ITEM 1. BUSINESS
Overview
ITEX, The Membership Trading CommunitySM, is a leading marketplace for cashless business transactions across North America (“the Marketplace”). We service our member businesses through our independent licensed brokers and franchise network and corporate-owned prototype offices (individually, “Broker” and together, the “Broker Network”) in the United States and Canada. Our business services and payment systems enable member businesses (our “members”) to trade goods and services without exchanging cash. These products and services are instead exchanged for ITEX dollars which can only be redeemed in the Marketplace (“ITEX dollars”). We administer the Marketplace and act as a third-party record-keeper for our members’ transactions. 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 maintain our executive offices at 3326 160th Avenue SE, Suite 100, Bellevue, Washington 98008-6418. Our telephone number is 425-463-4000. We routinely post important information on our website under the Investor Relations tab. Our website address is www.itex.com. There we also make available, free of charge, our SEC reports including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports, as soon as reasonably practicable after we file such material electronically with, or furnish it to, the SEC. These reports are also available from the SEC website at www.sec.gov. 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 our currency called “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 the rules of the Marketplace. As described below, we issue, on a case by case basis, ITEX dollar credit lines to certain members. Members with positive ITEX dollar account balances or those within their ITEX dollar credit line may use available ITEX dollars to purchase products or services from other members and may sell their products or services to other members. Those members with negative ITEX dollar account balances are obligated to sell their products or services to other Marketplace members in order to offset their negative account balance.
We assist members in marketing their products and services through our Broker Network, newsletters, e-mail, on our website at www.itex.com and through other promotional means. Transactions are generally conducted by members directly but can be facilitated by our Brokers.
Businesses use our Marketplace to attract new customers, increase sales and market share, 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 hotels, media, and other service related businesses. For example, a hotel that has not filled its rooms by the end of the day has lost potential revenue but still has nearly the same overhead associated with owning and maintaining its facility. Selling these unused rooms for ITEX dollars is beneficial for both the traveler or buyer and the hotel or seller. The traveler receives a hotel room without spending USD and the hotel can use the ITEX dollars earned to purchase other products or services in the Marketplace.
In order to facilitate transactions, we may grant ITEX dollar credit lines to certain members. When considering an ITEX dollar credit line, we assess the financial stability of the member and the demand by others for the member’s product or service. Members without a line of credit may only use their ITEX dollars received from selling their product or service to purchase other products or services in the Marketplace.
For tax purposes, the Internal Revenue Service considers ITEX dollar sales to be equivalent to USD sales and ITEX dollar expenses to be equivalent to USD expenses. ITEX is obliged under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) to send Forms 1099-B to each of our members and to the Internal Revenue Service (“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. The IRS requires all Form 1099-B recipients to report their ITEX dollars received (sales) as gross income on their tax returns. Expenditures of ITEX dollars may be reported as deductions in tax returns if they qualify as a deductible business expense or as other deductions that are permitted by the Internal Revenue Code.
Broker Network
Brokers are independent contractors with respect to the Company. Combined, our corporate staff, Brokers and their staff, and outside contractors total more than 300 individuals supporting 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 Broker Network technology.
Our Brokers provide Marketplace members with information about products and services that are available locally, nationally and in Canada. Brokers do not typically have exclusive contractual rights to operate in a geographical area. Each Broker is responsible for enrolling new Marketplace 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. Members of the Marketplace have a direct contractual relationship with 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 both provide for a five-year term unless we terminate the contract for cause as defined in the agreement. These agreements provide for subsequent five-year renewal terms as long as the franchisee or broker is not in breach of the agreement and is in compliance with our performance requirements, policies, and procedures then in place.
Since early 2003, we have offered the sale of ITEX franchises to qualified individuals and entities. In addition, we have sought to renew all individual Broker contracts 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 and logos. 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 and proprietary marks. The franchise agreement allows us to oversee the obligations and responsibilities of the franchisee. Under federal and state franchise and business opportunity laws, franchisees are entitled to additional protections including the provision that many of the substantive aspects of the business relationship (e.g., termination, transfer, cancellation, and non-renewal) will be governed by state law. Refer to “Government Regulation” for more information.
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”, “2008” for August 1, 2007 to July 31, 2008, “2007” for August 1, 2006 to July 31, 2007). We report our results as of the last day of each calendar month (“accounting cycle”).
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 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. 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 the years ended July 31, 2008 and 2007, members made approximately 87% and 86%, respectively, of their payments through electronic funds transfer or by credit cards using our Preferred Member Autopay System (“Autopay System”). If paying through our Autopay System, generally, the USD transaction fee is 5% to 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 95% and 96% of our total revenue in 2008 and 2007, respectively.
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. As discussed in our critical accounting policies, due to the lack of readily determinable fair values and our ability to control and manipulate ITEX dollars, we recognize a small amount of Marketplace revenues or expenses of ITEX dollars on our financial statements that meet very specific criteria. We recognize ITEX dollars as required by the Internal Revenue Service for income tax reporting purposes. We account for ITEX dollar transactions and USD fee assessments in statements to members and Brokers. The majority of the ITEX dollars we earn are distributed back to the Broker Network as revenue share and sales incentives. Additionally, we use ITEX dollars we earn to fund the ITEX co-op advertising program utilized by both members and Brokers. We expend a small amount of ITEX dollars for certain ITEX operating expenses.
Business Strategy
Our goal is to expand our market share of the cashless transaction industry, principally in the United States and Canada. We believe we can successfully increase the number of members participating in our Marketplace and our revenues if we provide members:
o
A system that enables members to execute and track transactions in the Marketplace. We have internally developed an industry exclusive, comprehensive, customer relationship management and payment processing software called “TEAM.” This online software solution provides members, Brokers and our management team with enhanced information systems and marketing tools. We continue to upgrade and enhance our technologically advanced multi-channel payment system that provides efficient internet access to ITEX members and our Broker Network. These upgrades and enhancements in computer and communications technology provide Brokers and members with additional tools and more effective computer applications to more easily engage in “real-time” transactions.
o
A community where members can meet and feel comfortable with other members. Our website has a casual, community approach conveying to Marketplace members the variety of businesses that comprise the Marketplace and the benefits that come with their participation. The member business profile section of our website allows business owners to provide personal pictures, tell the Marketplace more about themselves and communicate with other member businesses via blogs. We believe that seeing the photograph of a business owner and sharing selected personal information will differentiate member businesses and encourage others to conduct transactions with them in the Marketplace.
o
More regions in which to trade by increasing the size and effectiveness of our Broker Network. To attract new franchisees and increase the trade regions covered by the Marketplace, we have a franchise portion of our website, www.itex.com. We identified target markets, provided added detail about our company and business model, and allowed potential franchisees to calculate sample financial forecasts.
