and reputation may suffer, causing our revenues or profitability to decline. Further, the success and growth of our Broker Network depends on our maintaining a satisfactory working relationship with our existing brokers and attracting new brokers to our network. Lawsuits and other disputes with our brokers could discourage our brokers from expanding their business or lead to negative publicity, which could discourage new brokers from entering our network or existing brokers from renewing their agreements, and could have a material adverse effect on our business, financial condition and results of operations.

 

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Stockholders or investors may attempt to effect changes or acquire control over our business, which could adversely affect our results of operations and financial condition.

 

Recent developments in corporate governance indicate there is lack of agreement between boards of directors and stockholders as to the relative balance of authority in the corporate decision-making process, and shareholders are challenging the longstanding legal principle that directors, rather than the stockholders, manage the business and affairs of the corporation. During the past several years, U.S. companies have seen a high and increasing level of insurgent campaigns, proxy solicitations, and shareholder derivative actions or other attempts to acquire control of companies or effect operational changes. Within the last four years, we have been the subject of two proxy contests seeking control of our board of directors, as well as a related lawsuit. We cannot assure you that we will not be subject to further proxy contests, litigation or other activity or demands in the future. If we are, such activity or demands could harm the Company because:

 

·Responding to proxy contests, litigation and other actions by dissident shareholders can interfere with our ability to execute our strategic plan, disrupt our operations, be costly and time-consuming, and divert the attention of our management and employees from the pursuit of business strategies;

 

·Perceived uncertainties as to our future direction diverts the attention of, damages morale and creates instability among members of our Broker Network, and adversely impact our existing and potential strategic and operational relationships and opportunities;

 

·We may experience difficulties in hiring, retaining and motivating personnel during the resulting uncertain and turbulent times;

 

·If individuals are elected or appointed to our Board of Directors with a specific agenda, it may adversely affect our ability to effectively implement our business strategy and create additional value for our stockholders;

 

·We would experience substantial increases in legal fees, insurance, administrative and associated costs incurred in connection with responding to proxy contests and related litigation;

 

·A successful change in control of the Company could result in substantial compensation charges and other expenses, and potentially allow an insurgent shareholder to reimburse his proxy or takeover expenses, resulting in substantial charges.

 

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We may be held responsible by members, third parties, regulators or courts for the actions of, or failures to act by, our brokers or their employees, which exposes us to possible adverse judgments, other liabilities and negative publicity

 

From time to time we are subject to claims for the conduct of our brokers in situations where a broker is alleged to have caused injury to a member as a result of a transaction in the Marketplace. Third parties, regulators or courts may seek to hold us responsible for the actions or failures to act by our brokers or their employees. The failure to comply with laws and regulations by our brokers, or litigation involving potential liability for broker activities could be costly and time consuming for us, divert management attention, result in increased costs of doing business, lead to adverse judgments, expose us to possible fines and negative publicity, or otherwise harm our business.

 

Failure to deal effectively with member disputes could result in costly litigation, damage our reputation and harm our business

 

ITEX faces risks with respect to transactional disputes between members of the Marketplace. From time to time we receive complaints from members who may not have received the products or services that they had purchased, concerning the quality of the products or services, or who believe they have been defrauded by other members. We also receive complaints from sellers because a buyer has changed his or her mind and decided not to honor the contract to purchase the item. While ITEX does, in some cases, as part of its transaction dispute resolution process, reverse transactions, reduce or eliminate credit lines, suspend accounts, or take other measures with members who fail to fulfill their payment or delivery obligations to other members, the determination as to whether a transaction is reversed or how to resolve a specific dispute is made by ITEX in its sole discretion. Measures we may take to resolve transactional disputes or combat risks of fraud have the potential to damage relations with our members or brokers or decrease transactional activity in the Marketplace by restricting the activities of certain members. Furthermore, negative publicity and member sentiment generated as a result of member complaints or fraudulent or deceptive conduct by members of our Marketplace could damage our reputation, or reduce our ability to attract new members or retain our current members.

 

We occasionally receive communications from members requesting reimbursement or threatening or commencing legal action against us if no reimbursement is made. In addition, because we service our member businesses through our Broker Network, we are subject to claims and could potentially be found liable for the conduct of our brokers in a situation where that broker has caused injury to a member. Litigation involving disputes between members and liability for broker actions could be costly and time consuming for us, divert management attention, result in increased costs of doing business, lead to adverse judgments, or otherwise harm our business. In addition, affected members may complain to regulatory agencies that could take action against us, including imposing fines or seeking injunctions.

