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EX-23.1 - EXHIBIT 23.1 - ITEX CORPv449971_ex23-1.htm
EX-32.2 - EXHIBIT 32.2 - ITEX CORPv449971_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - ITEX CORPv449971_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - ITEX CORPv449971_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - ITEX CORPv449971_ex31-1.htm
EX-21.1 - EXHIBIT 21.1 - ITEX CORPv449971_ex21-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

 

FORM 10 - K

 

(Mark One)

xAnnual report under Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the fiscal year ended July 31, 2016.

or

 

¨Transition report under 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

(Name of small business issuer in its charter)

 

Nevada   93-0922994
(State or other jurisdiction of
incorporation or organization)
  (IRS Employer
Identification No.)

 

3326 160th Avenue SE, Suite 100, Bellevue, WA 98008-6418

(Address of principal executive offices)

 

(425) 463-4000

(Issuer’s telephone number including area code)

 

Securities registered under Section 12 (b) of the Exchange Act   None
     
Securities registered pursuant to Section 12 (g) of the Exchange Act

Common Stock (par value $0.01);

Rights to Purchase Series A Junior Participating Preferred Stock (par value $0.01)

     
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act  

 

Yes ¨  No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act  

 

Yes ¨  No x

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K 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.

  

   

Large accelerated filer ¨    

Non-accelerated filer  ¨

Accelerated filer ¨     

Smaller Reporting Company x

 

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

 

 

Yes ¨  No x

     

The aggregate market value of the common stock held by non-affiliates of the Company as of January 31, 2016 was approximately $3,525,232 based upon 1,068,252 shares held by such persons and the closing bid price of $3.30 as reported by the OTC Marketplace. Shares of common stock held by each officer and director and by each person who owns 10.0% or more of the outstanding common stock have been excluded because these people may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for any other purpose.

 

As of September 30, 2016, we had 2,081,083 shares of common stock outstanding (including unvested restricted stock).

 

 

 

 

 

 

ITEX CORPORATION

 

FORM 10-K

 

For The Fiscal Year Ended July 31, 2016

 

INDEX

 

 

 

        Page
PART I        
ITEM 1.   Business   1
ITEM 1A.   Risk Factors   6
ITEM 1B.   Unresolved Staff Comments   16
ITEM 2.   Properties   16
ITEM 3.   Legal Proceedings   16
ITEM 4.   Mine Safety Disclosures   16
         
PART II        
ITEM 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   17
ITEM 6.   Selected Financial Data   18
ITEM 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations   18
ITEM 7A.   Quantitative and Qualitative Disclosures About Market Risk   30
ITEM 8.   Financial Statements and Supplementary Data   31
ITEM 9.   Changes In and Disagreements With Accountants on Accounting and Financial Disclosure   55
ITEM 9A.   Controls and Procedures   55
ITEM 9B.   Other Information   56
         
PART III        
ITEM 10.   Directors, Executive Officers and Corporate Governance   57
ITEM 11.   Executive Compensation   57
ITEM 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   57
ITEM 13.   Certain Relationships and Related Transactions, and Director Independence   58
ITEM 14.   Principal Accountant Fees and Services   58
         
PART IV        
ITEM 15.   Exhibits and Financial Statement Schedules   58
         
    Signatures   60

 

ii 

 

 

PART I

 

Special Note Regarding Forward-Looking Statements

 

In addition to current and historical information, this Annual Report on Form 10-K contains forward-looking statements. These statements relate to our future operations, prospects, potential products, services, developments, business strategies or our future financial performance. These statements are presented in thousands, except per share amounts, unless otherwise indicated.

 

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 discussion of certain risks and uncertainties that could cause actual results and events to differ materially from our forward-looking statements in the section entitled “Risk Factors” (refer to Part I Item 1A). 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.

 

ITEM 1.BUSINESS

 

Overview

 

ITEX Corporation operates a marketplace (the “Marketplace”) in which products and services are exchanged by Marketplace members utilizing ITEX dollars (“ITEX dollars”). ITEX dollars are 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”).

 

We make available free of charge on our website, www.itex.com, our reports filed with or furnished to the SEC pursuant to the Securities and Exchange Act of 1934, as amended (the “Exchange Act”) as soon as reasonably practicable after we file this material with, or furnish it to, the SEC. The information found on our website is not part of this or any other report we file with or furnish to the SEC.

 

Marketplace Transactions

 

The Marketplace provides a forum for our members to purchase from and sell their products and services to other members using ITEX dollars instead of USD. An ITEX dollar is an accounting unit used to record the value of transactions as determined by the members in the Marketplace. ITEX dollars are not intended to constitute legal tender, securities, or commodities and have no readily determinable correlation to USD. ITEX dollars may only be used in the manner and for the purpose set forth in our Member Agreement and the rules of the Marketplace.

 

Businesses use our Marketplace to attract new customers, increase sales and to utilize unproductive assets, surplus inventory, or excess capacity. The Marketplace is especially useful to businesses where the variable costs of products or services are low, such as hospitality, media, and service related businesses.

 

 1 

 

 

For tax purposes, the Internal Revenue Service (“IRS”) considers ITEX dollar sales to be equivalent to USD sales and ITEX dollar expenses to be equivalent to USD expenses. As a third-party record keeper under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), ITEX is required to annually send Forms 1099-B to each of our members and to the IRS, which we do electronically. The Form 1099-B reflects the member’s total ITEX dollar sales for the calendar year less the amount of any returns. Form 1099-B recipients are required to recognize ITEX dollars received (sales) as gross income on their tax returns, while expenditures of ITEX dollars may qualify as deductible business expenses or as other deductions that are permitted by the Internal Revenue Code.

 

Broker Network

 

Brokers are independent contractors with respect to the Company. Our corporate staff, brokers and their staff, and outside contractors support the Marketplace. Because we depend on a high rate of repeat business, the quality of broker interactions with members is an important element of our business strategy. We develop strong, cooperative relationships with our Broker Network by providing training, marketing materials and programs, internet and computer-related support, incentive programs, and investments in customer relationship management technology.

 

Our brokers provide Marketplace members with information about products and services that are available locally, nationally and in Canada. Brokers are responsible for enrolling new members, training them in Marketplace policies and procedures, facilitating their transactions and assuring payment in USD of transaction fees, association fees and other fees to us. In turn, brokers receive a commission in USD for a percentage of revenue collected from the members serviced by those brokers.

 

Our franchise agreements and independent licensed broker contracts generally provide for a five-year, renewable term unless terminated for reasons defined in the agreement.

 

We offer the sale of ITEX franchises to qualified individuals under our most current franchise agreement which we periodically amend as current events and circumstances deem necessary. Through our franchisees, we distribute our services by licensing our business ideas and concepts while retaining legal ownership of those concepts and ideas, including our name, logos, trademarks and member relationships. Our franchise agreement grants a limited license and right to use and operate a recognizable ITEX outlet to the franchisee by utilizing our business system, technology and proprietary marks.

 

The franchise agreement sets forth the obligations and responsibilities of the franchisee and provides certain protections to which franchisees are entitled to under federal and state franchise and business opportunity laws. See “Government Regulation.”

 

Sources of Revenue

 

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”, “2016” for August 1, 2015 to July 31, 2016, “2015” for August 1, 2014 to July 31, 2015). We report our results as of the last day of each calendar month (“accounting cycle”).

 

Our main sources of revenue are transaction and association fees. Additionally, we may charge various auxiliary fees to members, such as annual membership dues, late fees, insufficient fund fees and other fees. The fees we charge members are in USD and partially in ITEX dollars. We bill members for all fees at the end of each operating cycle. Members have the option of paying USD fees automatically by credit card, by electronic funds transfer or by check. In the fiscal year ended July 31, 2016, members made approximately 95% of their payments through electronic funds transfer, by credit cards and using our Preferred Member Autopay System (“Autopay System”). Members that pay through our Autopay System will generally be charged a USD transaction fee equal to 6.0% of the ITEX dollar amount of the member’s purchases and sales during the operating cycle. If paying by check, generally, the USD transaction fee is 7.5%. Additionally, regardless of a member’s transaction activity, each operating cycle we charge most members an association fee of $20 USD ($260 USD annually) and $10 ITEX dollars ($130 ITEX dollars annually). Transaction and association fees composed 96% of our total revenue in 2016 and 2015.

 

 2 

 

 

We prepare our financial statements on an accrual basis in accordance with United States Generally Accepted Accounting Principles (GAAP). Refer to Note 1 ― “Summary of Significant Accounting Policies” included in the “Notes to Consolidated Financial Statements”, Item 8 – Financial Statements for a description of our accounting policies.

 

Business Strategy

 

We seek to increase the number of members participating in our Marketplace and our revenues by providing members:

 

oAn efficient method to execute and track transactions in the Marketplace. We have developed a comprehensive, customer relationship management and payment processing software called Trade Exchange Account Manager “TEAM.” This software solution provides members, brokers and our management team with enhanced information systems and marketing tools. We continue to upgrade and enhance TEAM.

 

oA community where members can interact and safely transact business with other members. Our website conveys to members the variety of businesses that comprise the Marketplace and the benefits that come with their participation. Our Broker Network and corporate staff seek to maintain a fair and equitable environment for our members. Members may sell in the Marketplace only those products and services they have the legal right to sell.

 

oMore coverage by increasing the size and effectiveness of our Broker Network. We seek to attract new franchisees in order to increase the trade regions covered by the Marketplace. A portion of our website at www.itex.com provides information about our franchise program, in which we identify target markets, and provides detail about our company and business model.

 

oExcellent customer service by the Broker Network and our corporate staff. We provide training and support for brokers and refine our operating manuals and related support materials on an ongoing basis to better service our members. Additionally, we hold a national convention and regional meetings each year in which we discuss and openly share solutions for current issues and plan future enhancements to and benefits for the Marketplace.

 

oSocial media presence. We utilize social media to create and enhance relationships with and for our members, facilitate transactions, as well as to attract new members to our Marketplace. We are on several of the leading social media websites, including Facebook, YouTube, LinkedIn, Google+ and Twitter.

 

oSmart Phone technology. ITEX MobileSM enables our members to easily register new prospects in the Marketplace; complete a transaction with ITEXpaySM; search for other members with ITEXmapSM and to make payments to us.

 

 3 

 

 

Members

 

Our members are located in the United States and Canada. The majority of members are businesses with fewer than 10 employees. Members may choose to participate in the Marketplace for a number of reasons including to:

 

·Attract new customers
·Increase sales
·Add new channels of distribution
·Utilize unproductive assets, surplus inventory or excess capacity

 

Sales, Marketing and Transactions

 

The primary function of new member enrollment is to grow the Marketplace member base, increase transactional opportunities and generate additional revenue. We provide marketing and support materials, ongoing training, and promotion to assist our Broker Network in expanding the member base. Our brokers contact prospective members to market the benefits of joining the Marketplace. In addition, brokers obtain new members by attending networking events in their areas and through the referrals of existing members. We offer a Member Incentive Program that provides discounted association fees to existing members that invite new qualified members to the Marketplace.

 

Our marketing strategy is to promote our Marketplace and attract new members while instructing them how to effectively use the Marketplace to grow their business. To promote the Marketplace and the ITEX brand, we market products and services of existing members through our website, directories, newsletters, e-mail, social media and other means.

 

Brokers facilitate transactions between members by identifying their needs and making them aware of products and services available in the Marketplace that could fulfill those needs. Members can also log onto our website and initiate product or service listings on the Marketplace or search for products or services to purchase. Reoccurring transactions often develop between Marketplace members, generating transaction fees with less interaction by brokers.

 

Systems and Technologies

 

The Marketplace is handled by TEAM. We designed TEAM to facilitate the activities of all parties involved in the Marketplace, from our corporate management and accounting personnel to brokers and members. The system extends well beyond record keeping and transaction processing. The major features of the system are as follows:

 

·Account Information Manager (“AIM”) Online - provides our brokers and corporate staff with customer relationship management tools.

 

·Marketplace - an online classified ad section where members can list products and services they are offering for sale as well as locate products and services they are seeking to purchase.

 

·Member Directory - a categorized listing of members.

 

·ITEX MobileSM - enables our members to easily register new prospects into our Marketplace, complete a transaction, search for other members, and make payments to us.

 

·Reporting provides a number of reports allowing for a comprehensive analysis of various aspects of the Marketplace.

 

 4 

 

 

We take a number of measures to ensure the security of our hardware and software systems and member information. We enhance our systems for data management and protection, intrusion detection and prevention, upgrade our network architecture, and to expand our disaster recovery processing capacity. Our technologies are co-hosted at our corporate office and a secure data center located in Bellevue, Washington and we perform back-ups daily. We continue to improve the speed and reliability of our information systems and transaction tools.

 

Industry Overview

 

Our industry was developed in 1960 when our wholly-owned subsidiary BXI Exchange, Inc. established a non USD-based index of valuation for credits and debits called “trade dollars.” For us, the index of valuation is the ITEX dollar and our trade exchange is our Marketplace, consisting of thousands of members served by our Broker Network. In 2011 we conducted an informal market analysis to determine the size of our industry composed of various trade exchanges (“Exchanges”), contacting hundreds of Exchanges across the United States. Based on our information, we estimated the industry size to consist of approximately 300 exchange locations servicing 90,000 members, generating $680 million in gross merchandise value (GMV) transactions and $56 million in revenues.

 

Competition

 

We encounter significant competition in our efforts to develop our Marketplace. Our competitors include internet distribution channels and local Exchanges. Based on reported USD revenues, participating member businesses and regions served, we believe that we are the Exchange leader in the United States and Canada.