During 2008, we acquired certain assets of two commercial trade exchange networks (refer to “Overview” included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, Part II Item 7) and expanded our presence in six U.S. regions, four of which were previously not served by existing Brokers.
o
Excellent customer service by the Broker Network and our corporate office. We provide training and support for new and existing Brokers and refine our franchisee and Broker operating manuals and related support materials. Additionally, we hold an annual convention and several regional meetings where we discuss and attempt to find solutions for current issues and proactively plan for future enhancements and benefits to our Trading Community. We created a national sales manager position to work with Brokers to implement various strategies and methods for obtaining new members and a business development position to execute partnerships with national organizations to create more members within our trading community.
o
Develop a web based Software as a Service (SaaS) model. This potential new revenue stream is targeted at midsized businesses to enable them in creating reward communities within their employee and customer base, using the ITEX proprietary exchange platform.
Members
The Marketplace has approximately 24,000 members in the United States and Canada. The majority of members are business owners with fewer than 10 employees. Members may choose to participate in the Marketplace for a number of reasons including to:
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Attract new customers
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Increase sales and market share
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Add new channels of distribution
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Utilize unproductive assets, surplus inventory or excess capacity
Members earn ITEX dollars which they have the opportunity to spend on products and services offered by other ITEX members. The following is a representative example of a transaction:
A dentist wants to remodel her office. Through the Marketplace, she hires a contractor who agrees to perform the remodeling work for $1,500 ITEX dollars. The dentist has ITEX dollars in her account to spend because she had previously provided dental work to the owner of a vacation resort, a restaurant owner and a lawyer, all members of the Marketplace, in exchange for ITEX dollars. These other members originally acquired ITEX dollars by providing products or services for other Marketplace members.
Sales, Marketing and Transactions
Sales
The primary function of new member enrollment is to grow and retain the Marketplace member base and generate additional revenue. We provide standardized marketing and support materials, advertising, 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 various meetings and networking events in their areas and through the referrals of existing Marketplace members. We offer a Member Referral Program that provides incentive awards and discounted fees to existing members that refer new qualified members to the Marketplace.
Marketing
Our marketing strategy is to promote our Membership Trading Community brand and attract new members to the Marketplace while instructing them how to effectively use the Marketplace to grow their business. Our marketing efforts include a program of support and education for our members and Brokers in addition to continual upgrades and features of our website, www.itex.com. New tools for Brokers to customize and use in their sales efforts include pre-designed advertisements, brochures and sales presentations to give ITEX a consistent look and message. To promote the Marketplace, we market products and services of existing members through our website, directories, newsletters, e-mail, and other means. In addition, we pursue strategic affiliations with companies with access to potential business members.
Transactions
Our Brokers focus on maximizing transaction volume and maximizing the ITEX dollar amount per transaction. 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. Brokers actively market products and services available to and from the members they service on our ITEX website and pursue potential member businesses by introducing them to the Marketplace.
Systems and Technologies
The Marketplace is handled by an internally developed, proprietary, online system we call Trade Exchange Account Manager (“TEAM”) that is based on Microsoft® technologies. We designed TEAM to facilitate the activities of all parties involved in the Marketplace, from our corporate management and accounting personnel to Brokers and Marketplace members. The system extends well beyond record keeping and transaction processing. The major features of the system are as follows:
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Account Information Manager (“AIM”) Online - provides our Brokers and corporate management with customer relationship management (“CRM”) features including notes, transaction histories, calendaring and scheduling capabilities as well as Marketplace management features.
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Trade Flash - an online classified ad section where members can list products and services they are offering for ITEX dollars as well as locate products and services they are seeking to purchase with ITEX dollars.
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Member Directory - a categorized listing of ITEX members that allows members to advertise their business.
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Reporting - Brokers, corporate management and accounting personnel are provided with a number of reports allowing for a comprehensive analysis of various aspects of the Marketplace.
We take the steps necessary to ensure the adequate security of our hardware and software systems including monitoring and correcting outside intrusions and attacks. Our technologies are co-hosted in Washington and Idaho and we perform full back-ups every 24 hours. We continue to improve the speed and reliability of our information systems and transaction tools for all of TEAM’s users by continually updating hardware and enhancing our software with new, internally developed programs and functionalities.
Industry Overview
General
Our industry was developed when various trade exchanges (“Exchanges”) 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. There are several hundred single office Exchanges in the United States and Canada.
Competition
We have three primary competitors: Exchanges, internet distribution channels, and private label payment cards. We believe that we are the Exchange leader in the United States and Canada based on reported USD revenues, participating member businesses, the number of payments processed, regions served, and completed transactions of a single, non-USD currency. After ITEX, the next largest Exchange is International Monetary Systems, Ltd.
Internet distribution channel competitors include eBay, Travelocity, Priceline, and Overstock.com. Similar to our Marketplace, these companies provide distribution channels to move excess or surplus inventory. The greater the number of avenues to move excess inventory, the more competitive it is to attract businesses to trade their inventory in our Marketplace. We also compete with these companies through price and brand name awareness.
Private labeled, network branded, payment and incentive cards, such as Card USA, Galileo Processing and Springbok Services compete with us by providing a branded solution for local distribution or sales channels and the ability to create in-kind payment solutions.
While we are currently providing a single small business service, a unique sales and distribution channel via our Marketplace, we may expand to other small business services. In that case, we would face competition from other small business service providers.
We compete primarily on a service basis, including the number of products and services available in the Marketplace and the liquidity of ITEX dollars. We expect to encounter competition in our efforts to expand our Marketplace. In addition to existing Exchanges, new, smaller competitors can launch new Exchanges at a relatively low cost since technological and financial barriers to entry are relatively low. However, we believe participation from a significant number of members is necessary to offer a quality Exchange. We also know there is a steep learning curve to manage an Exchange as well as a potentially significant investment in software. Ultimately, we believe these elements create a difficult barrier to entry for new competitors and may require significant ramp-up times to make a competitive Exchange successful. Regardless, our competitors 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. Such companies could be strong competitors if they decided to develop a focused business effort in our industry.
In general, customer demands for wider availability of products and services, stronger customer service, better computer servicing technology and the acceptance of the internet as a medium for communication and business have resulted in a more competitive industry. We believe that in order to capture greater market share, local Exchanges will need to expand into larger regional or national organizations that possess the ability to offer a wider selection of products and services, service a more diverse and dispersed member clientele and have greater access to growth capital and management expertise.