 

Use of our services for illegal purposes could damage our reputation and harm our business

 

Our members, typically small businesses, actively market products and services through the Marketplace and our website. We may be unable to prevent our members from selling unlawful or stolen goods or unlawful services, or selling goods or services in an unlawful manner, and we could be subject to allegations of civil or criminal liability for unlawful activities carried out by members through our services. It is possible that third parties, including government regulators and law enforcement officials, could allege that our services aid and abet certain violations of certain laws, for example, laws regarding the sale of counterfeit items, the fencing of stolen goods, selective distribution channel laws, and the sale of items outside of the U.S. that are regulated by U.S. export controls.

 

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Although we have prohibited the listing of illegal goods and services and implemented other protective measures, we may be required to spend substantial resources to take additional protective measures or discontinue certain service offerings, any of which could harm our business. Any costs incurred as a result of potential liability relating to the alleged or actual sale of unlawful goods or services could harm our business. In addition, negative media publicity relating to the listing or sale of unlawful goods and stolen goods using our services could damage our reputation, diminish the value of our brand, and make members reluctant to use our services.

 

ITEX’s virtual currency, ITEX dollars, is also susceptible to potentially illegal or improper uses. Recent changes in law have increased the penalties for intermediaries providing payment services for certain illegal activities. Despite measures taken by ITEX as administrator and as transaction processor and record-keeper to detect and lessen the risk of this kind of conduct, illegal activities could still be funded using ITEX dollars. Any resulting claims or liabilities could harm our business.

 

Our business is subject to online security risks, including security breaches and identity theft

 

We host confidential information as part of our client relationship management and transactional processing platform. Our security measures may not detect or prevent security breaches that could harm our business. Currently, a significant number of our members authorize us to bill their credit card or bank accounts directly for fees charged by us. We take a number of measures to ensure the security of our hardware and software systems and member and client information. Advances in computer capabilities, new discoveries in the field of cryptography or other developments may result in the technology used by us to protect transaction data being breached or compromised. Many companies have been the subject of sophisticated and highly targeted attacks on portions of their websites. In addition, any party who is able to illicitly obtain a members’ password could access the members’ transaction data. An increasing number of websites have reported breaches of their security. Any compromise of our security could harm our reputation and, therefore, our business, and could result in a violation of applicable privacy and other laws. In addition, a party that is able to circumvent our security measures could misappropriate proprietary information, cause interruption in our operations, damage our computers or those of our users, or otherwise damage our reputation and business. Under credit card rules and our contracts with our card processors, if there is a breach of credit card information that we store, we could be liable to the credit card issuing banks for their cost of issuing new cards and related expenses. In addition, if we fail to follow credit card industry security standards, even if there is no compromise of customer information, we could incur significant fines or lose our ability to give customers the option of using credit cards to pay their fees. If we were unable to accept credit cards, our business would be seriously damaged.

 

We continue to enhance our systems for data management and protection, and intrusion detection and prevention. In the third quarter of 2014, we upgraded our software platform with .NET technology. However, our servers may be vulnerable to computer viruses, physical or electronic break-ins, and similar disruptions. We may need to expend significant resources to protect against security breaches or to address problems caused by breaches. Security breaches, including any breach by us or by parties with which we have commercial relationships that result in the unauthorized release of our members’ personal information, could damage our reputation and expose us to a risk of loss or litigation and possible liability. Our insurance policies carry coverage limits which may not be adequate to reimburse us for losses caused by security breaches.

 

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Unplanned system interruptions or system failures could harm our business and reputation

 

Any interruption in the availability of our transactional processing services due to hardware and operating system failures will reduce our revenues and profits. Our revenue depends on members using our processing services. Any unscheduled interruption in our services results in an immediate, and possibly substantial, loss of revenues. Frequent or persistent interruptions in our services could cause current or potential members to believe that our systems are unreliable, leading them to switch to our competitors or to avoid our website or services, and could permanently harm our reputation. Furthermore, any system failures could result in damage to our members’ and brokers’ businesses. These persons could seek compensation from us for their losses. Even if unsuccessful, this type of claim likely would be time-consuming and costly for us to address.