 

Internet distribution channel competitors include well-known companies such as eBay, Travelocity, Priceline, Amazon and Overstock. Similar to our Marketplace, these companies provide distribution channels to move excess or surplus inventory. We currently and potentially compete with a wide variety of online and offline companies providing products and services to consumers and merchants, including big box stores such as Best Buy, Costco and Sam’s Club. In addition, the internet and mobile networks provide new, rapidly evolving and intensely competitive channels for the sale of all types of products and services. The greater the number of avenues to move excess inventory or products and services, the more competitive it is to attract businesses to trade their inventory in our Marketplace. We also compete with these companies with respect to price, ease of use and brand name awareness.

 

We compete with other Exchanges primarily on a service basis, the number of products and services available in the Marketplace and the liquidity of ITEX dollars. In addition to existing Exchanges, new competitors could launch new Exchanges. For more information regarding these competition risks, see the information in “Risk Factors” under the caption “Substantial and increasing competition from the ecommerce industry, exchanges and other distribution channels may adversely affect our overall business, revenues and results of operations.”

 

Government Regulation

 

Government regulation impacts several key aspects of our business and regulatory changes have potential to further affect our industry. In particular, we are subject to laws and regulations that govern relationships with our franchisees, transaction reporting and the management of member information. For more information regarding these risks, see the information in “Item 1A: Risk Factors.”

 

 5 

 

 

Intellectual Property

 

We rely on a combination of copyright and trademark laws, trade secrets, software security measures, franchise and license agreements and nondisclosure agreements to protect our intellectual property. We pursue the registration of our domain names, copyrights, trademarks and service marks in the U.S. We seek to protect our intellectual property rights and other proprietary rights, a process that is expensive and time consuming, may require litigation and may not be successful. If we are unable to register or protect our trademarks or domain names, we could be adversely affected in any jurisdiction in which our trademarks or domain names are not registered or protected.

 

Employees

 

As of July 31, 2016, we had 13 full-time or part-time employees. From time to time, we utilize independent consultants or contractors for additional support.

 

ITEM 1A.RISK FACTORS

 

This Annual Report on Form 10-K 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”, Part II Item 7 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 Broker Network, and as a result the loss of our brokers or the financial performance of our brokers can negatively impact our business

 

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 providing excellent customer service, proactively engaging members with transaction opportunities, 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.

 

 6 

 

 

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

 

Marketplace revenue decreased 8% for the year ended July 31, 2016, compared to the previous year ended July 31, 2015 and decreased 11% for the year ended July 31, 2015 compared to the same period ended July 31, 2014. 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 33% recurring revenues. We do not have an order backlog, and approximately 63% 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.

 

We cannot assure you that we can continue to be operated profitably, which depends on many factors, including, 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, economic factors and new regulations. 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.

 

Substantial and increasing competition from the ecommerce industry, exchanges and other distribution channels may adversely affect our overall business, revenues and results of operations

 

We encounter significant competition in our efforts to develop our Marketplace. Our competitors include internet distribution channels and local Exchanges. Internet distribution channel competitors include well-known companies such as eBay, Travelocity, Priceline, Amazon and Overstock. Similar to our Marketplace, these companies provide distribution channels to move excess or surplus inventory. We currently and potentially compete with a wide variety of online and offline companies providing products and services to consumers and merchants, including big box stores. The internet and mobile networks provide new, rapidly evolving and intensely competitive channels for the sale of all types of products and services. The greater the number of avenues to move excess inventory or products and services, the more competitive it is to attract businesses to trade their inventory in our Marketplace. We also compete with these companies with respect to price, ease of use and brand name awareness.

 

We compete with other Exchanges primarily on a service basis, the number of products and services available in the Marketplace and the liquidity of ITEX dollars. In addition to existing Exchanges, new competitors could launch new Exchanges at a relatively low cost since technological and financial barriers to entry are relatively low. Businesses can readily launch online sites or mobile platforms and applications at nominal cost by using commercially available software. Potential competitors undertaking this effort could include companies with longer operating histories, greater market presence and name recognition, larger customer bases and greater financial, technical and marketing resources than we have.

 

Our ability to compete successfully will depend on our ability to enhance and improve our existing services, adapt to current technologies, and to continually improve our operating efficiencies. Our competitors may develop competing exchanges, distribution channels, technologies, products or strategic alliances and affiliations that make our brand, products and services less marketable or less useful or desirable. Increased competition could result in erosion of our market share, and adversely affect our revenues, business operating results and financial condition.

 

 7 

 

 

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. 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 ability to use our net operating loss carryforwards to offset future taxable income would be limited if we do not generate sufficient taxable income or if an ownership change occurs, which would negatively impact our results of operations and stockholders’ equity

 

As of July 31, 2016, we reported a consolidated federal net operating loss (“NOL”) carryforward and deferred tax asset, net of valuation allowances, of $2,634, which represents approximately 30% of our total assets. The use of our NOL carryforwards is subject to uncertainty because, in addition to the factors discussed below, it is dependent upon the amount of taxable income we generate. In the fourth quarter of 2016, we recorded a deferred tax asset valuation allowance of $866. The valuation allowance was the result of a sustained decline in our revenue and our projected continued decline in future growth rates and profitability levels. There can be no assurance that we will have sufficient taxable income, if any, in future years to use the net operating loss carryforwards before they expire. If we have uncertainties surrounding our ability to continue to generate future taxable income to realize these tax assets, a valuation allowance will be established to offset our deferred tax assets. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not (greater than 50%) that a tax benefit will not be realized.

 

Additionally, the future utilization of our NOL carryforwards to offset future taxable income may be subject to an annual limitation as a result of ownership changes that could occur in the future. Federal and state tax laws impose restrictions on the utilization of NOL and tax credit carryforwards in the event of an “ownership change” as defined by Section 382 of the Internal Revenue Code of 1986, as amended. Generally, an ownership change occurs if the percentage of the value of the stock that is owned in the aggregate by our direct or indirect “five percent shareholders” increases by more than 50% over their lowest ownership percentage at any time during any three-year testing period. Future changes in our stock ownership, which may be outside of our control, may trigger an “ownership change.” In addition, future equity offerings or acquisitions that have equity as a component of the purchase price could result in an “ownership change.” If an “ownership change” has occurred or does occur in the future, utilization of the NOL carryforwards or other tax attributes may be limited, which could potentially result in increased future tax liability to us and cause us to pay U.S. federal income taxes earlier than we otherwise would, adversely affecting our future cash flow. The additional write off of NOL carryforward tax benefits would also negatively affect our net earnings and reduce stockholders’ equity.

 

 8 

 

 

 

We may be required to record a further charge to earnings as a result of impairment of goodwill or intangible assets, which could have a negative impact on stockholders’ equity

 

In the fourth quarter of 2016, we recorded a $1,750 impairment in goodwill resulting in a reduction of our total assets, net income and stockholders’ equity. The impairment loss was the result of a sustained decline in our revenue and our projected continued decline in future growth rates and profitability levels together with a reduction of our total assets. Since 2011, we have returned approximately $12,000 to stockholders in the form of dividends and stock buybacks, which has reduced our net asset base. We have remaining goodwill of $1,441 and net other intangible assets of $48 as of July 31, 2016, which represents approximately 17% of our total assets. Goodwill represents the excess of cost over the fair value of identified net assets acquired. We review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. For example, lower projected operating results reflect changes in assumptions related to revenue initiatives, organic revenue growth rates, market trends, cost structure, and other expectations about the anticipated short-term and long-term operating results. We may be required to record a significant charge in our consolidated financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, which would reduce earnings in such period, and reduce stockholders’ equity.

 

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.

 

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.

 

During the past several years, U.S. companies have seen an increasing level of insurgent campaigns, proxy solicitations, and shareholder derivative actions or other attempts to acquire control of companies or effect operational changes. In recent 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 could 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;

 

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

 

·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 change in the composition of the Board of Directors could result in additional compensation charges and other expenses, including reimbursement of proxy or takeover expenses; and may not produce an effective business strategy or create additional value for stockholders.

 

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. 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.

 

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.

 

Our business is subject to government regulation and future regulation or regulatory changes may increase the cost of compliance and doing business

 

We are subject to various federal, state and local laws, regulations and administrative practices affecting our businesses. These include the requirement to obtain business licenses, withhold taxes, remit matching contributions for our employees’ social security accounts, and other such legal requirements, regulations and administrative practices required of businesses in general. We are a third party record-keeper under the Tax Equity and Fiscal Responsibility Act (“TEFRA”) and accordingly, we account for and report annually to the IRS the total ITEX dollar sales transactions, net of any returns, of each member in our Marketplace. Under the Federal Trade Commission Act and state franchise and business opportunity laws, our franchisees are entitled to certain protections including mandatory disclosures and the provision that many of the substantive aspects of the business relationship (i.e., termination, transfer, cancellation, and non-renewal) will be governed by state law. An adverse finding in one or more of these business relationship aspects could govern the enforceability of our franchise agreements or permit the recovery of damages and penalties which could have a material adverse effect on our financial condition.

 

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In addition, we are currently or potentially subject to laws and regulations affecting our operations in a number of other areas, including data privacy requirements, intellectual property ownership and infringement, prohibited items and stolen goods, digital content, promotions, virtual currency, taxes, as well as laws and regulations intended to combat money laundering and the financing of terrorist activities. With respect to our online and mobile operations, it is not always clear how certain laws and regulations apply to our business. Many of these laws were adopted prior to the advent of the internet, mobile, and related technologies and, as a result, are subject to interpretation by the courts on an ongoing basis. We cannot predict the impact, if any, that future internet-related regulation or regulatory changes might have on our business. Compliance with these laws, regulations, and similar requirements may be onerous and expensive, and variances and inconsistencies from jurisdiction to jurisdiction may further increase the cost of compliance and doing business. Any such costs, which may rise in the future as a result of changes in these laws and regulations or in their interpretation, could individually or in the aggregate make our services less attractive to our members, delay the introduction of new products or services in one or more regions, or cause us to change or limit our business practices. We implement policies and procedures designed to ensure compliance with applicable laws and regulations, but there can be no assurance that our employees or brokers will not violate these laws and regulations or our policies and procedures.

 

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.

 

Although we have prohibited the listing of illegal products 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.

 

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.

 

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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 enhance our systems for data management and protection, and intrusion detection and prevention. 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.

 

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 considered “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 an administer of a Marketplace utilizing ITEX dollars 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.

 

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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.

 

We may 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 10 ― “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.

 

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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.

 

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.

 

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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. 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 5.5% and 6.2% of total revenue in the years ended July 31, 2016 and 2015, respectively. Part of our cash reserves are held in Canadian banks and subject to currency exchange rate fluctuations. Foreign currency expense for the year ended July 31, 2016 decreased by $152 compared to the year ended July 31, 2015. Foreign currency exchange fluctuations may or may not materially adversely affect our operations. Changes in the relation of the Canadian dollar to the USD could affect our revenues, cost of sales, operating margins or value of bank holdings which could 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 $875 at July 31, 2016 and $1,083 at July 31, 2015. In the event one or more brokers default on their loans, it may adversely affect our financial condition.

 

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

 

Our common stock trades on the OTC Pink tier of the over-the-counter market known as the OTC 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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Escheatment of our unclaimed common stock could result in our being eligible to deregister our stock under the Exchange Act

 

We are subject to state unclaimed property (escheat) laws which require us to turn over to state authorities unclaimed property including stocks and uncashed dividends. We work with an agent to comply with applicable unclaimed property laws, including preparation of unclaimed property reports, completion of required due diligence notifications, delivery of abandoned stock and dividends to various states and other services as necessary. It is expected that as the process is completed there will be some escheatment of shares owned by lost stockholders.

 

It is possible that as the process continues there will be escheatment of a sufficient number of shares owned by lost stockholders to reduce our number of registered stockholders to below 300. As of July 31, 2016, we had 472 stockholders of record. If the number of registered stockholders drops below 300, we would be eligible to deregister our shares under the Exchange Act, and to exit the SEC reporting system. If we are eligible, a decision to deregister could be viewed in a negative manner by stockholders due to diminished available information about the Company and the potentially adverse impact on liquidity in the trading market for our shares and our stock price.

 

ITEM 1B.UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2.PROPERTIES

 

Our corporate and administrative headquarters offices are located in Bellevue, Washington. In the year ended July 31, 2016, we leased our property on a month-to-month basis. In July 2016, we signed a 5-year lease for a new location in Bellevue, Washington, with a lease commencement date of September 15, 2016. Our new premises will be utilized by our senior management, marketing, finance, general and administrative personnel.

  

   Area leased   Monthly    
Location  (sq. feet)   rent (1)   Lease expiration
Bellevue, Washington   7,035   $7,750   September 30, 2016
Bellevue , Washington   3,379   $9,221   March 31, 2022

 

(1) Base rent including estimated operating costs

  

We believe that our facilities are adequate and suitable for their current use, and that all of the leased space and all property maintained within are adequately insured. For additional information regarding our obligations under leases, refer to Note 8 ― “Commitments” included in the “Notes to Consolidated Financial Statements”, Item 8 – Financial Statements.

 

ITEM 3.LEGAL PROCEEDINGS

 

For information regarding legal proceedings, refer to Note 10 ― “Legal Proceedings and Litigation Contingencies” included in the “Notes to Consolidated Financial Statements”, Item 8 – Financial Statements.

 

Item 4.MINE SAFETY DISCLOSURES

 

Not applicable.