We believe we will remain in a good competitive position as long as we continue to maintain the quality of our services and our relationships with our Broker Network and our member base. Our ability to compete successfully will depend on our ability to continually enhance and improve our existing products and services, to adapt products and services to the needs of our Brokers, members and potential members, to successfully develop and market new products and services, and to continually improve our operating efficiencies. However, we cannot assure you that we will be able to compete successfully, that competitors will not develop competing technologies, products or strategic alliances and affiliations that make our brand, products and services less marketable or less useful or desirable. Furthermore, we may not be able to successfully enhance our products and services or develop new products or services to meet our members’ needs. Increased competition, price or other circumstances, could result in erosion of our market share and may require price reductions and increased spending on marketing and product development to remain competitive.
Government Regulation
Along with our Brokers, 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 we are required to account for and report annually to the IRS the total ITEX dollar sales transactions of each member in our Marketplace.
It is the legal responsibility of our Brokers to pay and withhold all applicable federal and state income taxes (including estimated taxes), Social Security, Medicare and all applicable federal and state self-employment taxes, and in general to comply with all applicable federal, state, and local laws, statutes, codes, rules, regulations and standards, including but not limited to the Americans with Disabilities Act. Except for our three corporate-owned offices, our Brokers are independent contractors, and we do not own, control or operate the businesses comprising our Broker Network. However, a number of federal and state laws and regulations are implicated by virtue of our relationship with our Broker Network. For example, our contractual relationship with a Broker could be subject to challenge to determine whether an individual is an independent contractor or an employee for purposes of the Fair Labor Standards Act or state equivalents. Under various agency positions, we could potentially be found liable for the conduct of our independent contractors in a situation where that contractor has caused injury to a third party. In addition, under federal (Federal Trade Commission Act) and state franchise and business opportunity laws, 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. Many states broadly view the requirements of what constitutes a franchise and, consequently, many types of relationships that are ordinarily not considered franchises can be brought within the ambit of state and federal franchise regulation. There is a risk that one or more of our non-franchise business relationships could be deemed to constitute a franchise. An adverse finding in one or more of these regulated areas could govern the enforceability of our agreements or permit the recovery of damages and penalties which could have a material adverse effect on our business, results of operations, cash flows and financial condition.
With respect to our online technologies, there are currently few laws or regulations directly applicable to access to or commerce on the internet. However, it is possible that a number of laws and regulations may be adopted with respect to the internet, covering issues such as taxes, user privacy, information security, pricing and characteristics and quality of products and services. We cannot predict the impact, if any, that future internet-related regulation or regulatory changes might have on our business.
Proprietary Rights
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 proprietary technology and software products. We have registered service marks for the word mark ITEX®, as well “ITEX” used in connection with our logo design. We intend to file additional service mark word and design applications for ITEX. We seek to police the use of our marks and to oppose any infringement. We have registered the internet domain name “ITEX.com” and other related domain names.
We cannot be certain that others will not develop substantially equivalent or superseding proprietary technology or be certain that equivalent products or services will not be marketed in competition with our products thereby substantially reducing the value our proprietary rights. Furthermore, there can be no assurance that any confidentiality agreements between us and our employees or any license agreements with our customers will provide meaningful protection of our proprietary information in the event of any unauthorized use or disclosure of such proprietary information.
Employees
As of July 31, 2008, we had 31 full-time, contract and temporary employees - 20 in our corporate headquarters and 11 in our corporate prototype offices. From time to time, we utilize independent consultants or contractors for technology support, marketing, sales and support, accounting or administrative functions. Our employees are not represented by any collective bargaining unit and we have never experienced a work stoppage. We believe relations with our employees are good.
ITEM 1A.
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 future revenue growth and profitability remains uncertain.
During 2008, we increased revenues by 13% through organic growth and through acquisitions. We cannot assure you that our revenues will continue to increase in future quarters or future years. We may continue to add revenue through acquisitions, but we cannot assure you that we will be successful in our acquisition efforts or that financing for these endeavors will be available. We have sustained profitable operations for five years. However, our prospects for the future must be considered in light of the uncertainty of revenues and markets. We cannot assure you that we can continue to be operated profitably, which depends on many factors, including the success of our development and expansion efforts, the control of expense levels and the success of our business activities. Our future operating results will depend on a variety of factors, including those discussed in the other risk factors set forth below.
Acquisitions could result in operating difficulties, dilution and other harmful consequences; Our evaluation of new strategic directions may not result in viable new alliances, mergers or acquisitions, may not enhance shareholder value, and may create a distraction for our management and uncertainty that may adversely affect our operating results and business.
We completed our acquisition of BXI in 2005, the Intagio assets on August 1, and ATX The Barter Company on March 1, 2008. Subsequent to year-end, we completed an acquisition of Intagio Media Services. Despite these acquisitions, three of which were with the same company, we have a limited amount of experience acquiring companies. We have evaluated, and expect to continue to evaluate, other potential strategic transactions. In May 2008, we retained the investment bank Montgomery & Co, LLC as our financial advisor to assist us in evaluating a range of strategic alternatives and opportunities and update us regarding prevailing market conditions for mergers and acquisitions. Strategic alternatives may include, without limitation, continued execution of our operating plan, the sale of some or all of our continuing operations, partnering or other collaboration agreements, or a merger or other strategic transaction. Our exploration of strategic alternatives may not result in any additional agreements or transactions, or ensure that, if completed, any agreements or transactions will be successful, on attractive terms or enhance shareholder value. It is possible that nothing may result from our exploration or that we may acquire, be acquired or enter into some other strategic relationship, and that in consummating or further exploring such avenues, we may incur additional costs. Furthermore, we may enter into letters of intent and other non-definitive agreements that do not culminate in a completed transaction, engage in contract negotiations, or incur due diligence expenses which affect our quarterly earnings prior to or without entering into a material definitive agreement required to be disclosed publicly. We do not intend to disclose developments with respect to this process unless and until the evaluation of strategic alternatives has been completed or we have entered into a material definitive agreement. The mere negotiation or the consummation of any of these transactions could be material to our financial condition and results of operations. In addition, 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 risks include:
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The need to implement or remediate controls, procedures and policies appropriate for a public company at companies that prior to the acquisition lacked these controls, procedures and policies.
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Diversion of management time and focus from operating our business to alliance, merger or acquisition integration challenges.
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Cultural challenges associated with integrating employees from the acquired company into the acquiring organization.
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Retaining employees from the businesses acquired.
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The need to integrate each company’s accounting, management information, human resource and other administrative systems to permit effective management.
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 incurrence of debt, contingent liabilities or amortization expenses, or write-offs of goodwill, any of which could harm our financial condition. Future acquisitions may require us to obtain additional equity or debt financing, which may not be available on favorable terms or at all.