 

Although our systems have been designed around industry-standard architectures to reduce downtime in the event of outages or catastrophic occurrences, they remain vulnerable to damage or interruption from earthquakes, floods, fires, power loss, telecommunication failures, terrorist attacks, computer viruses, computer denial-of-service attacks, and similar events or disruptions. Some of our systems are not fully redundant, and our disaster recovery planning may not be sufficient for all eventualities. Our systems are also subject to break-ins, sabotage, and intentional acts of vandalism. Despite any precautions we may take, the occurrence of a natural disaster, a decision by any of our third-party hosting providers to close a facility we use without adequate notice for financial or other reasons, or other unanticipated problems at our hosting facilities could cause system interruptions, delays, and loss of critical data, and result in lengthy interruptions in our services. Our business interruption insurance may not be sufficient to compensate us for losses that may result from interruptions in our service as a result of system failures.

 

Failure to comply with laws and regulations that protect our members’ and brokers’ personal and financial information could result in liability and harm our reputation

 

We store personal and financial information for members of the Marketplace and our brokers. Privacy concerns relating to the disclosure and safeguarding of personal and financial information have drawn increased attention from federal and state governments. Federal and state law requires us to safeguard our members’ and brokers’ financial information, including credit card information. Although we have established security procedures to protect against identity theft and the theft of this personal and financial information, breaches of our privacy may occur. To the extent the measures we have implemented are breached or if there is an inappropriate disclosure of confidential or personal information or data, we may become subject to litigation or administrative sanctions, which could result in significant fines, penalties or damages and harm to our brand and reputation. Even if we were not held liable, a security breach or inappropriate disclosure of confidential or personal information or data could harm our reputation. In addition, we may be required to invest additional resources to protect us against damages caused by these actual or perceived disruptions or security breaches in the future. Changes in these federal and state regulatory requirements could result in more stringent requirements and could result in a need to change our business practices. Establishing systems and processes to achieve compliance with these new requirements may increase our costs and could have a material adverse effect on our business, financial condition and results of operations.

 

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We have claims and lawsuits against us that may result in adverse outcomes

 

From time to time we are subject to a variety of claims and lawsuits. See Note 3 ― “Legal Proceedings and Litigation Contingencies” included in the “Notes to Consolidated Financial Statements”. Adverse outcomes in one or more claims could occur which may result in significant monetary damages that could adversely affect our ability to conduct our business. Although management does not believe resolving any pending matter, individually or in the aggregate, would have a material adverse impact on our financial statements, litigation and other claims are subject to inherent uncertainties and management’s view of these matters may change in the future. A material adverse impact on our financial statements could occur for the period in which the effect of an unfavorable final outcome becomes probable and reasonably estimable.

 

If we lose the services of our Chief Executive Officer, our business could suffer

 

Our Board places heavy reliance on the continued services of our Chief Executive Officer, Steven White, and his industry experience and relationships, management and operational skills. We have not entered into an employment agreement with Mr. White. If we were to lose the services of Mr. White, we could face substantial difficulty in hiring a qualified successor or successors, and could experience a loss in performance while any successor obtains the necessary training and experience. Corporate staff and our brokers could lose confidence in the direction and stability of the Company and choose to pursue other opportunities. In addition, in connection with a management transition we may need to attract, train, retain and motivate additional financial, technical, managerial, marketing or support personnel. We face the risk that if we are unable to attract and integrate new personnel, or retain and motivate existing personnel, our business, financial condition and results of operations will be adversely affected.

 

Alliances, mergers and acquisitions could result in operating difficulties, dilution and other harmful consequences

 

We expect to evaluate and consider potential strategic transactions, including business combinations, acquisitions and dispositions of businesses, technologies, services, products and other assets and strategic investments. At any given time we may be engaged in discussions or negotiations with respect to one or more of these types of transactions. Any of these transactions could be material to our financial condition and results of operations. The process of integrating an acquired company, business or technology may create unforeseen operating difficulties and expenditures and is risky. The areas where we may face difficulties include:

 

    Diversion of management time, as well as a shift of focus from operating the businesses to challenges related to integration and administration;

 

    Challenges associated with integrating employees from the acquired company into the acquiring organization.  These may include declining employee morale and retention issues resulting from changes in, or acceleration of, compensation, or changes in management, reporting relationships, future prospects, or the direction of the business;

 

    The need to integrate each company’s accounting, management, information, human resource and other administrative systems to permit effective management, and the lack of control if such integration is delayed or not implemented;

 

    The need to implement controls, procedures and policies appropriate for a public company at companies that prior to acquisition had lacked such controls, procedures and policies;

 

    The need to transition operations, members, and customers onto our existing platforms; and

 

    Liability for activities of the acquired company before the acquisition, including violations of laws, rules and regulations, commercial disputes, tax liabilities and other known and unknown liabilities.