 

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PART II

 

ITEM 5.MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

Market Information

 

Our common stock trades on the OTC Pink tier of the over-the-counter market known as the OTC Marketplace under the ticker symbol “ITEX.” The range of high and low closing bid prices for our common stock for each quarter during the two most recent years, and dividends paid for the quarter, are as follows:

 

   Fiscal Year 2016   Fiscal Year 2015 
   Prices   Dividends   Prices   Dividends 
   High   Low   Paid   High   Low   Paid 
First  $3.40   $2.75   $0.00   $3.60   $2.70   $0.05 
Second   3.40    3.01    0.10    3.05    2.66    0.05 
Third   3.75    3.03    0.00    3.67    2.32    0.05 
Fourth   3.87    3.25    0.10    3.42    2.62    0.05 

 

This table reflects the range of high and low closing bid prices for our common stock during the indicated periods, as compiled by OTC Markets Group Inc. based on trading information reported by the FINRA Composite Feed or other qualified interdealer quotation medium. The quotations merely reflect the prices at which transactions were proposed and do not necessarily represent actual transactions. Prices do not include retail markup, markdown or commissions.

 

There were 472 holders of record of our common stock as of July 31, 2016. Most shares of our common stock are held by brokers and other institutions on behalf of shareholders.

 

During 2016, we paid semi-annual dividends of $0.10 per share, totaling $0.20 for the year. See Item 1A ─ Risk Factors ─ 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.

 

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 July 31, 2016 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)
 
5/01/16 - 5/31/16   369   $3.52    -   $921,860 
6/01/16 – 6/30/16   1,596   $3.60    -   $916,108 
7/01/16 - 7/31/16   9   $4.00    -   $916,072 

 

(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.  

 

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ITEM 6.SELECTED FINANCIAL DATA

 

Not required for smaller reporting companies.

 

ITEM 7.          MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands except per share amounts unless otherwise indicated)

 

The following discussion is provided as a supplement to the accompanying consolidated financial statements and notes (refer to Item 8 – Financial Statements) and is intended to help provide information we believe is relevant to an assessment and understanding of our results of operations and financial condition. In addition to our consolidated financial statements and notes, it should be read in conjunction with the section entitled “Risk Factors” (refer to Part I Item 1A) and the cautionary statement regarding forward-looking statements on page 1.

 

OVERVIEW

 

ITEX Corporation operates a Marketplace in which products and services are exchanged by Marketplace members utilizing ITEX dollars, enabling our member businesses to acquire products and services without exchanging cash. We generate revenue by charging members percentage-based transaction fees, association fees, and other fees. Our most significant cost of revenue consists of commissions paid to our brokers, and our most significant expenses are related to compensating employees, selling, general and administrative, and income taxes.

 

In fiscal year 2016, faced with continued contracting revenues, we implemented organizational changes and made strategic and tactical moves to support the generation of cash flow and operational income. During the year we continued development of smartphone technology to enable our members to expand their trading community and instantly complete transactions through a mobile device. As a result of our initiatives for the year ended 2016, as compared to 2015, income from operations, exclusive of Goodwill impairment charges of $1,750, increased by $271, or 28%. However, for the year ended 2016, as compared to 2015, our revenue decreased by $907, or 8%.

 

In the fourth quarter of 2016, we recorded a $1,750 impairment in goodwill resulting in a reduction of our total assets, net income and stockholders’ equity. The impairment loss was the result of a sustained decline in our revenue and our projected revenue growth rates and profitability levels, together with a reduction of our total assets. Since 2011, we have returned approximately $12,000 to stockholders in the form of dividends and stock buybacks, which has reduced our asset base. In addition, during the fourth quarter of 2016, we recorded an $866 valuation allowance against our deferred tax asset.

 

Industry Trends

 

Based on reported revenues and informal market information available to us, trade exchanges overall are faced with a general decline in year-over-year revenue. We believe this reflects, in part, the effect of enhanced competition. Trade exchanges currently compete with a wide variety of online and offline companies providing products and services to consumers and merchants, including big box stores. There are numerous avenues to move excess inventory or products and services. We strive to view industry change as an opportunity to conceive new services, technologies, or new ideas that can further evolve the industry and our business.

 

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Economic Conditions, Challenges, and Risks

 

We encounter significant competition in our efforts to develop our Marketplace. Our competitors include internet distribution channels and local Exchanges. The greater the number of avenues to move excess inventory or products and services, the more competitive it is to attract businesses to trade their inventory in our Marketplace.

 

We have approximately 33% recurring revenues from association fees. Approximately 63% of our revenues each year come from transaction fees assessed during that year. Our reduction in revenue this year 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 attributable in part to the prolonged weak economic climate for small businesses (our primary clientele), as well as the increased competition from pricing and convenience of distribution channels such as big box stores and internet outlets.

 

We seek to increase our revenue by enhancing our internet applications, offering expanded tools and features with ITEX MobileSM, marketing the benefits of participation in the Marketplace, expanding Marketplace offerings of goods and services, and attracting and retaining qualified brokers. Adding new brokers is a component of our overall growth plan, and 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.

 

Our Canadian operations provide a portion of our total revenue and expenses. Revenues denominated in Canadian dollars comprised 5.5% of total revenue in 2016. Changes in foreign exchange rates affects our revenue and expenses.

 

See a discussion of these factors and other risks under Risk Factors (Part I, Item 1A of this Form 10-K).

 

Financial Position

 

Our financial condition and balance sheet at July 31, 2016, had cash of $3,235 compared to $2,047 at the same period in 2015. In April 2015, we completed a partial tender offer to purchase shares of our common stock, for an aggregate cost of $3,000, excluding fees and expenses relating to the tender offer. The shares purchased in the tender offer represented approximately 26% of our outstanding common shares (including shares of unvested restricted stock). During 2016 we repurchased $113 of our stock through our stock repurchase plan and we paid semi-annual dividends of $0.10 per share, totaling $0.20 per share for the year. We recorded a $1,750 impairment in goodwill and an $866 deferred tax asset valuation allowance in the fourth quarter of 2016, resulting in a reduction of our total assets, net income and stockholders’ equity. Total assets were $8,894 at July 31, 2016, compared to $10,740 at July 31, 2015, and stockholders’ equity decreased to $7,577 at July 31, 2016, compared to $9,372 at July 31, 2015.

 

Our net cash flows provided by operating activities was $1,513 for the year ended July 31, 2016, compared to $1,608 for the previous year. The decrease in net cash provided by operating activities is primarily due to the negative change of $286 in operating assets and liabilities in the year ended July 31, 2016.

 

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RESULTS OF OPERATIONS (in thousands except per share amounts unless otherwise indicated)

 

Condensed Results

 

   Year Ended July 31, 
   2016   2015 
         
Revenue  $11,110   $12,017 
           
Cost of marketplace revenue   6,883    7,394 
Operating expenses   2,999    3,666 
Goodwill impairment   1,750    - 
Income from operations   (522)   957 
           
Other income   61    90 
(Loss)/income before income taxes   (461)   1,047 
           
Income tax expense   1,058    357 
Net (loss)/income  $(1,519)  $690 
           
Net (loss)/income per common share:          
Basic  $(0.79)  $0.29 
Diluted  $(0.79)  $0.28 
           
           
Average common and equivalent share:          
Basic   1,930    2,414 
Diluted   1,930    2,423 

 

Revenue

 

Revenue consists of Marketplace transaction fees, association fees and other revenue net of revenue adjustments for both broker offices and corporate-owned offices. Revenue also includes a nominal amount of ITEX dollars (non-cash).

 

Marketplace and other revenue for the year ended July 31, 2016, decreased $907 or 8% to $11,110 from $12,017 during the prior year. This decrease was due to a reduction in the number of members, a reduction in transaction volume and a corresponding decrease in transaction and association fees.

 

Loss before income taxes for the year ended July 31, 2016 was ($461), compared to net income of $1,047 in 2015. This decrease is primarily due to the write down of $1,750 in goodwill along with a reduction in gross profit of $396 offset by a reduction in operating expenses of $667.

 

Earnings per share, fully diluted, decreased to ($0.79) per share for the year ended July 31, 2016, from $0.28 per share for the year ended July 31, 2015. This decrease is primarily due to the write down of $1,750 in goodwill and a deferred tax asset valuation allowance of $866 along with a reduction in gross profit of $396 offset by a reduction in operating expenses of $667.

 

Revenue, Costs and Expenses

 

The following table summarizes our selected consolidated financial information for the years ended July 31, 2016 and 2015, with amounts expressed as a percentage of total revenues:

 

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   Years Ended July 31, 
   2016   2015 
         
   Amount   Percent of
Revenue
   Amount   Percent of
Revenue
 
Revenue:                    
Marketplace revenue and other revenue  $11,110    100%  $12,017    100%
                     
Costs and expenses:                    
Cost of Marketplace revenue   6,883    62%   7,394    61%
Salaries, wages and employee benefits   1,782    16%   1,864    16%
Selling, general and administrative   1,135    10%   1,711    14%
Depreciation and amortization   82    1%   91    1%
Goodwill impairment   1,750    16%   -    0%
    11,632    105%   11,060    92%
                     
Income from operations   (522)   -5%   957    8%
                     
Other income   61    1%   90    1%
                     
(Loss)/income before income taxes   (461)   -4%   1,047    9%
                     
Income tax expense   1,058    10%   357    3%
                     
Net (loss)/income  $(1,519)   -14%  $690    6%

 

The following are the components of revenue that are included in the consolidated statements of income:

 

   Year Ended July 31, 
   2016   Percent
change
from 2015
   2015 
             
Association fees  $3,717    -7%  $3,991 
Transaction fees   6,994    -8%   7,577 
Other revenue   238    3%   232 
                
Revenue, subtotal  $10,949    -7%  $11,800 
                
ITEX dollar revenue  $161    -26%  $217 
                
Total Revenue  $11,110    -8%  $12,017 

 

Revenue decreased by $907 or 8% for the year ended 2016 compared to 2015. Association revenue decreased $274 or 7% to $3,717 from $3,991. The association revenue decrease was due to a reduction in the number of members assessed association fees. Transaction revenue decreased $583 or 8% to $6,994 from $7,577. The transaction revenue decrease was due to lower transaction volume in the Marketplace in 2016 when compared to 2015.

 

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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. Occasionally we spend ITEX dollars in the Marketplace for our corporate needs. As discussed in Note 1 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 $161 and $217 as ITEX dollar revenue for the years ended July 31, 2016 and 2015, respectively.

 

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:

 

   Year Ended July 31, 
   2016   Percent
change
from 2015
   2015 
Association fee commissions  $1,352    -6%  $1,433 
Transaction fee commissions   5,261    -7%   5,668 
Other Marketplace expenses   270    -8%   293 
                
   $6,883    -7%  $7,394 
                
Costs of Marketplace revenue as a percentage of total revenue   62%        61%

 

Costs of Marketplace revenue for 2016, as compared to 2015, decreased by $511, or 7%. Costs of Marketplace revenue as a percentage of total revenue was 62% and 61%, respectively.

 

Association fee commissions decreased by $81, or 6% for the year ended 2016 as compared to 2015. The decrease in commissions paid was comparable to the decrease in the corresponding association revenue.

 

Transaction fee commissions decreased by $407, or 7% for the year ended 2016, as compared to 2015. Transaction fee commissions will generally increase or decrease at a similar percentage as the increase or decrease in transaction revenue, which was the case for 2016.

 

Other Marketplace expenses consist of miscellaneous Marketplace related expenses such as credit card processing fees and other commissions not associated with association or transaction revenue. Other Marketplace expenses decreased by $23, or 8% for the year ended 2016 as compared to 2015. The primary decrease in the year ended 2016 is due to a reduction in credit card processing fees due to lower transaction volume.

 

Association fee commissions as a percentage of its related revenue remained at 36% in both 2016 and 2015. Transaction fee commissions, as a percentage of corresponding revenue, was also the same at 75% in both years ended 2016 and 2015.

 

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Corporate Salaries, Wages and Employee Benefits

 

Corporate salaries, wages and employee benefits include expenses for employee salaries and wages, payroll taxes, 401(k), payroll related insurance, healthcare benefits, recruiting costs, temporary services and other personnel-related items.

 

Corporate salaries, wages and employee benefits expenses for 2016 decreased by $82 or 4% to $1,782 from $1,864 for the year ended 2015. The decrease in compensation-related costs for the year is primarily due to a reduction of staff and lower stock compensation costs during the year ended July 31, 2016.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses, SG&A, include consulting, legal and professional services, as well as expenses for rent and utilities, marketing, insurance, bad debts, sales tax and other taxes, and other costs.

 

SG&A expenses for 2016 decreased by $576 or 34% to $1,135 from $1,711 for the year ended 2015. The decrease is due primarily to a $152 decrease in foreign currency expense. We hold some assets and conduct business in Canada and the decrease in CDN exchange rates during 2015 caused an increase in this expense. In 2016 we moved the majority of the cash held in Canadian banks into U.S. based institutions. In addition, legal fees decreased $119 and ITEX dollars used for corporate purposes decreased $56 during 2016.

 

Depreciation and Amortization

 

Depreciation and amortization expenses include depreciation on our fixed assets and amortization of our intangible assets.

 

Depreciation and amortization for 2016 decreased by $9, or 10% to $82 from $91 for the year ended 2015. The primary reason for the decrease is that there were no material additions of property and equipment or amortizable intangible assets in 2016.