We are largely dependent on key personnel who may not continue to work for us.
Potentially, any loss of key officers, key management, and other personnel could impair our ability to successfully execute our business strategy, particularly when these individuals have acquired specialized knowledge and skills with respect to ITEX and our operations. Although we believe we are currently being administered capably, we remain substantially dependent on the continued services of our key personnel and in particular, the services of CEO and interim CFO Steven White. Management places heavy reliance on Mr. White’s experience and management skills. We have not entered into formal employment agreements with Mr. White or any of our employees. We carry a $2.0 million life insurance policy covering Mr. White to insure the business in the event of his death, but do not carry life insurance for any other key personnel. If Mr. White or other key personnel were to leave ITEX unexpectedly, we could face substantial difficulty in hiring qualified successors and could experience a loss in productivity while any successor obtains the necessary training and experience. We believe we have the necessary management expertise to implement our business strategy and that support personnel can be increased as needed. However, we may need to attract, train, retain and motivate additional financial, technical, managerial, marketing and 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 will be adversely affected.
We may need additional financing; current funds may be insufficient to finance our plans for growth or our operations
Although we believe that our financial condition is stable and that our cash balances and operating cash flows provide adequate resources to fund our ongoing operating requirements, we have limited funds and may have contractual obligations in the future. 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 business opportunities. We believe our current core operations reflect a scalable business strategy, which will allow our business model to be executed with limited outside financing. However, we also may expand our operations, enter into a strategic transaction, or acquire competitors or other business to business enterprises. We have a line of credit with our primary banking institution, which will provide additional reserve capacity for general corporate and working capital purposes, and if necessary, enable us to make certain expenditures related to the growth and expansion of our business model. However, if adequate capital were 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 assure you that we will be able to implement various financing alternatives or otherwise obtain required working capital if needed or desired.
We are dependent on our Broker Network and franchise model
We look to our Broker Network to enroll new members, train them in the use of the Marketplace, facilitate business among members, provide members with information about ITEX products and services, and assure the payment of our dues and fees. Brokers have a contractual relationship with ITEX, typically for a renewable three or five-year term. There can be no assurance that our Brokers will continue to participate in the Marketplace, or that we will be able to attract new franchisees at rates sufficient to maintain a stable or growing revenue base. We depend on the ability of our Brokers to expand the number of members and the volume of transactions through the Marketplace. We cannot assure you that the market for our products and services will continue to develop as expected. If our industry does not grow, becomes saturated with competitors, or if our products and services do not continue to achieve market acceptance, or if our Brokers are unsuccessful in enrolling new members to equalize the attrition of members leaving the Marketplace, the overall share of the market handled by our Broker Network could be reduced, and consequently our business operating results and financial condition may be materially adversely affected.
We are dependent on the value of foreign currency.
We transact business in Canadian dollars as well as US dollars. Revenues denominated in Canadian dollars comprised 7.7% and 7.3% in the years ended July 31, 2008 and 2007, respectively. While foreign currency exchange fluctuations are not believed to materially adversely affect our operations at this time, changes in the relation of the Canadian dollar to the US dollar could continue to affect our revenues, cost of sales, operating margins and result in exchange losses.
We are required to evaluate our internal control over financial reporting under Section 404 of the Sarbanes Oxley Act of 2002, and any adverse results from such evaluation could result in a loss of investor confidence in our financial reports and have an adverse effect on our stock price.
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 and SEC rules, we are required to furnish a report by our management assessing the effectiveness of our internal control over financial reporting. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. In addition, we must comply with Section 404(b) requirements to provide an auditor’s attestation report on internal control over financial reporting beginning with our Annual Report on Form 10-K for our year ending July 31, 2010. The Committee of Sponsoring Organizations of the Treadway Commission (COSO) provides a framework for companies to assess and improve their internal control systems. The Public Company Accounting Oversight Board’s (“PCOAB”) Auditing Standard No. 5, adopted by the SEC on July 27, 2007, provides the professional standards and related performance guidance for auditors to report on the effectiveness of our internal controls over financial reporting under Section 404. Our assessment of internal controls over financial reporting requires us to make subjective judgments and, particularly because Standard No. 5 is newly effective, some of the judgments will be in areas that may be open to interpretation.
While we have determined in our Management Report on Internal Control over Financial Reporting included in this Form 10-K, that our internal control over financial reporting was effective as of July 31, 2008, we must continue to monitor and assess our internal control over financial reporting. If we identify one or more future material weaknesses in our internal control over financial reporting and such weakness remains uncorrected at fiscal year end, we will be unable to assert our internal control is effective. If we are unable to assert that our internal control over financial reporting is effective for a particular year (or if our auditors are unable to attest that we have maintained, in all material respects, effective internal controls), we could lose investor confidence in the accuracy and completeness of our financial reports. That would likely have an adverse effect on our stock price.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable
ITEM 2.
ITEM 2. PROPERTIES
Our corporate and administrative headquarters offices are located in Bellevue, Washington. We lease properties in the following locations that are utilized by our sales and marketing, and general and administrative personnel:
(1)
This facility is utilized for our prototype office.
(2)
We entered into this lease subsequent to year-end as part of the acquisition of Intagio media assets (refer to “Overview” included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, Part II Item 7.)
We believe that our current 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 -“Commitments” included in the “Notes to Consolidated Financial Statements”, Item 8 - Financial Statements.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
For information regarding legal proceedings, refer to Note 11 - “Legal Proceedings” included in the “Notes to Consolidated Financial Statements”, Item 8 - Financial Statements.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth quarter of the year ended July 31, 2008.
PART II
ITEM 5.
ITEM 5.
MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
Our common stock trades on the OTC Bulletin Board under the symbol “ITEX.OB” The range of high and low bid prices for our common stock for each quarter during the two most recent years is as follows:
This table reflects the range of high and low bid prices for our common stock during the indicated periods, as published by the OTC Bulletin Board. 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 approximately 880 holders of record of our common stock as of July 31, 2008. Most shares of our common stock are held by brokers and other institutions on behalf of shareholders.
We have not paid any cash dividends and do not intend to pay any cash dividends in the foreseeable future.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
No repurchases of common stock were made during the fourth quarter of 2008.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion is provided as a supplement to the accompanying consolidated financial statements and notes (refer to Item 8
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
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statement of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
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 as of July 31, 2008 and 2007, and the related consolidated statements of income, 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 standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated 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 consolidated financial position of ITEX Corporation as of July 31, 2008 and 2007, and the consolidated results of their operations and their cash flows for each of the years ended July 31, 2008 and 2007 in conformity with accounting principles generally accepted in the United States of America.