 

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The expected benefit of any of these strategic relationships may not materialize and the cost of these efforts may negatively impact our financial results. Future alliances, mergers or acquisitions or dispositions could result in potentially dilutive issuances of our equity securities, the expenditure of our cash or the incurrence of debt, contingent liabilities or amortization expenses of which could adversely affect our results of operations and dilute the economic and voting rights of our stockholders. Future acquisitions may require us to obtain additional equity or debt financing, which may not be available on favorable terms or at all.

 

We may need additional financing; current funds may be insufficient to finance our plans for growth or our operations

 

We believe that our financial condition is stable and that our cash balances and operating cash flows provide adequate resources to fund our ordinary operating requirements. However, our existing working capital may not be sufficient to allow us to execute our business plan as fast as we would like or may not be sufficient to take full advantage of all available strategic opportunities. We believe our current core operations reflect a scalable business strategy, which will allow our business model to be executed with limited outside financing. However, we also may expand our operations, enter into a strategic transaction, or acquire competitors or other business to business enterprises. We have a line of credit with our primary banking institution, which will provide additional reserve capacity for general corporate and working capital purposes, and if necessary, enable us to make certain expenditures related to the growth and expansion of our business model. However, if adequate capital was not available or were not available on acceptable terms at a time when we needed it, our ability to execute our business plans, develop or enhance our services, make acquisitions or respond to competitive pressures would be significantly impaired. Further, we cannot be certain that we will be able to implement various financing alternatives or otherwise obtain required working capital if needed or desired.

 

We are dependent on the value of foreign currency.

 

We transact business in Canadian dollars as well as USD. Revenues denominated in Canadian dollars comprised 6.7% and 7.6% in the years ended July 31, 2014 and 2013, respectively. Foreign currency expense for the three-months ended October 31, 2014 increased by $20 compared to the three-months ended October 31, 2013. While foreign currency exchange fluctuations are not believed to materially adversely affect our operations at this time, changes in the relation of the Canadian dollar to the USD could affect our revenues, cost of sales, operating margins and result in exchange losses.

 

Our Brokers may default on their loans

 

From time to time we finance the operational and expansion activities of our brokers. We loan brokers funds for general operational purposes, to acquire the management rights to select member accounts, and for other reasons. These loans are repaid from regular deductions from broker commissions. We had outstanding loans to brokers of $1,374 at October 31, 2014 and $1,424 at July 31, 2014. In the event one or more brokers default on their loans, it may adversely affect our financial condition.

 

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The emergence of “virtual currencies” could result in competitive trading platforms which may reduce transaction volume and revenues

 

Virtual currencies are receiving increasing interest from investors, businesses and governments. Examples include private virtual currency or payment systems such as BitCoin, Ripple, and Litecoin. As peer-to-peer currencies, they rely on a system of mutual trust and do not rely on a central bank, a third party or other intermediary to effect transactions or act as guarantor in the event the currency collapses. They do not have the status of legal tender. However, increased popularity or government acceptance of virtual currencies could encourage competitors to utilize virtual or community currencies or the exchange of online credits for goods and services. Our potential competitors could enjoy advantages, including greater financial resources and access to capital, a wider geographic presence, more accessible branch office locations, more aggressive marketing campaigns, better brand recognition, the ability to offer a wider array of services or more favorable pricing alternatives. If other virtual or community currencies gain widespread merchant acceptance, to the extent that we cannot compete effectively, it may adversely affect our business operations and financial performance.

 

The emergence of increased regulation related to virtual currencies could increase our costs by requiring us to update our products and services; or subject us to operational requirements that result in substantial compliance costs which would adversely affect our business

 

Innovation in the payments industry has led to a variety of virtual currencies, community currencies and reward points, and federal and state regulatory regimes are seeking to revise antiquated currency provisions. The increased attention to virtual currencies could result in changes in federal or state regulations or the adoption of new regulations that could affect us as well as many companies transacting in credits that might be called “virtual currency.” For example, the Financial Crimes Enforcement Network (“FinCEN”), a bureau of the U.S. Treasury, as the delegated administrator of the Bank Secrecy Act (“BSA”) issued interpretive guidance in March 2013 to clarify the applicability of regulations to persons creating, obtaining, distributing, exchanging, accepting, or transmitting virtual currencies. Although we do not believe we as a payment processor are currently subject to the BSA requirements that could potentially change with new regulation. Registering with FinCEN and complying with FinCEN’s regulations would be burdensome, as would getting licensed as a money transmitter and complying with the money transmission regulatory regimes in each state. Changes to existing laws or regulations or adoption of new laws or regulations relating to the use of virtual currencies could require us to incur significant costs to update our products and services, significantly increase our compliance costs or may impose conditions that we are unable to meet. This could make our business cost-prohibitive in the affected state or states and could materially adversely affect our business.