 

Goodwill Impairment

 

We review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Factors that may be a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in our stock price and market capitalization, reduced future cash flow estimates, the industry specific weighted average cost of capital, adverse changes in legal factors or the business climate, and lowered expectations of future financial results. Accordingly, as of July 31, 2016 the Company tested its goodwill for impairment and concluded that the net asset carrying value exceeded the estimated fair value of the Company’s single reporting unit and recognized an impairment loss during the fourth quarter of 2016 of $1,750. The estimated fair value of the Company’s single reporting unit was based on estimates of future operating results, discounted cash flows and other market-based factors. During the fourth quarter the Company revised its forecast which resulted in a goodwill impairment loss primarily from a sustained decline in the Company’s projected revenue growth rates and profitability levels. The lower projected operating results reflect changes in assumptions related to revenue initiatives, organic revenue growth rates, market trends, cost structure, and other expectations about the anticipated short-term and long-term operating results.

 

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Other Income

 

Other income includes interest received on notes receivable and promissory notes. The interest income is derived primarily from our notes receivable for corporate-owned office sales and loans to Brokers. Other income in 2016 decreased by $29 or 32% to $61 from $90 for the year ended 2015. The notes receivable are repaid in installments. The installment payments for the various notes receivable end between 2017 and 2022.

 

Recoverability of Deferred Tax Assets

 

Deferred tax assets on our balance sheet primarily include federal and state net operating loss carry forwards (collectively “NOLs”) which are expected to result in future tax benefits. Realization of these NOLs assumes that we will be able to generate sufficient future taxable income to realize these assets. Deferred tax assets also include temporary differences between the financial reporting basis and the income tax basis of our assets and liabilities at enacted tax rates expected to be in effect when such assets or liabilities are realized or settled. In 2016 and 2015, respectively, we utilized $1,120 and $844 of our available NOLs. As of July 31, 2016, we have approximately $7,997 of NOLs available to offset future taxable income.

 

We periodically assess the realizability of our available NOLs by assessing whether we believe we will generate enough future taxable income to utilize substantially all of the available NOLs. We determined that we will not be able to utilize all of our Federal NOLs as of July 31, 2016. As of July 31, 2016 and 2015, we have an $866 and $0 valuation on Federal NOLs, respectively. As of July 31, 2016, California NOLs have expired and the valuation allowance has been removed accordingly. As of July 31, 2016 and 2015, we have a $0 and $99 valuation allowance on state of California NOLs, respectively.

 

FINANCIAL CONDITION (in thousands)

 

Our total assets were $8,894 and $10,740 at July 31, 2016 and 2015, respectively, representing a decrease of $1,846 or 17%. The decrease in asset base is primarily due to the write down of $1,750 in goodwill impairment, valuation allowance of $866 of our deferred tax asset and cash dividends paid out to stockholders in 2016 of $417. In addition, we also repurchased 30 shares of our common stock for $113 through the stock repurchase program.

 

Our cash totaled $3,235 and $2,047 as of July 31, 2016 and 2015, respectively, representing an increase of $1,188, or 58%. Our cash flow activity is described in more detail below (see “Liquidity and Capital Resources”).

 

Accounts receivable balances, net of allowances of $408 and $439, were $429 and $398 as of July 31, 2016 and 2015 respectively, representing an increase of $31 or 8%, primarily due to the timing of our cycle close in comparable years.

 

Our total current liabilities were $1,317 and $1,368 at July 31, 2016 and 2015, respectively, representing a decrease of $51 or 4%. The decrease is primarily due to a reduction of $31 in accrued commissions and commissions payable to brokers.

 

Our stockholders’ equity decreased by $1,795 or 19% to $7,577 at July 31, 2016, compared to $9,372 at July 31, 2015 primarily due to $1,750 in goodwill impairment, $866 in deferred tax asset valuation allowance, $417 in dividends paid and $113 of stock repurchases during 2016.

 

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LIQUIDITY AND CAPITAL RESOURCES (in thousands)

 

Our principal sources of liquidity are our cash provided by operating activities and cash on hand. Net cash provided by operating activities was $1,513 and $1,608 for the years ended July 31, 2016 and 2015, respectively. Our cash balance as of July 31, 2016 totaled $3,235.

 

The following table presents a summary of our cash flows for the years ended 2016 and 2015 respectively (in thousands):

 

   Year Ended July 31, 
   2016   2015 
Net cash provided by operating activities  $1,513   $1,608 
Net cash provided by investing activities   202    338 
Net cash used in financing activities   (527)   (3,572)
Increase/(decrease) in cash and cash equivalents  $1,188   $(1,626)

 

We have financed our operational needs through cash flow generated from operations. During 2016, our cash position increased by $1,188 to $3,235. In 2015, we used a large portion of cash reserves to fund a partial tender offer of $3,000. We use operational cash flow provided by operating activities for routine operating expenses, loans to brokers, stock buybacks and quarterly dividend payments to common stockholders.

 

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 during the last two fiscal years. 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 year ended July 31, 2016, net cash provided by operating activities was $1,513 compared to $1,608 in the year ended July 31, 2015, a decrease of $95 or 6%. The decrease in net cash provided by operating activities is primarily due to reduced gross profit offset by a reduction to operating expenses.

 

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):

 

   Year ended July 31, 
   2016   2015 
         
Net (loss)/income  $(1,519)  $690 
Add: non-cash expenses   3,318    854 
(Less) plus: changes in operating assets and liabilities   (286)   64 
Net cash provided by operating activities  $1,513   $1,608 

 

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

 

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Investing Activities

 

For the year ended July 31, 2016, net cash provided by investing activities was $202 compared with $338 provided by investing activities in the year ended July 31, 2015, a decrease of $136. In the year ended July 31, 2015, the net cash provided by investing activities was primarily related to $371 in note receivable principal collections, offset by $30 in note receivable advances. In the year ended July 31, 2016, the net cash provided by investing activities was primarily related to $288 in note receivable principal collections, which were offset by $80 in note receivable advances and $6 of purchases of property and equipment.

 

Financing Activities

 

For the year ended July 31, 2016, net cash used in financing activities was $527 compared with $3,572 used in financing activities in the year ended July 31, 2015, a decrease of $3,045, or 85%. In the year ended July 31, 2016, the net cash used in financing activities was primarily related to the repurchase of $113 in common stock and $417 in dividends paid to common stockholders. In the year ended July 31, 2015, the net cash used in financing activities was primarily related to the partial tender offer of $3,000 along with the repurchase of $76 in common stock and $534 in dividends paid to common stockholders.

 

Our net cash used in financing activities consists of dividends paid to shareholders and discretionary repurchases of our common stock. We repurchased 30 and 23 shares of ITEX stock under our stock repurchase program in 2016 and 2015, respectively.

 

Commitments and Contingencies

 

We utilize leased facilities in the normal course of our business. We executed a new lease for our corporate headquarters in Bellevue, Washington. The lease commenced on September 15, 2016 and expires March 31, 2022. We have an option to extend the lease term once, for a five-year period, at the fair market value.

 

The lease expense, inclusive of utilities included in our lease payments, for our executive office space and corporate-owned offices for the years ended July 31, 2016 and 2015 was $89 and $149, respectively.

 

OTHER MATTERS

 

Critical Accounting Policies and Estimates

 

We have identified the policies below as critical to our understanding of the results or our business operations. We discuss the impact and any associated risks related to these policies on our business operations throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results.

 

In the ordinary course of business, we have made a number of estimates and assumptions in preparing our financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates and assumptions. The following critical accounting policies are those that are most important to the portrayal of our consolidated financial statements. These policies require our most difficult, subjective, and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. For a summary of all of our significant accounting policies, including the critical accounting policies discussed below, refer to Note 1 ― “Summary of Significant Accounting Policies” included in the “Notes to Consolidated Financial Statements”, Item 8 – Financial Statements.

 

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Revenue Recognition

 

We generate our 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”). We recognize revenue when persuasive evidence of an arrangement exists, the transaction has occurred or a cycle period has ended, the charges are fixed and determinable and no major uncertainty exists with respect to collectability.

 

In each accounting cycle, we recognize as revenue all transaction fees, association fees and applicable other fees that occurred during that month regardless of which operating cycle the fees occurred. We defer annual dues, which are prepaid, and recognize this revenue over the periods they apply.

 

We generally do not record revenues or expenses in our financial statements for ITEX dollars we receive from or expend to members or brokers, but we do record revenues and expenses for ITEX dollars we spend on various products or services where the value of those ITEX dollars is readily determinable (see Note 1 below, “Accounting for ITEX Dollar Activities”).

 

Gross versus Net Revenue Recognition

 

In the normal course of business, we act as administrator of transactions between Marketplace members. We pay commissions to our brokers after the close of each operating cycle based on member transaction and association fees collected in USD.  We report revenue based on the gross amount billed to the ultimate customer, the Marketplace member.  When revenues are recorded on a gross basis, any commissions or other payments to brokers are recorded as costs or expenses so that the net amount (gross revenues less expenses) is reflected in operating income.

 

Determining whether revenue should be reported as gross or net is first based on an assessment of whether we are acting as the principal or acting as an agent in the transaction.  In determining whether we serve as principal or agent, we follow the related guidance. Pursuant to such guidance, we serve as the principal in transactions in which we have substantial risks and rewards of ownership.  The determination of whether we are acting as a principal or an agent in a transaction involves judgment and is based on an evaluation of the terms of an arrangement.  In our case, we administer the Marketplace, provide record-keeping and payment transaction processing services for our members, bill Marketplace members directly pursuant to contractual agreements with them for which we establish the terms, collect all revenue, and assess the collectability of our accounts receivable monthly.  Our revenues remain the property of ITEX.

 

Valuation of Notes Receivable and Accounts Receivable

 

We determine a present value of our notes receivable using a monthly average Treasury note rate with approximately the same term as the note to approximate a market value interest rate when we determine that a negotiated interest rate does not properly reflect the risk associated with the notes. We calculate the effective rate on the note given the market rate and the payment streams and record the note accordingly. We periodically review our notes for possible impairment whenever events or changes in circumstances indicate that the carrying value has been impaired and may not be recoverable. Factors we consider important that could trigger an impairment review include the following:

 

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·Significant underperformance relative to expected historical or projected future operating results;
·Change in management of the franchisee or independent licensed broker responsible for the note.

 

We assess the collectability of accounts receivable monthly based on past collection history and current events and circumstances. Accordingly, we adjust the allowance on accounts receivable to reflect net receivables that we ultimately expect to collect.

 

Valuation Allowance on Deferred Tax Assets

 

We account for income taxes using an asset and liability approach as required. This approach results in the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the book carrying amounts and the tax basis of assets and liabilities, and net operating loss carryforwards. We assess a valuation allowance on our deferred tax assets if it is more likely than not that a portion of our available deferred tax assets will not be realized. We record our deferred tax assets net of valuation allowances.

 

We also account for uncertainty in income taxes in accordance with related guidance. Under the related provisions, we recognize the tax benefits of tax positions only if it is more likely than not that the tax positions will be sustained, upon examination by the applicable taxing authorities, based on the technical merits of the positions. We also record any potential interest and penalties associated with our tax positions. We have opted to record interest and penalties as a component of income tax expense.

 

Deferred tax assets on our balance sheet primarily include Federal and State net operating loss carry forwards (collectively “NOLs”) which are expected to result in future tax benefits. Realization of these NOLs assumes that we will be able to generate sufficient future taxable income to realize these assets. Deferred tax assets also include temporary differences between the financial reporting basis and the income tax basis of its assets and liabilities at enacted tax rates expected to be in effect when such assets or liabilities are realized or settled.

 

In assessing the recoverability of deferred tax assets, we periodically assess the realizability of our available NOLs by assessing whether we believe we will generate enough future taxable income to utilize some portion or all of the available NOLs. We determined that we will not be able to utilize all of our Federal NOLs as of July 31, 2016. As of July 31, 2016 and 2015, we have an $866 and $0 valuation on Federal NOLs, respectively. As of July 31, 2016, California NOLs have expired and the valuation allowance has been removed accordingly. As of July 31, 2016 and 2015, we have a $0 and $99 valuation allowance on state of California NOLs, respectively.

 

On July 31, 2016, we had NOLs of approximately $7,997 available to offset future taxable income. When circumstances warrant, we re-assess the realizability of our available NOLs for future periods. When this occurs, if we determine that the realizability of our NOLs has changed, we record the impact of that change as a component of our tax expense in the consolidated statements of income in that period.

 

The deferred tax assets and valuation allowances recorded at July 31, 2016 represent our current estimate of all deferred tax benefits to be utilized in the current year and future periods beyond 2016.

 

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Goodwill

 

Goodwill represents the excess of the purchase price over the fair value of identifiable assets acquired, including domains and other definite-lived intangible assets, and liabilities assumed in business combinations accounted for under the acquisition method.

 

Goodwill acquired in a purchase business combination is determined to have an indefinite useful life and is not amortized, but instead tested for impairment at least annually. In testing goodwill for impairment, we first assess qualitative factors before calculating the fair value of our reporting unit in step 1 of the goodwill impairment test. If we determine that the fair value of the reporting unit is more likely than not less than its carrying value, then we will perform the two-phase approach. The first phase is a screen for potential impairment, while the second phase (if necessary) measures the amount of impairment, if any. Goodwill is written down and charged to operating results in any period in which the recorded value of goodwill exceeds its estimated fair value.

 

We analyzed goodwill as of July 31, 2016 and 2015 using a discounted cash flow methodology with a risk-adjusted weighted average cost of cost of capital (WACC). We believe the use of a discounted cash flow approach is the most reliable indicator for the Company to use when determining its fair market value. In order to determine the future cash flows, we prepared a cash flow forecast for the next 15 years based on past experience and our anticipated capital expenditures, revenue and expense forecast. In connection with our assessment of goodwill impairment, management determined that a Step 1 impairment assessment should be performed. Our evaluation determined after performance of Step 1, that goodwill was not impaired at July 31, 2015. However, we determined a $1,750 impairment in goodwill should be recorded in the fourth quarter of 2016. The goodwill impairment loss resulted primarily from a sustained decline in the Company’s projected revenue growth rates and profitability levels. The lower projected operating results reflect changes in assumptions related to revenue initiatives, organic revenue growth rates, market trends, cost structure, and other expectations about the anticipated short-term and long-term operating results.