/s/ Ehrhardt Keefe Steiner & Hottman PC
Ehrhardt Keefe Steiner & Hottman PC
Denver, Colorado
October 1, 2008
ITEX CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands)
The accompanying notes are an integral part of these Consolidated Balance Sheets.
ITEX CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(In thousands except per share amounts)
The accompanying notes are an integral part of these Consolidated Statements of Income.
ITEX CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
The accompanying notes are an integral part of these Consolidated Statements of Stockholders’ Equity.
ITEX CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
The accompanying notes are an integral part of these Consolidated Statements of Cash Flows.
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 and corporate-owned prototype offices (individually, “Broker,” and together the “Broker Network”) in the United States and Canada, we operate a leading exchange for cashless business transactions (the “Marketplace”) where products and services are exchanged for “currency” only usable in the Marketplace (“ITEX dollars”). We administer the Marketplace and act as a third-party record-keeper for our members’ transactions. 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.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us 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 our financial statements and notes. Examples of estimates and assumptions include estimating:
·
certain provisions such as allowances for accounts receivable
·
any impairment of long-lived assets
·
useful lives of property and equipment
·
the value and life of intangible assets
·
the value of assets and liabilities acquired through business combinations
·
deferred revenues and costs
·
expected lives of customer relationships
·
tax provisions and valuation allowances
·
accrued commissions and other accruals
·
litigation matters described herein
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”, “2008” for August 1, 2007 to July 31, 2008, “2007” for August 1, 2006 to July 31, 2007). We report our results as of the last day of each calendar month (“accounting cycle”).
Accounting for Business Acquisitions
We account for acquisitions as a purchase in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations. We report all acquired tangible and intangible assets and liabilities at fair value. We recognize the fair value of the purchased intangible assets as operating expenses over the estimated useful life of each separate intangible asset. Any excess purchase price over the fair values assigned to identifiable tangible and intangible assets is recorded as goodwill.
Concentrations of Credit Risk
At July 31, 2008, we maintained our cash balances at a U.S. Bank branch in Portland, Oregon, 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 $100 U.S. dollars and by the Canadian Deposit Insurance Corporation up to $100 Canadian dollars. Our cash balances have exceeded these insurable limits periodically throughout 2008 and 2007. At July 31, 2008 such balances exceeded these limits by $761.
Accounts and Notes Receivable
We assess the collectibility 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
At our discretion, we occasionally allow members who complete large transactions to pay the related transaction fee over time, typically three operating cycles. Additionally, we occasionally make cash loans and advances to Brokers for special purposes or as incentives for beneficial changes such as to convert former BXI brokers to lower ITEX franchise fee commission structures. The aggregate total owed to us on July 31, 2008 is $67. The maximum balance owed is $30. Payoff dates for the loans are scheduled within one year.
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 also includes internally developed software (refer to “Software for Internal Use”). 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 also developed software to provide new functionality to access benefits and other services that we now provide to our Brokers and members of the Marketplace. We account for qualifying costs incurred in the development of software for internal use in accordance with the American Institute of Certified Public Accountants’ Statement of Position (“SOP”) 98-1, Accounting for Costs of Computer Software Developed or Obtained for Internal Use. In accordance with SOP 98-1, costs incurred in the planning and post-implementation stages are expensed as incurred, while costs relating to application development are capitalized. Qualifying software development costs, including software in development meeting the criteria of SOP 98-1, are included as an element of property and equipment in the consolidated balance sheets.
Goodwill
We record goodwill when the cost of an acquired entity exceeds the net amounts assigned to identifiable assets acquired and liabilities assumed. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, we conduct a formal impairment test of goodwill on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value below its carrying value. We analyzed goodwill as of July 31, 2008 and we did not identify any impairment.
Intangible Assets
Upon acquisition, we amortize costs of acquired intangible assets using the straight-line method over the contractual life of two years for non-compete agreements and the estimated life of six years for membership lists. We periodically assess the remaining amortizable life when events or circumstances may warrant a revision to such lives.
Long-Lived Assets
In accordance with the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of 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 undiscounted future cash flows in our assessment of whether or not they have been impaired. If impairment is deemed to have occurred, we then consider the undiscounted future cash flows to determine if an adjustment is appropriate. In our most recent review conducted in the fourth quarter of 2008, we determined no impairment was 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, 2008 represents commissions payable from the operating cycle ending July 31, 2008. In 2007, the closest operating cycle ended August 2, 2007 so as of July 31, 2007 all commissions owed were estimated and accrued. 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 the acquisition of BXI. We defer this revenue and recognized it over the annual period to which it applies.
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 significant financial instruments are recognized in our balance sheet. The carrying amount of our financial instruments including cash, accounts receivable, loans and advances, notes receivable, accounts payable, commissions payable and accrued commissions and other accruals approximate their fair values at July 31, 2008 due to the short-term nature of these instruments. All of these instruments have terms of less than one year.
The fair value of notes payable is based on rates currently available to us for debt of similar terms and remaining maturities. There are no quoted market prices for the debt or similar debt, though we believe the fair value approximates the carrying amounts on our balance sheets due to the short-term nature of these instruments. We have no debt which is classified as long-term as of July 31, 2008.
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 collectibility.
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 the years ended July 31, 2008 and 2007, members made approximately 87% and 86%, respectively, of their payments through electronic funds transfer or by credit cards using our Preferred Member Autopay System (“Autopay System”). If paying through our Autopay System, generally, the USD transaction fee is 5% to 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 95% and 96% of our total revenue in 2008 and 2007, respectively.
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. We defer annual dues, which are prepaid, and recognize revenue over the period to which they apply.
Gross versus Net Revenue Recognition
In the normal course of 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. Most of our ITEX dollar transactions during the periods presented in the accompanying 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.
Our accounting policy follows the accounting guidance of the Financial Accounting Standards Board’s (“FASB”) Emerging Issues Task Force (“EITF”) 93-11, Accounting for Barter Transactions Involving Barter Credits, which indicates that transactions in which non-monetary assets are exchanged for barter credits should be accounted for under the Accounting Principle Board (“APB”) 29, Accounting for Non-monetary Transactions. The basic principle of APB 29 is that, generally, exchanges of non-monetary assets 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;
·
Revenue sharing with Brokers for transaction fees and association fees;
·
Incentives to Brokers for registering new members in the Marketplace;
We believe that the fair value of these items lack readily determinable fair values for several reasons. Under APB 29, 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. Because substantially all items upon which we expend ITEX dollars do not have readily determinable fair values, we have determined that meeting all of the required criteria for revenue recognition generally does not exist.