 

The market for our securities has limited liquidity and may become less liquid

 

Our common stock currently trades on the over-the-counter market known as the OTCQB Marketplace. The OTC Marketplace has three tiers, consisting of OTCQX, OTCQB and OTC Pink marketplaces. Many of the securities quoted in the OTC Marketplace do not have a liquid market. They are infrequently traded and can move up or down in price substantially from one trade to the next. As a result, an investment in our shares may be illiquid even if there is a market. Moreover, our securities are not listed on a national securities exchange. Under current regulations national securities exchanges have the ability to offer certain advantages to listed companies. For example, securities listed on a national securities exchange are exempt from state Blue Sky laws covering the offer or sale of securities within the state. We avail ourselves of applicable Blue Sky exemptions, however there are certain states in which we have not qualified for an exemption and our shares may not be traded. National securities exchanges also offer the ability to margin certain listed securities and the potential inclusion of listed securities in certain exchange-traded funds and indices. These differences between our marketplace and the national securities exchanges may make certain investors choose to not invest in our stock.

 

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In 2014, the OTC Markets Group introduced new eligibility requirements for the OTCQB Marketplace, including requiring companies to commence paying an annual fee. Issuers that do not pay the new fee will be downgraded to the OTC Pink marketplace. We do not presently intend to pay the additional fee, and expect to be downgraded to the OTC Pink marketplace in December 2014. On the OTC Pink marketplace, the trading market for our shares may be less liquid, the ability of our stockholders to sell their shares in the secondary market may be more limited, and our share price could decrease.

 

ITEM 4. CONTROLS AND PROCEDURES

 

(a) Disclosure controls and procedures.

 

Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective as of the end of the period covered by this report.

 

(b) Changes in internal control over financial reporting.

 

There have been no changes in our internal controls over financial reporting during our most recent quarter that we believe have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

See Note 3 ― “Legal Proceedings and Litigation Contingencies” included in the “Notes to Consolidated Financial Statements” for information regarding legal proceedings.

 

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

The following table provides information about our purchases or any affiliated purchaser during the three-months ended October 31, 2014 of equity securities that are registered by us pursuant to Section 12 of the Exchange Act.

 

   (a)   (b)   (c)   (d) 
Period  Total Number of
Shares Purchased
   Average Price Paid
per Share
   Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs
   Maximum Number (or
Approximate Dollar
Value) of Shares that
May Yet Be Purchased
Under the Plans or
Programs (1)
 
8/01/14 - 8/31/14   -    -    -    - 
9/01/14 – 9/30/14   -    -    -    - 
10/01/14 - 10/31/14   14,003   $2.99    14,003   $1,055,054 

 

(1)Amounts shown in this column reflect amounts remaining under the $2.0 million stock repurchase program, authorized by the Board of Directors and announced on March 9, 2010. The program authorizes the repurchase of shares in open market purchases or privately negotiated transactions, has no expiration date and may be modified or discontinued by the Board of Directors at any time.

 

Item 6. Exhibits

 

Exhibit
Number
Description
     
31.1   Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2   Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1**   Certification by Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2**   Certification by Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS   XBRL Instance Document
101.SCH   XBRL Taxonomy Extension Schema
101.CAL   XBRL Taxonomy Extension Calculation Linkbase
101.DEF   XBRL Taxonomy Extension Definition Linkbase
101.LAB   XBRL Taxonomy Extension Label Linkbase
101.PRE   XBRL Taxonomy Extension Presentation Linkbase
     
**   Furnished, not filed

 

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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.

 

    ITEX CORPORATION
    (Registrant)
       
Date:  December 5, 2014   By:   /s/ Steven White
    Steven White
    Chief Executive Officer
    (Duly Authorized Officer)
       
Date:  December 5, 2014   By: /s/ John Wade
    John Wade
    Chief Financial Officer

 

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