 

Share-based Payments

 

The Company accounts for share-based compensation to its employees and directors and measures of the amount of compensation expense for all stock-based awards at fair value on the date of grant and recognition of compensation expense over the service period for awards expected to vest. Restricted stock awards issued to employees and directors are measured based on the fair market values of the underlying stock on the dates of grant.  

 

Recent Accounting Pronouncements

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) (ASU 2014-09), which amends the existing accounting standards for revenue recognition. ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled when products or services are transferred to customers. In July 2015, the FASB voted to approve a one-year delay of the effective date. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early adoption is permitted as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within those annual periods. ASU 2014-09 may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption. In 2016, the FASB issued additional guidance to clarify the implementation guidance. The Company is evaluating the expected impact on its consolidated financial statements.

 

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In November 2015, the FASB issued Accounting Standards Update (ASU) 2015-17, Balance Sheet Classification of Deferred Taxes, intended to improve how deferred taxes are classified on organizations’ balance sheets. The ASU eliminates the current requirement for organizations to present deferred tax liabilities and assets as current and noncurrent in a classified balance sheet. Instead, organizations will now be required to classify all deferred tax assets and liabilities as noncurrent. The pronouncement is effective for reporting periods beginning after December 15, 2016. Early adoption is permitted as of the beginning of an interim or annual period. The adoption of ASU 2015-17 is not expected to have any material impact on the Company’s consolidated financial statements.

 

In February, 2016, the FASB issued ASU 2016-02, which amends the FASB Accounting Standards Codification and creates Topic 842, “Leases.”  The new topic supersedes Topic 840, “Leases,” and increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requires disclosures of key information about leasing arrangements.  The guidance is effective for reporting periods beginning after December 15, 2018.  ASU 2016-02 mandates a modified retrospective transition method.  The Company is currently assessing the impact this guidance will have on its consolidated financial statements.

 

In March 2016, the FASB amended the existing accounting standards for stock-based compensation, with Accounting Standards Update No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (ASU 2016-09). The amendments impact several aspects of accounting for share-based payment transactions, including the income tax consequences, forfeitures, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The ASU is effective for reporting periods beginning after December 15, 2016, with early adoption permitted. If early adoption is elected, all amendments must be adopted in the same period. The manner of application varies by the various provisions of the guidance, with certain provisions applied on a retrospective or modified retrospective approach, while others are applied prospectively. The Company is currently evaluating the impact of these amendments and the transition alternatives on its consolidated financial statements.

 

In June 2016, the FASB issued Accounting Standards Update No. 2016-13, Financial Instruments — Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments (ASU 2016-13), an ASU amending the impairment model for most financial assets and certain other instruments. The ASU is effective for reporting periods beginning after December 15, 2019, with early adoption permitted after December 15, 2018. The ASU must be adopted using a modified-retrospective approach. The Company does not expect adoption to have a material impact on its consolidated financial statements.

 

There were other various accounting standards and interpretations issued recently, none of which are expected to have a material impact on the Company’s consolidated financial position, operations or cash flows.

 

ITEM 7. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not required for smaller reporting companies.

 

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ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

The following financial statements of ITEX Corporation are included in Item 8:

 

Report of Independent Registered Public Accounting Firm 32
Consolidated Balance Sheets 33
Consolidated Statements of Operations 34
Consolidated Statement of Stockholders’ Equity 35
Consolidated Statements of Cash Flows 36
Notes to Consolidated Financial Statements 37

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders

ITEX Corporation

Bellevue, Washington

 

We have audited the accompanying consolidated balance sheets of ITEX Corporation (the “Company”) as of July 31, 2016 and 2015 and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ITEX Corporation as of July 31, 2016 and 2015, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

  /s/ EKS&H LLP
   
October 19, 2016  
Denver, Colorado  

 

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ITEX CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands)

 

   July 31, 2016   July 31, 2015 
ASSETS          
Current assets:          
Cash and cash equivalents  $3,235   $2,047 
Accounts receivable, net of allowance of $408 and $439   429    398 
Prepaid expenses   183    174 
Loans and advances   4    8 
Deferred tax asset, net of allowance of $136 and $15   414    554 
Notes receivable   283    291 
Other current assets   4    11 
Total current assets   4,552    3,483 
           
Property and equipment, net of accumulated depreciation of $353 and $397   16    38 
Goodwill   1,441    3,191 
Deferred tax asset, net of allowance of $730 and $84 and net of current portion   2,220    3,124 
Intangible assets, net of accumulated amortization of $3,380 and $3,325   48    102 
Notes receivable - net of current portion   592    792 
Other long-term assets   25    10 
Total assets  $8,894   $10,740 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
Current liabilities:          
Accounts and other expenses payable   37    50 
Commissions payable to brokers   233    259 
Accrued commissions to brokers   654    659 
Accrued expenses   254    261 
Deferred revenue   25    27 
Advance payments   114    112 
Total current liabilities   1,317    1,368 
Total liabilities   1,317    1,368 
           
Commitments and contingencies          
           
Stockholders’ equity:          
Common stock, $0.01 par value; 9,000 shares authorized; 1,948 shares and 1,890 shares issued and outstanding, respectively   20    19 
Additional paid-in capital   22,497    22,361 
Stockholder notes receivable   (3)   (6)
Accumulated deficit   (14,937)   (13,002)
Total stockholders' equity   7,577    9,372 
Total liabilities and stockholders’ equity  $8,894   $10,740 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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ITEX CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands except per share amounts)

 

   Year ended July 31, 
   2016   2015 
Revenue:          
Marketplace and other revenue  $11,110   $12,017 
           
Costs and expenses:          
Cost of Marketplace revenue   6,883    7,394 
Corporate salaries, wages and employee benefits   1,782    1,864 
Selling, general and administrative   1,135    1,711 
Depreciation and amortization   82    91 
Goodwill impairment   1,750    - 
    11,632    11,060 
           
(Loss)/income from operations   (522)   957 
           
Other income   61    90 
(Loss)/income before income taxes   (461)   1,047 
           
Income tax expense   1,058    357 
           
Net (loss)/income  $(1,519)  $690 
           
Net (loss)/income per common share:          
Basic  $(0.79)  $0.29 
Diluted  $(0.79)  $0.28 
           
Weighted average shares outstanding:          
Basic   1,930    2,414 
Diluted   1,930    2,423 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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ITEX CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(In thousands)

 

   Common Stock   Additional
paid
   Stockholder
Notes
   Accumulated     
   Shares   Amount   in capital   Receivable   deficit   Total 
                         
Balance, July 31, 2014   2,602   $26   $25,222   $(161)  $(13,158)  $11,929 
                               
Stock based compensation expense   90    1    324    -    -    325 
                               
Common Stock repurchased and retired   (23)   -    (76)   -    -    (76)
                               
Tender Offer, partial   (750)   (8)   (2,992)   -    -    (3,000)
                               
Payments on Broker notes receivables   -    -    -    38    -    38 
                               
Cancellation of Broker stock purchase   (29)   -    (117)   117    -    - 
                               
Dividend payment   -    -    -    -    (534)   (534)
                               
Net Income   -    -    -    -    690    690 
                               
Balance, July 31, 2015   1,890   $19   $22,361   $(6)  $(13,002)  $9,372 
                               
Stock based compensation expense   88    1    249    -    -    250 
                               
Common Stock repurchased and retired   (30)   -    (113)   -    -    (113)
                               
Payments on Broker notes receivables   -    -    -    3    -    3 
                               
Dividend payment   -    -    -    -    (417)   (417)
                               
Net Loss   -    -    -    -    (1,519)   (1,519)
                               
Balance, July 31, 2016   1,948   $20   $22,497   $(3)  $(14,937)  $7,577 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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ITEX CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

   Year ended July 31, 
   2016   2015 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net (loss)/income  $(1,519)  $690 
Items to reconcile to net cash provided by operating activities:          
Depreciation and amortization   82    91 
Goodwill imparment   1,750    - 
Stock-based compensation   250    325 
Bad debt expense   192    294 
Decrease in deferred income taxes   1,044    356 
Changes in operating assets and liabilities:          
Accounts receivable   (223)   (34)
Prepaid expenses   (9)   (70)
Loans and advances   4    7 
Other assets   (8)   20 
Accounts and other expenses payable   (13)   (2)
Commissions payable to brokers   (26)   (8)
Accrued commissions to brokers   (5)   (69)
Accrued expenses   (6)   7 
Deferred revenue   (2)   (5)
Advance payments   2    6 
Net cash provided by operating activities   1,513    1,608 
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Payments received from notes receivable - corporate office sales   288    371 
Payments of note payable   -    (3)
Notes receivable - advances   (80)   (30)
Purchase of property and equipment   (6)   - 
Net cash provided by investing activities   202    338 
           
CASH FLOWS FROM FINANCING ACTIVITIES:          
Principal payments on notes receivable from broker stock purchase   3    38 
Repurchase of Common stock   (113)   (76)
Tender offer, partial   -    (3,000)
Cash dividend paid to Common Stockholders   (417)   (534)
Net cash used in financing activities   (527)   (3,572)
           
Net increase (decrease) in cash and cash equivalents   1,188    (1,626)
Cash and cash equivalents at beginning of period   2,047    3,673 
Cash and cash equivalents at end of period  $3,235   $2,047 
           
Supplemental cash flow information:          
Cash paid (refund) for taxes   27    (7)
           
Non-cash activities:          
Cancellation of portion of private placement notes and equity   -    117 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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ITEX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts unless otherwise indicated)

 

NOTE 1 - DESCRIPTION OF OUR COMPANY AND SUMMARY OF OUR SIGNIFICANT ACCOUNTING POLICIES

 

Description of our 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 (individually, “broker,” and together the “Broker Network”) in the United States and Canada, we operate a “Marketplace” in which products and services are exchanged by Marketplace members utilizing ITEX dollars “ITEX dollars”. ITEX dollars are 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. A summary of significant accounting policies applied in the preparation of the accompanying consolidated financial statements follows:

 

Principles of Consolidation

 

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

 

Accounting Records and Use of Estimates

 

The accounting records are maintained in accordance with accounting principles generally accepted in the United States of America. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions affecting the amounts reported in the consolidated financial statements and accompanying notes. Changes in these estimates and assumptions may have a material impact on the Company’s financial statements and notes. Examples of estimates and assumptions include estimating:

 

·certain provisions such as allowances for accounts receivable and notes receivable
·any impairment of long-lived assets including goodwill
·useful lives of property and equipment
·the value and expected useful life of intangible assets
·the value of assets and liabilities acquired through business combinations
·tax provisions and valuation allowances
·accrued commissions and other accrual expenses
·litigation matters described herein
·stock based payments

 

Actual results may vary from estimates and assumptions that were used in preparing the financial statements.

 

Operating and Accounting Cycles

 

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”, “2016” for August 1, 2015 to July 31, 2016, “2015” for August 1, 2014 to July 31, 2015). We report our results as of the last day of each calendar month (“accounting cycle”).

 

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Business Combinations

 

The Company accounts for business combinations using the acquisition method of accounting. The total consideration paid in an acquisition is allocated to the fair value of the acquired company’s identifiable assets and liabilities. Any excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill. The consolidated financial statements reflect the results of operations of an acquired business from the completion date of an acquisition. The costs to acquire a business, including transaction costs, are expensed as incurred.

 

The Company identifies and records separately the intangible assets acquired apart from goodwill based on the specific criteria for separate recognition established per the accounting standards codification, namely:

 

·the asset arises from contractual or other legal rights; or

 

·the asset is capable of being separated from the acquired entity and sold, transferred, licensed, rented or exchanged.

 

Concentrations of Credit Risk

 

At July 31, 2016, we maintained our cash balances at a Washington Trust Bank branch in Seattle, Washington, an investment bank, a Royal Bank of Canada branch in Vancouver, Canada, and a Bank of Montreal branch in Toronto, Canada. The balances are insured by the Federal Deposit Insurance Corporation up to $250 U.S. dollars and by the Canadian Deposit Insurance Corporation up to $100 Canadian dollars.

 

Accounts and Notes Receivable

 

We assess the collectability of accounts receivable monthly based on past collection history and current events and circumstances. Accordingly, we adjust the allowance on accounts receivable to reflect net receivables that we ultimately expect to collect.

 

We review all notes receivable for possible impairment on an annual basis or whenever events or changes in circumstances indicate that the carrying value has been impaired and may not be recoverable. Factors considered important that could trigger an impairment review include significant underperformance relative to expected historical or projected future operating results and a change in management of the franchisee or independent licensed broker responsible for the note.

 

Loans and Advances and Notes Receivable

 

At our discretion, we occasionally allow members who complete large transactions to pay the related transaction fee over time, typically ranging from three to six operating cycles. The aggregate total owed to us on July 31, 2016 is $4. Interest rates are typically 13% charged on the outstanding balances. The maximum individual balance owed is $1. Payoff dates for the loans are scheduled within one year.

 

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. The amount of loans to brokers as of July 31, 2016 was $875. Interest rates are typically 6% to 8% charged on the outstanding balances. Payoff dates for the loans are from the year 2017 to 2022.