Because of all the above stated reasons, we believe that most of our ITEX dollar transactions during the periods presented in the accompanying financial statements lacked readily determinable fair values and 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 U.S. dollar 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.
Share-Based Compensation Expense
We account for share-based compensation in accordance with the provisions of SFAS No. 123(R), Share-Base Payment. Under the fair value recognition provisions of SFAS No. 123(R), we estimate share-based compensation cost at the grant date based on the fair value of the award. We recognize the expense ratably over the requisite service period of the award.
We account for stock-based non-employee compensation in accordance with the provisions of SFAS No. 123, Accounting for Stock-Based Compensation and EITF Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. We use the Black-Scholes model to value such compensation and recognize the expense over the period we receive the respective services. Additionally, we re-measure any unvested portion of an award at each measurement date and record the adjustment over the remaining period we receive the services. Determining the appropriate fair value model and calculating the fair value of stock-based awards, which includes estimates of stock price volatility, forfeiture rates and expected lives, requires judgment that could materially impact our operating results. During 2008, we issued 100 warrants to a consultant for a fair value of $66. We did not issue stock options in 2008 or 2007.
Operating Leases
We account for our executive office lease and other property leases in accordance with SFAS No. 13, Accounting for Leases, and FASB Technical Bulletin 85-3, Accounting for Operating Leases with Scheduled Rent Increases (as amended). 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 in accordance with SFAS No. 109, Accounting for Income Taxes. Under SFAS No. 109, an asset and liability approach is 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. 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 income taxes in accordance with FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. (“FIN 48”). Under the provisions of FIN 48, we recognize the tax benefits of tax positions only if it is more like than not that the tax positions will be sustained, upon examination by the applicable taxing authorities, based on the technical merits of the positions. FIN 48 also requires that we record potential interest and penalties associated with our tax positions. We have opted to record interest and penalties as a component of income tax expense.
Contingencies
In the normal course of our business we are periodically involved in litigation or claims. We follow the provisions of SFAS No. 5, Accounting for Contingencies, to record litigation or claim-related expenses. We evaluate, 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.
Income (Loss) Per Share
We prepare our financial statements in accordance with the provisions of SFAS No. 128, Earnings per Share, which requires presentation on the face of the income statement for 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, 2008, we had no contracts to issue common stock, but we did have 100 warrants outstanding.
NOTE 2 - RECENT ACCOUNTING PRONOUNCEMENTS
In June 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. EITF 03-6-1 gives guidance as to the circumstances when unvested share-based payment awards should be included in the computation of EPS. EITF 03-6-1 is effective for us beginning August 1, 2009, the beginning of our 2010 reporting periods. We are currently assessing the impact of EITF 03-6-1 on our results of operations, cash flows and financial position.
In April 2008, the FASB issued FASB Staff Position No. FSP 142-3, Determining the Useful Life of Intangible Assets. FSP 142-3 amends the factors to be considered in determining the useful life of intangible assets. Its intent is to improve the consistency between the useful life of an intangible asset and the period of expected cash flows used to measure its fair value. FSP 142-3 is effective for us beginning August 1, 2009, the beginning of our 2010 reporting periods. We are currently assessing the impact of FSP 142-3 on our results of operations, cash flows and financial position.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities - an amendment to FASB Statement No. 133. SFAS No. 161 enhances the disclosure requirements for derivative instruments and hedging activities under FASB Statement No. 133. Entities are required to provide disclosures about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for under Statement No. 133 and its related interpretations, and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. SFAS No. 161 is effective for us beginning August 1, 2009, the beginning of our 2010 reporting periods, though early adoption encouraged. We are currently assessing the impact of SFAS No. 161 on our results of operations, cash flows and financial position.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations, which replaces SFAS No. 141 and amends several others. The statement retains the purchase method of accounting for acquisitions but changes the way we will recognize assets and liabilities. It also changes the way we will recognize assets acquired and liabilities assumed arising from contingencies, requires us to capitalize in-process research and development at fair value, and requires us to expense acquisition-related costs as incurred. SFAS No. 141R is effective for us on, but not before, August 1, 2009, the beginning of our 2010 reporting periods. SFAS No. 141R will apply prospectively to our business combinations completed on or after August 1, 2009 and will not require us to adjust or modify how we recorded any acquisition prior to that date.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB 51, which changes the accounting and reporting requirements for minority interests. Under the provisions of SFAS No. 160, minority interests will be re-characterized as “noncontrolling interests” and reported as a component of equity separate from our equity. Subsequently, we would be required to record all changes in interests that do not result in changes in control as equity transactions. In addition, we would report net income attributable to noncontrolling interests on the face of our consolidated Statements of Income. Upon a loss of control, we would record the interest sold, as well as any interest retained, at fair value with recognition of any gain or loss in earnings. SFAS No. 160 is effective for us on, but not before, August 1, 2009, the beginning of our 2010 reporting periods. SFAS No. 160 will apply prospectively, except for the presentation and disclosure requirements, which will apply retrospectively. We do not expect the adoption of SFAS No. 160 will have a material impact on our results of operations, cash flows or financial position.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which is intended to provide guidance for using fair value to measure assets and liabilities. In general, this pronouncement is intended to establish a framework for determining fair value and to expand the disclosures regarding the determination of fair value. With certain financial instruments, a cumulative effect of a change in accounting principle may be required with the impact of the change recorded as an adjustment to opening retained earnings. We adopted certain provisions of SFAS No. 157 on August 1, 2008, the beginning of our reporting periods. The adoption of SFAS No. 157 affected our accounting policy regarding ITEX dollar activities but there will be no impact on future results of operations, cash flows and financial position. In February 2008, the FASB issued FASB Staff Position FAS 157-2, "Effective Date of FASB Statement No. 157". FSP SFAS No. 157-2 delays the effective date SFAS No. 157 for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis. The non-financial assets and non-financial liabilities for which the Company has not applied the fair value provisions of SFAS No. 157 include goodwill and other intangible assets. Full adoption of SFAS No. 157 is effective for us beginning August 1, 2009, the beginning of our 2010 reporting periods. We are currently assessing the impact of the adoption of FSP SFAS No. 157-2 on our results of operations, cash flows and financial position.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Liabilities - Including an Amendment of FASB Statement No. 115, which permits an entity to choose to measure many financial instruments and certain other items at fair value. Most of the provisions of SFAS No. 159 are elective; however the amendment to SFAS No. 115 applies to all entities with available-for-sale and trading securities. The FASB’s stated objective in issuing the standard is to improve financial reporting by entities by providing them with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedging accounting provisions. The provisions of SFAS No. 159 are effective for us on August 1, 2008, the beginning of our 2009 reporting periods. We have chosen not to adopt the fair value measurement provisions of SFAS No. 159, so the impact of SFAS No. 159 will not have a significant impact on our results of operations, cash flows and financial position.