 

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Property and Equipment

 

We report property and equipment at cost less accumulated depreciation recorded on a straight-line basis over useful lives ranging from three to seven years. Included in property and equipment are additions and improvements that add to productive capacity or extend useful life of the assets. Property and equipment may also include internally developed software (refer to “Software for Internal Use” below). When we sell or retire property or equipment, we remove the cost and related accumulated depreciation from the balance sheet and record the resulting gain or loss in the income statement. We record an expense for the costs of repair and maintenance as incurred.

 

Software for Internal Use

 

We have developed extensive software to manage and track the ITEX dollar activity in the Marketplace to calculate USD and ITEX dollar fees accordingly. We have expensed costs incurred in the development of software for internal use in the period incurred as such costs were not significant during the related application development phase.

 

Goodwill

 

Goodwill represents the excess of the purchase price over the fair value of identifiable assets acquired, including domains and other definite-lived intangible assets, and liabilities assumed in business combinations accounted for under the purchase method.

 

Goodwill acquired in a purchase business combination is determined to have an indefinite useful life and is not amortized, but instead tested for impairment at least annually. In testing goodwill for impairment, we first assess qualitative factors before calculating the fair value of our reporting unit in step 1 of the goodwill impairment test. If we determine that the fair value of the reporting unit is more likely than not less than its carrying value, then we will perform the two-phase approach. The first phase is a screen for potential impairment, while the second phase (if necessary) measures the amount of impairment, if any. Goodwill is written down and charged to operating results in any period in which the recorded value of goodwill exceeds its estimated fair value.

 

We analyzed goodwill as of July 31, 2016 using a discounted cash flow methodology with a risk-adjusted weighted average cost of cost of capital (WACC). We believe the use of a discounted cash flow approach is the most reliable indicator for the Company to use when determining its fair market value. In order to determine the future cash flows, we prepared a cash flow forecast for the next 15 years based on past experience and our anticipated capital expenditures, revenue and expense forecast. In connection with our assessment of goodwill impairment, management determined that a Step 1 impairment assessment should be performed. Our evaluation determined after performance of Step 1, that goodwill was impaired at July 31, 2016. We determined a $1,750 impairment in goodwill should be recorded in the fourth quarter of 2016.  The goodwill impairment loss resulted primarily from a sustained decline in the Company’s projected revenue growth rates and profitability levels. The lower projected operating results reflect changes in assumptions related to revenue initiatives, organic revenue growth rates, market trends, cost structure, and other expectations about the anticipated short-term and long-term operating results.

 

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Intangible Assets with Definite Lives

 

Intangible assets acquired in business combinations are estimated to have definite lives and are comprised of membership lists, noncompetition agreements and trade names. The Company amortizes costs of acquired intangible assets using the straight-line method over the contractual life of one to three years for noncompetition agreements, the estimated life of six to ten years for membership lists and the estimated life of ten years for trade names.

 

The carrying value of intangible assets with definite lives is reviewed on a regular basis for the existence of facts that may indicate that the assets are impaired. An asset is considered impaired when the estimated undiscounted future cash flows expected to result from its use and disposition are less than the amount of its carrying value. If the carrying value of an asset is deemed not recoverable, it is adjusted downward to the estimated fair value.

 

Long-Lived Assets

 

We review our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recovered. We look primarily at the market values of the assets when available, or, alternatively, the estimated undiscounted future cash flows in our assessment of whether or not they have been impaired. If impairment is deemed to have occurred, we then measure the impairment by looking to the excess of the carrying value over the discounted future cash flows or market value, as appropriate.

 

Commissions Payable to Brokers and Accrued Commissions to Brokers

 

We compute commissions to brokers as a percentage of cash collections of revenues from association fees, transactions fees, and other fees. We pay most commissions in two tranches with approximately 50% paid one week after the end of the operating cycle and the remainder paid two weeks later. Commissions payable to brokers on our balance sheet as of July 31, 2016 represents commissions payable from the operating cycle ending July 21, 2016. In 2015, the closest operating cycle ended July 23, 2015. Accrued commissions to brokers on our balance sheets are the estimated commissions on the net accounts receivable balance and unpaid commissions on cash already collected as of the financial statement date.

 

Deferred Revenue

 

We bill annual dues to certain members acquired as part of legacy fee plans related to acquisitions. We defer this revenue and recognize it over the annual period to which it applies. As of July 31, 2016 and 2015 we have $25 and $27 of annual dues deferred on our balance sheet.

 

Advance Payments

 

In some cases, members pre-pay transaction and/or association fees or receive USD credits on their accounts for previously paid fees associated with transactions that are subsequently reversed. We defer these payments and recognize revenue when these fees are earned.

 

Fair Value of Financial Instruments

 

All of our financial instruments are recognized in our balance sheet. The carrying amount of our financial instruments including cash, accounts receivable, loans and advances, accounts payable, commissions payable and accrued commissions and other accruals approximate their fair values at July 31, 2016 due to the short-term nature of these instruments. All of these instruments have terms of less than one year. For notes receivable, the Company has determined that the rates are commensurate with current rates for similar transactions, and therefore, net book value approximates fair value.

 

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Revenue Recognition

 

We generate our 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”). We recognize revenue when persuasive evidence of an arrangement exists, the transaction has occurred or a cycle period has ended, the charges are fixed and determinable and no major uncertainty exists with respect to collectability.

 

Our largest sources of revenue are transaction fees and association fees. We charge members of the Marketplace an association fee every operating cycle in accordance with our members’ individual agreements. We also charge both the buyer and the seller a transaction fee based on the ITEX dollar value of that Marketplace transaction. Additionally, we may charge various auxiliary fees to members, such as annual membership dues, late fees, and insufficient fund fees. The total fees we charge to members are in USD and partially in ITEX dollars (see below, “Accounting for ITEX Dollar Activities”). We bill members for all fees at the end of each operating cycle. We track all financial activity in our internally developed database. Members have the option of paying USD fees automatically by credit card, by electronic funds transfer or by check. In each of the years ended July 31, 2016 and 2015, member payments of approximately 95% were made through electronic funds transfer, by credit cards and using our Preferred Member Autopay System. If paying through our Autopay System, generally, the USD transaction fee is 6% of the ITEX dollar amount of the member’s purchases and sales during the operating cycle. If paying by check, generally, the USD transaction fee is 7.5% of the ITEX dollar amount of that member’s purchases and sales during the operating cycle. Additionally, regardless of a member’s transaction activity, each operating cycle we charge most members an association fee of $20 USD ($260 USD annually) and $10 ITEX dollars ($130 ITEX dollars annually). Transaction and association fees composed 96% of our total revenue in 2016 and 2015.

 

In each accounting cycle, we recognize as revenue all USD transaction fees, association fees and applicable other fees that occurred during that month regardless of which operating cycle the fees occurred. Annual dues, billed in advance of the applicable service periods, are deferred and recognized into revenue on a straight-line basis over the term of one year.

 

For transaction and association fees charged to members, we share a portion of our revenue with the brokers in the Broker Network in the form of commissions based on a percentage of cash collections from members. For those fees, revenues are recorded on a gross basis. Commissions to brokers are recorded as cost of revenue in the period corresponding to the revenue stream on which these commissions are based.

 

We record an allowance for uncollectible accounts based upon its assessment of various factors. We consider historical experience, the age of the accounts receivable balances, the credit quality of its customers, current economic conditions and other factors that may affect customers’ ability to pay to determine the level of allowance required.

 

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Gross versus Net Revenue Recognition

 

In the normal course of our core business, we act as administrator to execute transactions between Marketplace members. We pay commissions to our brokers after the close of each operating cycle based on member transaction and association fees collected in USD. We report revenue based on the gross amount billed to our ultimate customer, the Marketplace member. When revenues are recorded on a gross basis, any commissions or other payments to brokers are recorded as costs or expenses so that the net amount (gross revenues less expenses) is reflected in operating income.

 

Accounting for ITEX Dollar Activities

 

Primarily, we receive ITEX dollars from members’ transaction and association fees, but we also receive ITEX dollars, to a much lesser extent, from other member fees. We expend ITEX dollars for revenue sharing transaction fees and association fees with our Broker Network, and for general Marketplace costs. Our policy is to record transactions at the fair value of products or services received when those values are readily determinable.

 

Our accounting policy follows the accounting standards codification which indicates that transactions in which non-monetary assets are exchanged for barter credits should be recorded at fair value of the assets (or services) involved. The fair value of the assets received (in this case ITEX dollars) should be used to measure the cost if it is more clearly evident than the fair value of the asset surrendered or service provided. Our position is that the fair value of the non-monetary asset exchanged is more clearly evident than the fair value of the ITEX dollar received. In addition, there is no cost basis to us for ITEX dollars. Our conclusion may change if we could convert ITEX dollars into USD in the near term, as evidenced by a historical practice of converting ITEX dollars into USD shortly after receipt, or if quoted market prices in USD existed for the ITEX dollar.

 

We expend ITEX dollars primarily on the following items:

 

·Co-op advertising with Marketplace members and brokers;
·Revenue sharing with brokers for transaction fees and association fees;
·Incentives to brokers for registering new members in the Marketplace.

 

We believe that fair value should not be regarded as determinable within reasonable limits if major uncertainties exist about the realizability of the value that would be assigned to the asset received in a non-monetary transaction at fair value. If neither the fair value of the non-monetary asset (or service) transferred or received in the exchange is determinable within reasonable limits, the recorded amount of the non-monetary asset transferred from the enterprise may be the only measure of the transaction. When our ITEX dollar transactions during the periods presented in the accompanying financial statements lacked readily determinable fair values they were recorded at the cost basis of the trade dollars surrendered, which was zero. However, we have reflected in our financial statements those items that meet non-monetary recognition by having readily determinable fair values. Our consolidated statements of income include ITEX dollar expenses for corporate expenses for certain products or services we purchased at prices comparable to what we would have expended had we paid in USD.

 

While the accounting policies described above are used for financial reporting purposes, the Internal Revenue Service requires, for purposes of taxation, that we recognize revenues, expenses, assets, and liabilities for all transactions in which we either receive or spend ITEX dollars using the ratio of one USD per ITEX dollar. For this reason, we track our ITEX dollar activity in statements to members and brokers and in other ways necessary for the operation of the Marketplace and our overall business.

 

Advertising Expenses

 

We expense all advertising costs as incurred. Advertising expense was $1 and $5 for the years ended July 31, 2016 and 2015, respectively.

 

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Share-based Payments

 

We account for share-based compensation to our employees, contractors and directors and measure the amount of compensation expense for all stock-based awards at fair value on the date of grant and recognition of compensation expense over the service period for awards expected to vest. Restricted stock awards issued to employees, contractors and directors are measured based on the fair market values of the underlying stock on the dates of grant. Share based expense was $250 and $325 for the years ended July 31, 2016 and 2015, respectively.

 

Operating Leases

 

We account for our executive office lease and other property leases in accordance with related guidance. Accordingly, because our executive office lease has scheduled rent escalation clauses, we record minimum rental payments on a straight-line basis over the term of the lease. We record the appropriate deferred rent liability or asset and amortize that deferred rent over the term of the lease as an adjustment to rent expense.

 

Accounting for Income Taxes

 

We account for income taxes using an asset and liability approach as required. Such approach results in the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the book carrying amounts and the tax basis of assets and liabilities and net operating loss carryforwards. We assess a valuation allowance on our deferred tax assets if it is more likely than not that a portion of our available deferred tax assets will not be realized. We record our deferred tax assets net of valuation allowances.

 

We also account for uncertainty in income taxes in that we recognize the tax benefits of tax positions only if it is more likely than not that the tax positions will be sustained, upon examination by the applicable taxing authorities, based on the technical merits of the positions. As required, we record potential interest and penalties associated with our tax positions. We have opted to record interest and penalties, if any, as a component of income tax expense.

 

Contingencies

 

In the normal course of our business we are periodically involved in litigation or claims. We record litigation or claim-related expenses upon evaluation of among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. We accrue for settlements when the outcome is probable and the amount or range of the settlement can be reasonably estimated. In addition to our judgments and use of estimates, there are inherent uncertainties surrounding litigation and claims that could result in actual settlement amounts that differ materially from estimates. We expense our legal costs associated with these matters when incurred.

 

Net Income (Loss) per Share

 

We present in our financial statements on the face of the income statement 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 July 31, 2016, we had no contracts to issue common stock. The Company had 133 unvested restricted stock units as of July 31, 2016. These stock units were excluded from the net income (loss) per share as their effect would be anti-dilutive.

 

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NOTE 2 – RECENT ACCOUNTING PRONOUNCEMENTS

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) (ASU 2014-09), which amends the existing accounting standards for revenue recognition. ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled when products or services are transferred to customers. In July 2015, the FASB voted to approve a one-year delay of the effective date. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early adoption is permitted as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within those annual periods. ASU 2014-09 may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption. In 2016, the FASB issued additional guidance to clarify the implementation guidance. The Company is evaluating the expected impact on its consolidated financial statements.

 

In November 2015, the FASB issued Accounting Standards Update (ASU) 2015-17, Balance Sheet Classification of Deferred Taxes, intended to improve how deferred taxes are classified on organizations’ balance sheets. The ASU eliminates the current requirement for organizations to present deferred tax liabilities and assets as current and noncurrent in a classified balance sheet. Instead, organizations will now be required to classify all deferred tax assets and liabilities as noncurrent. The pronouncement is effective for reporting periods beginning after December 15, 2016. Early adoption is permitted as of the beginning of an interim or annual period. The adoption of ASU 2015-17 is not expected to have any material impact on the Company’s consolidated financial statements.

 

In February, 2016, the FASB issued ASU 2016-02, which amends the FASB Accounting Standards Codification and creates Topic 842, “Leases.”  The new topic supersedes Topic 840, “Leases,” and increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requires disclosures of key information about leasing arrangements.  The guidance is effective for reporting periods beginning after December 15, 2018.  ASU 2016-02 mandates a modified retrospective transition method.  The Company is currently assessing the impact this guidance will have on its consolidated financial statements.