NOTE 3 - CASH AND CASH EQUIVALENTS, ACCOUNTS RECEIVABLE, COMMISSIONS PAYABLE TO BROKERS AND ACCRUED COMMISSIONS TO BROKERS
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.
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, 2007 was 18 business days. In 2008, our operating cycle and accounting cycle both ended on July 31, 2008. Therefore, commissions earned for that operating cycle were known and payable.
NOTE 4 - NOTES RECEIVABLE - CORPORATE OFFICE SALES
During 2004, we sold five corporate-owned offices to franchisees and an independent licensed broker. We facilitated these sales by issuing notes receivable to the buyers for part of the purchase prices. In the first quarter of 2007, one of these offices was sold to another broker by the existing broker. We settled the note receivable from this office from the selling broker for $328 in cash and recorded a reserve of $65 on the note. During 2007, we refinanced a note receivable at current market rates, extended the termination dates on some notes receivable and modified the periodic payments accordingly.
In the first quarter of 2008, we purchased a membership list, representing approximately two thousand member businesses, from Intagio (see Note 10 - Acquisitions). These new member businesses are located primarily in six regions in the United States, four of which were previously not served by existing Brokers. We retained three of these regions as new corporate owned prototype offices. We combined and sold two of the regions we acquired in the Intagio asset purchase to an existing franchisee for $100 ITEX dollars plus $260 USD composed of a one-time payment of $50 and a note receivable for $210 with a term of approximately seven years. Additionally, we sold a region acquired in the Intagio asset purchase for $200 to an existing franchisee who already had one of the notes receivable issued in 2004. Operating cycle payments remain the same on the note, but we extended the term to account for the $200 purchase price. Originally, the payoff date of the note was scheduled to be 2009, but after the sale, the payoff date of the note increased to 2011. We increased the principal due on that note by the present value of the payments equal to $184.
The aggregate total owed to us on July 31, 2008 is $1,090. Balances owed range from $14 to $337. Payoff dates for the loans are scheduled between 2008 and 2016.
The activity for corporate office receivables was as follows:
NOTE 5 - PROPERTY AND EQUIPMENT
The following table summarizes property and equipment:
We depreciate property and equipment using the straight-line method over the assets’ estimated useful lives. Depreciation expense for property and equipment was $49 and $43 for the years ending July 31, 2008 and 2007, respectively.
In the second quarter of 2007, we relocated our principal executive offices. Prior to our relocation, we made $52 in improvements to our new location. We amortize these leasehold improvements using the straight-line method over the term of the lease. Amortization expense for leasehold improvements as $16 and $8 for the years ending July 31, 2008 and 2007, respectively.
NOTE - INTANGIBLE ASSETS
We acquired a membership list as part of our acquisition of BXI in the fourth quarter of 2005. We acquired an additional membership list from a franchisee in the fourth quarter of 2007. In connection with our asset acquisition from Intagio in the first quarter of 2008 and ATX The Barter Company in the third quarter of 2008 (see Note 11 - Acquisions), we acquired additional membership lists and non-compete agreements. We subsequently sold part of the membership list acquired from Intagio. Changes in the carrying amount of the intangible assets are summarized as follows:
The following schedule outlines the expected intangible related amortization expense over the next six years:
NOTE 7 - NOTES PAYABLE AND LINE OF CREDIT
On August 1, 2007, we incurred a $1,137 note payable to The Intagio Group, Inc. in the form of a senior subordinated secured promissory note (see Note 10 - Acquisitions) with interest at 8.0% and repayments in 24 equal monthly installments. Our total principal repayments during 2008 were $546 leaving an outstanding balance as of July 31, 2008 of $591.
We have a revolving credit agreement to establish a $1 million line of credit facility from our primary banking institution. The maturity date of this short-term debt facility is November 30, 2008. During 2008, we borrowed and repaid $300 to fund the Intagio asset acquisition (see Note 10 - Acquisitions). Additionally, we borrowed and repaid $210 and $175 in 2008 and 2007, respectively, to meet our short term cash flow needs. There is no outstanding balance under this line of credit as of July 31, 2008. We may utilize this credit facility for short-term needs in the future.
Subsequent to July 31, 2008, we incurred a $688 note payable to The Intagio Group, Inc. in the form of a senior subordinated secured promissory note (see Note 19 - Subsequent Events) with interest at 8.0% and repayments in 11 equal monthly installments.
NOTE 8 - COMMITMENTS
We utilize leased facilities in the normal course of our business. As of July 31, 2008, the future minimum commitments under these operating leases are as follows:
The lease expense for our executive office space and corporate prototype offices for the years ended July 31, 2008 and 2007 was $232 and $134, respectively.
We have not leased any equipment in 2008 or 2007.
We have purchase commitments for telecommunications and data communications as well as for promotion and advertising. As of July 31, 2008, the future minimum commitments in both U.S. dollars and ITEX dollars under these purchase commitments are as follows:
NOTE - ITEX DOLLAR ACTIVITY
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. 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, in accordance with APB 29, were recorded at the cost basis of the trade dollars surrendered, which we have determined to be zero.
In 2008, we utilized ITEX dollars on certain products and services for corporate purposes such as legal, consulting and marketing services. We include these ITEX dollar activities on our Consolidated Statements of Income. The following ITEX dollar activity is included in our Consolidated Statements of Income for the years ending July 31, 2008 and 2007 (in thousands):
We do not include any ITEX dollar amounts on our Consolidated Balance Sheets or Consolidated Statement of Stockholders’ Equity and we do not include any ITEX dollar activities on our Consolidated Statement of Cash Flows.
NOTE 10 - ACQUISITIONS
ATX The Barter Company
On February 1, 2008, in order to increase our Marketplace member base, we acquired from ATX The Barter Company, Inc. (“ATX The Barter Company”) certain assets of a commercial trade exchange network including a membership list of approximately four hundred member businesses. These new member businesses are located in or near Cleveland, Ohio. The total acquisition cost, funded from our existing cash balances, included:
a)
USD in the amount of $325 paid to ATX The Barter Company
b)
Third party acquisition related costs of $9
The following table summarizes the purchase consideration and fair values of the assets acquired at the date of acquisition:
We have included the results of operations for ATX The Barter Company in our financial statements since February 1, 2008. We will amortize the membership list over a period of six years and the non-compete agreement over three years.
Intagio
On August 1, 2007, in order to increase our Marketplace member base, we acquired from The Intagio Group, Inc. (“Intagio”) certain assets of a commercial trade exchange network including a membership list of approximately two thousand member businesses. These new member businesses are located primarily in six regions in the United States, four of which were previously not served by existing Brokers. The total acquisition cost included:
1.