 

In March 2016, the FASB amended the existing accounting standards for stock-based compensation, with Accounting Standards Update No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (ASU 2016-09). The amendments impact several aspects of accounting for share-based payment transactions, including the income tax consequences, forfeitures, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The ASU is effective for reporting periods beginning after December 15, 2016, with early adoption permitted. If early adoption is elected, all amendments must be adopted in the same period. The manner of application varies by the various provisions of the guidance, with certain provisions applied on a retrospective or modified retrospective approach, while others are applied prospectively. The Company is currently evaluating the impact of these amendments and the transition alternatives on its consolidated financial statements.

 

In June 2016, the FASB issued Accounting Standards Update No. 2016-13, Financial Instruments — Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments (ASU 2016-13), an ASU amending the impairment model for most financial assets and certain other instruments. The ASU is effective for reporting periods beginning after December 15, 2019, with early adoption permitted after December 15, 2018. The ASU must be adopted using a modified-retrospective approach. The Company does not expect adoption to have a material impact on its consolidated financial statements.

 

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There were other various accounting standards and interpretations issued recently, none of which are expected to have a material impact on the Company’s consolidated financial position, operations or cash flows.

 

NOTE 3 – CASH AND CASH EQUIVALENTS, ACCOUNTS RECEIVABLE, COMMISSIONS PAYABLE TO BROKERS AND ACCRUED COMMISSIONS TO BROKERS

 

The timing differences between our operating cycles and our accounting cycles cause fluctuations in the comparative balances of cash and cash equivalents, accounts receivable, commissions payable to brokers and accrued commissions to brokers presented on the consolidated balance sheets. Depending on the length of time between the end of the operating cycle and the end of the accounting cycle, members’ payments on accounts receivable balances may vary. The longer the time, the greater amount of USD collections causes an increase in the reported cash and cash equivalents balance and a decrease in the net accounts receivable balance. The difference between our operating cycle ending date and the reporting date for July 31, 2016 was six business days as our cycle end date was on July 21, 2016. In 2015, our operating cycle ending date was July 23, 2015 or six business days different than the accounting cycle end date of July 31, 2015.

 

We compute commissions to brokers as a percentage of USD collections of our revenues from association fees, transactions fees, and other fees. Commissions payable to brokers include amounts owed for the most recently ended operating cycle. We pay commissions in two tranches with approximately 50% paid approximately one week after the end of the operating cycle and the remainder paid approximately two weeks later. Commissions accrued are the estimated commissions on the net accounts receivable balance and USD collections on accounts receivable since the most recently ended operating cycle.

 

Our payments for salaries and wages to our employees occur on the same bi-weekly schedule as our commission payments to brokers.

 

NOTE 4 – NOTES RECEIVABLE

 

Notes receivables have been originated primarily by the sales of corporate-owned offices to brokers and loans for general operating purposes. In 2016, we originated loans to brokers as new notes receivables in the amount of $80.

 

The aggregate total owed to us on July 31, 2016 is $875. Payoff dates for the loans are scheduled between 2017 and 2022.

 

Original Principal
Balance on Notes
   Principal Additions
in 2016
   Balance Receivable
at
July 31, 2016
   Current Portion   Long-Term
Portion
 
$2,338   $80   $875   $283   $592 

 

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The activity for Notes receivables was as follows:

 

Balance at July 31, 2014  $1,424 
Principal additions   30 
Interest income at stated rates   90 
Payments received   (461)
Balance at July 31, 2015  $1,083 
      
Principal additions   80 
Interest income at stated rates   61 
Payments received   (349)
Balance at July 31, 2016  $875 

 

NOTE 5 - PROPERTY AND EQUIPMENT

 

The following table summarizes property and equipment:

 

   July 31, 2016
Fixed Asset Type  Estimated
Useful Life
  Cost   Accumulated
Depreciation
   Net Book
Value
 
Computers  3 years  $225   $(218)  $7 
Software  3 years   42    (36)   6 
Equipment  7 years   37    (34)   3 
Furniture  7 years   13    (13)   - 
Leasehold Improvements  3.3 years   52    (52)   - 
      $369   $(353)  $16 

 

   July 31, 2015
Fixed Asset Type  Estimated
Useful Life
  Cost   Accumulated
Depreciation
   Net Book
Value
 
Computers  3 years  $240   $(216)  $24 
Software  3 years   92    (79)   13 
Equipment  7 years   38    (37)   1 
Furniture  7 years   13    (13)   - 
Leasehold Improvements  3.3 years   52    (52)   - 
      $435   $(397)  $38 

 

We depreciate property and equipment using the straight-line method over the assets’ estimated useful lives. Depreciation expense for property and equipment was $26 and $36 for the years ended July 31, 2016 and 2015, respectively.

 

We amortize leasehold improvements using the straight-line method over the term of the lease. There was no amortization expense for leasehold improvements for the years ended July 31, 2016 or 2015.

 

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NOTE 6 – INTANGIBLE ASSETS

 

Changes in the carrying amount of the intangible assets are summarized as follows:

 

   Membership
Lists
   Non-Compete
Agreements
   Trade Name
Amortization
   Total
Intangible
Assets
 
Balance as of July 31, 2014  $149   $-   $8   $157 
                     
Amortization   (53)   -    (2)   (55)
                     
Balance as of July 31, 2015  $96   $-   $6   $102 
                     
Amortization   (52)   -    (2)   (54)
                     
Balance as of July 31, 2016  $44   $-   $4   $48 

 

The Company recorded goodwill in connection with business combinations completed in fiscal years from 2005 to 2009.

 

In September 2012, ITEX sold assets originally acquired in the 2011 Oregon acquisition. As part of the sales, ITEX allocated a pro rata portion of the membership list to the sale in the amount of $42. The pro rata percentage amount of unamortized membership list to apply as basis was calculated using the amount of the sold corporate-owned office members over the retained members acquired in the original purchase transaction.

 

The expected lives of the membership list and noncompetition agreement purchased as part of previous acquisitions are six years and three years, respectively.

 

The following schedule outlines the expected intangible related amortization expense over the respective lives:

 

Year ending July 31,  Membership List
Amortization
   Trade Name
Amortization
   Total Amortization 
             
2017   36    2    38 
2018   8    2    10 
Total  $44   $4   $48 

 

NOTE 7 - GOODWILL

 

Changes in the carrying amount of goodwill for the year ended July 31, 2016 are as follows:

 

Balance at July 31, 2015  $3,191 
      
Goodwill impairment   (1,750)
      
Balance at July 31, 2016  $1,441 

 

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We analyzed goodwill as of July 31, 2016 using a discounted cash flow methodology with a risk-adjusted weighted average cost of cost of capital (WACC). We believe the use of a discounted cash flow approach is the most reliable indicator for the Company to use when determining its estimated fair market value. In order to determine the future cash flows, we prepared a cash flow forecast for the next 15 years based on past experience and our anticipated capital expenditures, revenue and expense forecast. In connection with our assessment of goodwill impairment, management determined that a Step 1 impairment assessment should be performed. Our evaluation determined after performance of Step 1, that goodwill was impaired at July 31, 2016. We determined a $1,750 impairment in goodwill should be recorded in the fourth quarter of 2016.  The goodwill impairment loss resulted primarily from a sustained decline in the Company’s projected revenue growth rates and profitability levels. The lower projected operating results reflect changes in assumptions related to revenue initiatives, organic revenue growth rates, market trends, cost structure, and other expectations about the anticipated short-term and long-term operating results.

 

NOTE 8 - COMMITMENTS

 

The Company leases office space for its corporate headquarters in Bellevue, Washington. In the year ended July 31, 2016, we leased our property on a month-to-month basis. As of July 31, 2016, there were no future minimum commitments under our current operating lease, which was terminated on September 30, 2016.

 

In July 2016, we signed a 5-year lease for a new location in Bellevue, Washington, with a lease commencement date of September 15, 2016. The lease expiration date is March 31, 2022.

 

Lease commitments
for the year ending
July 31,
    
     
2017  $30 
2018   81 
2019   84 
2020   88 
2021   91 
Thereafter   54 
      
Total  $428 

 

The lease expense for our executive office space for the years ended July 31, 2016 and 2015 was $89 and $149, respectively.

 

NOTE 9 – ITEX DOLLAR ACTIVITY

 

Primarily, we receive ITEX dollars from members’ transaction and association fees. ITEX dollars earned from members are later used by the Company as a method of payment in revenue sharing and incentive arrangements with its Broker Network, co-op advertising with Marketplace members, as well as for certain general corporate expenses.

 

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We record transactions at the fair value of products or services received when those values are readily determinable. Most of our ITEX dollar transactions during the periods presented in these financial statements lacked readily determinable fair values and were recorded at the cost basis of the trade dollars surrendered, which we have determined to be zero.

 

As discussed in Note 1 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 $161 and $217 as ITEX dollar revenue for the years ended July 31, 2016 and 2015, respectively.

 

NOTE 10 — 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 in the future if the effect of an unfavorable final outcome becomes probable and reasonably estimable.

 

NOTE 11 – STOCK-BASED PAYMENTS

 

In March 2004 the Company adopted and stockholders approved the ITEX Corporation 2004 Equity Incentive Plan (the “2004 Plan”), which authorized 400 shares of common stock for issuance pursuant to awards under the plan. The 2004 Plan provided for the grant of incentive and nonqualified stock options, restricted stock, and stock bonuses to our employees, directors, officers and consultants. In February 2011, the Board of Directors amended and restated the 2004 Plan to increase the aggregate number of shares available for issuance by 400 shares. No shares remained available for future grants under the 2004 Plan after July 31, 2013, and the 2004 Plan expired on March 14, 2014.

 

In December 2013, stockholders approved the adoption of the ITEX Corporation 2014 Equity Incentive Plan (the “2014 Plan”), pursuant to which 400 shares of common stock were authorized for issuance. The 2014 Plan provides for the awards of restricted stock, restricted stock units, and other awards including unrestricted stock awards, stock bonuses, or the payment of cash for bonuses or in settlement of restricted stock unit awards to the Company’s employees, directors, officers or consultants. 293 shares remained available for future grants under the 2014 Plan as of July 31, 2016.

 

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During the year ended July 31, 2016, the Company issued 25 shares to an employee. The fair value of these shares as of the grant date was $80. The grant was expensed in the period granted.

 

At July 31, 2016, 133 shares of common stock granted under the 2004 Plan remained unvested. At July 31, 2016, the Company had $433 of unrecognized compensation expense, expected to be recognized over a weighted-average period of approximately six years.

 

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.

 

The following table summarizes the components of stock based compensation:

 

   Year ended July 31, 
   2016   2015 
         
Employee Compensation  $231   $273 
Board Compensation   19    52 
           
Totals  $250   $325 

 

The following table summarizes the granted, forfeited and vested shares of the 2004 Plan:

 

   Number of Shares/Options 
   Expired   Restricted
Shares
   Stock Options 
             
Balance, July 31, 2014   -    400    - 
                
Granted   -    -    - 
Forfeited   -    (10)   - 
                
Balance, July 31, 2015   -    390    - 
                
Granted   -    -    - 
Forfeited   -    -    - 
                
Balance, July 31, 2016   -    390    - 
                
Vesting as of July 31, 2016:               
Shares Vested        257    - 
Shares Unvested        133    - 
Balance at July 31, 2016        390    - 

 

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The following table summarizes the granted, forfeited and vested shares of the 2014 Plan:

 

   Number of Shares/Options 
   Available   Restricted
Shares
   Stock Options 
             
Balance, July 31, 2014   360    40    - 
                
Granted   (44)   44    - 
Forfeited   2    (2)   - 
                
Balance, July 31, 2015   318    82    - 
                
Granted   (25)   25    - 
Forfeited   -    -    - 
                
Balance, July 31, 2016   293    107    - 
                
Vesting as of July 31, 2016:               
Shares Vested        107    - 
Shares Unvested        -    - 
Balance at July 31, 2016        107    - 

 

The stock-based compensation expense charged against the results of operations was as follows:

 

   Year ended July 31, 
   2016   2015 
         
Stock-based compensation expense included in:          
Corporate salaries, wages and employee benefits  $231   $273 
Selling, general and administrative   19    52 
           
Total stock-based compensation expense  $250   $325 

 

NOTE 12 - STOCKHOLDERS’ EQUITY

 

On March 16, 2015, the Company commenced a partial tender offer to purchase up to 750 shares of its common stock, at a price of $4.00 per share. The tender offer closed on April 15, 2015, after which the Company purchased and canceled a total of 750 shares of its common stock at an aggregate cost of $3,000, excluding fees and expenses relating to the tender offer. The shares purchased in the tender offer represented approximately 26% of ITEX’s outstanding common shares (including shares of unvested restricted stock).

 

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On March 11, 2011, the Board of Directors of the Company declared a dividend, payable to stockholders of record on March 25, 2011 of one right (a “Right”) per each share of outstanding Common Stock of the Company, par value $0.01 per share (“Common Stock”), to purchase 1/1000th of a share of Series A Junior Participating Preferred Stock, par value $0.01 per share, of the Company (the “Preferred Stock”), at a price of $15.00 per share (such amount, as may be adjusted from time to time as provided in the Rights Agreement described below, the “Purchase Price”). In connection therewith, on March 11, 2011, the Company entered into a Rights Agreement (the “Rights Agreement”) with OTR, Inc., as Rights Agent. The Rights will be exercisable upon the earlier of (i) such date the Company learns that a person or group, without Board approval, acquires or obtains the right to acquire beneficial ownership of 15% or more of ITEX’s outstanding common stock or a person or group that already beneficially owns 15% or more of the Company’s outstanding common stock at the time the Rights Agreement was entered into, without Board approval, acquires any additional shares (other than pursuant to the Company’s compensation or benefit plans) (any person or group specified in this sentence, an “Acquiring Person”) and (ii) such date a person or group announces an intention to commence or following the commencement of (as designated by the Board) a tender or exchange offer which could result in the beneficial ownership of 15% or more of ITEX’s outstanding common stock. If a person or group becomes an Acquiring Person, each Rights holder (other than the Acquiring Person) will be entitled to receive, upon exercise of the Right and payment of the Purchase Price, that number of 1/1000ths of a share of Preferred Stock equal to the number of shares of Common Stock which at the time of the applicable triggering transaction would have a market value of twice the Purchase Price. In the event the Company is acquired in a merger or other business combination by an Acquiring Person, or 50% or more of the Company’s assets are sold to an Acquiring Person, each Right will entitle its holder (other than an Acquiring Person) to purchase common shares in the surviving entity at 50% of the market price. The Rights Agreement was originally scheduled to expire on March 11, 2014, unless earlier redeemed or exchanged by the Company. At the annual meeting on December 13, 2013, stockholders approved an extension of the Rights Agreement to December 13, 2016.

 

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. In addition to our common stock activity described in Note 12 – Share-Based Payments, as part of our stock repurchase program, we repurchased a total of 30 and 23 shares of ITEX common stock for $113 and $76 in 2016 and 2015, respectively.

 

The Company has 5,000 shares of preferred stock authorized at $0.01 par value. No shares were issued or outstanding as of July 31, 2016 or 2015.

 

NOTE 13 - INCOME TAXES

 

Deferred tax assets on our balance sheet primarily include Federal and State net operating loss carry forwards (collectively “NOLs”) which are expected to result in future tax benefits. Realization of these NOLs assumes that we will be able to generate sufficient future taxable income to realize these assets. Deferred tax assets also include temporary differences between the financial reporting basis and the income tax basis of its assets and liabilities at enacted tax rates expected to be in effect when such assets or liabilities are realized or settled.

 

In assessing the recoverability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences are expected to be deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income and projections for future taxable income over the periods in which the deferred tax assets are expected to be deductible.

 

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On July 31, 2016, we had NOLs of approximately $7,997 available to offset future taxable income. These are composed of approximately $6,092 from ITEX operating losses and approximately $1,905 from BXI operating losses. The future utilization is recorded as a deferred tax asset given that management believes it is more likely than not that we will generate sufficient future taxable income. We periodically assess the realizability of our available NOLs to determine whether we believe we will generate enough future taxable income to utilize some portion or all of the available NOLs. We determined that we will not be able to utilize all of our Federal NOLs as of July 31, 2016. As of July 31, 2016 and 2015, we have an $866 and $0 valuation on Federal NOLs, respectively As of July 31, 2016, California NOLs have expired and the valuation allowance has been removed accordingly. As of July 31, 2016 and 2015, we have a $0 and $99 valuation allowance on state of California NOLs, respectively.

 

The deferred tax assets recorded represent our estimate of all deferred tax benefits to be utilized in the current year and future periods beyond 2016. The following table reflects the reconciliation of the company’s income tax expense:

 

   Year Ended July 31, 
   2016   2015 
         
Pre-tax financial income  $(461)  $1,047 
Federal tax (benefit)/expense computed at the statutory rate of 34%   (157)   356 
State tax expense   84    17 
State ASC 740 adjustment   (12)   (16)
Change in valuation allowance   769    (10)
Permanent and other differences   374    10 
Net tax expense  $1,058   $357 

 

 

Our income tax expense is composed of the following:

 

   Year Ended July 31, 
   2016   2015 
         
Current federal tax expense  $14   $8 
Current state tax expense   11    9 
    25    17 
           
Deferred federal tax expense   1,065    355 
Deferred state tax (benefit)   (32)   (15)
    1,033    340 
           
    1,058    357 

 

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The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities at July 31, 2016 and 2015 are presented below:

 

   As of July 31, 
   2016   2015 
Deferred Tax Assets          
Net operating loss carryforwards  $2,719   $3,100 
Goodwill and other intangible assets   227    21 
Non-compete covenants   47    55 
Reserve for uncollectible receivables   145    151 
Federal tax credits   219    205 
Other temporary differences   143    245 
    3,500    3,777 
Less: Valuation allowance   (866)   (99)
           
Net deferred tax asset  $2,634   $3,678 

 

The following components are included in the net deferred tax assets in the accompanying balance sheets:

 

Current Deferred Tax Assets          
Current deferred tax asset   550    569 
Valuation allowance   (136)   (15)
           
Net Current deferred tax asset   414    554 
           
Non-Current Deferred Tax Assets          
Non-current deferred tax asset   2,950    3,208 
Valuation allowance   (730)   (84)
           
Net non-current deferred tax asset   2,220    3,124 

 

ITEX Federal NOLs of approximately $6,092 expire, if unused, from calendar years 2019 to 2024. BXI Federal NOLs of approximately $1,905 expire, if unused, from 2020 to 2026 and are subject to an annual limitation of approximately $172. This limitation is equal to the long-term federal tax exempt rate multiplied by the total purchase price of BXI. ITEX has no state NOLs for California as they expired in calendar year 2015.

 

The Company has AMT credits of $214 and research and development credits of $5 available to offset future taxes payable.

 

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In accordance with the accounting guidance surrounding the uncertainty in Income Taxes we have recorded unrecognized tax liabilities of $25 as follows:

 

   Year Ended July 31, 
   2016 
     
Balance at July 31, 2015  $37 
Increases as a result of tax positions taken in the current year   6 
Increases as a result of tax positions taken in the prior year   2 
Decreases resulting from settlements, payments and changes in estimates of probability tax positions will be sustained   (20)
Balance at July 31, 2016  $25 

 

We file income tax returns in the United States as well as various United States state jurisdictions. We also have available NOLs dating from 1999 which, when used, could be subject to examination by taxing authorities. We do not believe there will be any material changes in our unrecognized tax positions over the next twelve months.

 

As of July 31, 2016, accrued expenses are included on our consolidated balance sheet for uncertain tax positions related primarily to state jurisdictions in the amount of $25 which includes $5 for interest and penalties associated with unrecognized tax benefits. Interest and penalties are included in income tax expense.

 

NOTE 14 – RELATED PARTY TRANSACTIONS

 

ITEX and its subsidiaries had no transactions during our last fiscal year, nor are there any currently proposed transactions, in which ITEX or its subsidiaries was or is to be a participant, where the amount involved exceeded $120,000, and any director or director nominee, executive officer, holder of more than 5% of our common stock or any of their immediate family members, or any promoter or control person, had a material direct or indirect interest.

 

NOTE 15 – SUBSEQUENT EVENTS

 

On August 16, 2016, the Board of Directors of ITEX Corporation declared a semi-annual cash dividend in the amount of $0.10 per share, payable on December 12, 2016 to stockholders of record as of the close of business on December 1, 2016.

 

Item 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

 

Item 9A.CONTROLS AND PROCEDURES

 

(a) Disclosure controls and procedures.

 

Under the supervision and with the participation of our management, including the Chief Executive Officer and our 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. 

 

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(b) Management’s Report on Internal Control over Financial Reporting.

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions; providing reasonable assurance that transactions are recorded as necessary for preparation of our financial statements; providing reasonable assurance that receipts and expenditures of company assets are made in accordance with management authorization; and providing reasonable assurance that unauthorized acquisition, use, or disposition of company assets that could have a material effect on our financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected.

 

Management conducted an assessment of the effectiveness of our internal control over financial reporting based on the 2013 framework published by the Committee of Sponsoring Organizations of the Treadway Commission, referred to as the Internal Control—Integrated Framework. Based on its assessment, management concluded that the Company’s internal control over financial reporting was effective as of July 31, 2016.

 

This Annual Report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to rules of the Securities and Exchange Commission that exempt non-accelerated filers from including auditor attestation reports.

 

(c) Changes in internal control over financial reporting.

 

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

 

Item 9B.OTHER INFORMATION

 

Not applicable.

 

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PART III

 

Item 10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

Certain of the information called for by Item 10 will be set forth in our definitive proxy statement for the 2016 meeting of stockholders (the “Proxy Statement”) to be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this Form 10-K under the captions “Director Nominees”, “Section 16(a) Beneficial Ownership Reporting Compliance”, “Corporate Governance” and “Board of Directors” and is incorporated herein by reference.

 

We have adopted the ITEX Code of Ethics (the “Code of Ethics”), a code of ethics which is applicable to our executive officers, including financial officers, and other finance organization employees. The Code of Ethics is available on the governance page of the investor relations section of our website at www.itex,com under the tab entitled “Our Story.” Any waiver of, or material amendment to, the Code of Ethics applicable to our principal executive officer, principal financial officer, principal accounting officer or controller or persons performing similar functions will be posted promptly to our web site in accordance with applicable SEC rules.

 

Executive Officers

 

Steven White has served as Chief Executive Officer of the Company since June 2003. John Wade has served as Chief Financial Officer since January 2013. Background information about these executive officers who are also nominees for election as directors will be set forth in Proxy Statement under the caption “Director Nominees.”

 

Significant Employees

 

Brian Argetsinger, Vice President of the Marketplace, joined the Company in 2000. He is responsible for supporting the broker network and overseeing franchise development. Prior to becoming Vice President in 2003, Mr. Argetsinger served as our Northwest Regional Manager and as Broker Services Manager. Prior to joining us, he was an ITEX broker in Seattle from 1991 to 2000.

 

Rob Benson, Vice President of Operations, joined the Company in 2004. Mr. Benson was General Manager of the Company’s Seattle office from 2001 to 2003.

 

Troy Hellman, Information Technology Manager, joined the Company in 2000. Mr. Hellman oversees the administration, operation and maintenance of our IT infrastructure, internal systems, and hardware and software products.

 

Item 11.EXECUTIVE COMPENSATION

 

The information in the Proxy Statement set forth under the captions “Executive Compensation” and “Director Compensation” is incorporated herein by reference.

 

Item 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

The information in the Proxy Statement set forth under the captions “Securities Authorized for Issuance under Equity Compensation Plans” and “Beneficial Ownership” is incorporated herein by reference.

 

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Item 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

The information in the Proxy Statement set forth under the captions “Corporate Governance,” “Committees of the Board” and “Transactions with Related Persons” is incorporated herein by reference.

 

Item 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

Information concerning principal accountant fees and services appears in the Proxy Statement under the heading “Fees of the Independent Registered Public Accounting Firm” and is incorporated herein by reference.

 

PART IV

 

Item 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

EXHIBIT INDEX

 

        Incorporated by Reference    
Exhibit No.   Exhibit Description   Form   Exhibit   Filing
Date
  Filed
Herewith
                     
3.1   Amended and Restated Articles of Incorporation of ITEX Corporation   10-KSB   3.1   11/13/03    
3.2   Certificate of Designation of Series A Junior Participating Preferred Stock   8-K   3.1   3/14/11    
3.3   Amended and Restated Bylaws of ITEX Corporation   8-K   3.2   4/08/16    
4.1   Rights Agreement between ITEX Corporation and OTR, Inc., dated December 13, 2013   8-K   4.1   12/13/13    
10.1   Form of Indemnification Agreement   8-K   10.9   3/07/13    
10.2   Lease dated as of June 10, 2016   8-K   10.1   6/17/16    
10.3   Change in Control Agreement dated as of February 28, 2008 between Steven White and ITEX Corporation   10-Q   10.15   3/03/08    
10.4   Form of Employee Change in Control Agreement   10-Q   10.16   3/03/08    
10.5   ITEX Corporation 2014 Equity Incentive Plan   8-K   10.1   12/13/13    
10.6   Form of Executive Restricted Stock Agreement   8-K   10.2   12/13/13    
10.7   Form of Restricted Stock Agreement   8-K   10.3   12/13/13    

 

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        Incorporated by Reference    
Exhibit No.   Exhibit Description   Form   Exhibit   Filing
Date
  Filed
Herewith
21.1   Subsidiaries of Registrant               x
23.1   Consent of Independent Registered Public Accounting Firm               x
31.1   Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002              

x

31.2   Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002              

x

32.1**   Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002              

x

32.2**   Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002              

x

101.INS   XBRL Instance Document               x
101.SCH   XBRL Taxonomy Extension Schema               x
101.CAL   XBRL Taxonomy Extension Calculation Linkbase               x
101.DEF   XBRL Taxonomy Extension Definition Linkbase               x
101.LAB   XBRL Taxonomy Extension Label Linkbase               x
101.PRE   XBRL Taxonomy Extension Presentation Linkbase               x
**   Furnished, not filed                

 

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SIGNATURES

 

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    ITEX CORPORATION
     
Date: October 19, 2016 By: /s/ Steven White
    Steven White, Chief Executive Officer
     
Date: October 19, 2016 By: /s/ John Wade
    John Wade, Chief Financial Officer

 

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities an on the dates indicated.

 

Date: October 19, 2016 By: /s/ Steven White
    Steven White, Chairman of the Board
     
Date: October 19, 2016 By: /s/ John Wade
    John Wade, Director
     
Date: October 19, 2016 By: /s/ Eric Best
    Eric Best, Director
     
Date: October 19, 2016 By: /s/ Timothy Morones
    Timothy Morones, Director
     
Date: October 19, 2016 By: /s/ Kevin Callan
    Kevin Callan, Director

 

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