USD in the amount of $2,000 paid to Intagio
2.
Third party acquisition related costs of $47
3.
A secured promissory note in the amount of $1,137 due to the seller with interest at the rate of 8.00% and twenty-four equal monthly payments of $51.
4.
If and to the extent we achieve certain revenue targets during the four quarters beginning August 1, 2008, additional USD payments totaling up to $150.
To fund the $2,000 USD payment, we utilized $1,700 from our cash and cash equivalent balances and borrowed $300 on our line of credit. During the first quarter of 2008, we repaid the $300 balance on our line of credit in full and there was no balance outstanding as of July 31, 2008.
As of July 31, 2008, we have repaid $546 on the promissory note. Future minimum commitments under the promissory note are $591 due in 2009.
After the acquisition of the Intagio membership list, we sold three of the newly acquired regions to two existing franchisees in two separate transactions. On August 1, 2007, we sold the greater New York City region comprised of approximately 200 former Intagio member businesses to our existing franchisee in New Jersey for $200. We financed the entire sales price by adding the present value of the payments, $184, to an existing note receivable from the franchisee. We modified the repayment terms accordingly to repay the entire balance in equal payments through 2011. We recorded a reduction of goodwill and membership lists and did not record a gain or loss on this transaction.
On August 20, 2007, we sold the Connecticut and Massachusetts regions comprised of approximately 500 former Intagio member businesses to our existing franchisee in Connecticut for $260. We received $50 of the purchase price in USD and financed the remaining $210 at 7.5% interest with payments in equal installments through 2014. We recorded a reduction of goodwill and membership lists and did not record a gain or loss on this transaction.
The following table summarizes the purchase consideration and fair values of the assets acquired at the date of acquisition:
We have included the results of operations for Intagio in our financial statements since August 1, 2007. We will amortize the membership list over a period of six years and the non-compete agreement over two years.
If we had acquired Intagio on August 1, 2006, our pro-forma combined results of operations would have been:
In accordance with SFAS No. 141, Business Combinations, in the above two acquisitions, we assigned all of the acquired identifiable assets and liabilities a portion of the cost of the acquisition based on their respective fair values. In our allocation of purchase price to all identifiable assets acquired in connection with both acquisitions, we evaluated various criteria and assumptions. When estimating the fair value for all identifiable intangible assets acquired in connection with these acquisitions, our evaluation included the preparation of financial projections, supporting financial data and consideration of a number of factors, including, in the case of the Intagio acquisition, the analysis of a third-party valuation firm. We provided the third-party valuation firm with the data and analysis we utilized in our evaluation, and we reviewed drafts of their conclusions prior to making the allocations. We are responsible for the appropriateness of the estimated fair values allocated to the identifiable intangible assets including membership lists, non-compete agreements and goodwill.
NOTE 11 - LEGAL PROCEEDINGS
In October 2005, we were served with a statement of claim in Canada relating to a Marketplace dispute (Wembley Marketing Ltd. and Ariza Technology Inc. v. ITEX Corporation and Cable Network News LPLLP (“CNN”); Ontario Superior Court of Justice, Canada; Case No. 05-cv-296043PD3). Plaintiff seeks damages from us for alleged fraud or deceit or breach of contract in the amount of $1,300 Canadian. The claim relates primarily to plaintiff’s purchase of CNN advertising that plaintiff alleges was never fulfilled together with other products or services that plaintiff claims were not delivered. Except for one transaction representing approximately 26 Canadian ITEX dollars, all transactions cited in the claim were between the plaintiff and other members in the Marketplace. We are seeking enforcement of our member agreement which includes changing the venue of the action to the United States and holding us harmless from transaction disputes between members. In December 2005, we filed a motion to stay or dismiss the claim based on lack of subject matter jurisdiction pursuant to a forum selection clause in our Trading Rules. On July 24, 2006, the court stayed the action because Wembley's corporate status was cancelled at the time the action started and therefore had no status to start an action. The court also ordered the Plaintiffs' solicitor to pay the costs of the proceeding to date. Plaintiffs unsuccessfully appealed this decision. Plaintiff subsequently brought a motion for leave to lift the stay of the action and allow it to proceed. In December 2007 the plaintiffs' motion was heard and the court ordered that upon completion of the costs assessment process and payment of the costs assessed, the stay of proceedings is lifted. In April 2008, we received payment of the costs awarded. The hearing date for our motion to stay or dismiss the claim based on lack of subject matter jurisdiction pursuant to the forum selection clause in our Trading Rules was held on September 10, 2008. We await a ruling on the motion.
In June 2003, a former Broker filed a complaint against us for wrongful termination of his brokerage agreement and breach of contract in connection with the termination of plaintiff's brokerage in 1999 (Bruce Kamm v. ITEX Corporation, Supreme Court of the State of New York County of New York, Index No.: 602031/2003). Plaintiff sought damages against us in the amount of $5,000 and a preliminary injunction enjoining us from selling a New York office, previously managed by plaintiff, to any person, company or entity. In July 2003, the Court denied plaintiff's motion for a preliminary injunction. Plaintiff failed to prosecute the action, and, in May 2004, the Court administratively dismissed the action. During September 2005, the Court granted a motion from plaintiff to vacate the dismissal of his action and for leave to amend the complaint. On or about October 12, 2005, we were served with an amended complaint stating claims of breach of contract, wrongful termination of the brokerage agreement and breach of covenant of good faith and fair dealing and seeking damages in the amount of $30,000 plus attorneys' fees. In November 2005, we filed a motion to dismiss the action for lack of subject matter jurisdiction pursuant to a forum selection clause in the contract between the parties requiring litigation be filed in Oregon. Our motion to dismiss was granted on December 12, 2005. In June 2006, plaintiff re-filed in the Circuit Court of the State of Oregon, (Bruce Kamm and Invision LTD v. ITEX Corporation, Case No. 0606-05949), stating claims of breach of contract and breach of covenant of good faith and fair dealing and seeking damages in the amount of $30,000 plus attorneys’ fees. We moved the lawsuit to federal court in July 2006. Plaintiff filed a motion to remand the lawsuit to Oregon state court in August 2006 and the court ruled in favor of the motion in January 2007. We appealed the ruling and that appeal is pending in federal court. In the interim, the matter is stayed in state court except for discovery purposes. We believe the termination of plaintiff's brokerage was for proper cause.
We will vigorously defend against the lawsuits discussed above. While it is not feasible to predict the exact outcome of the proceedings, in our opinion, none of the foregoing proceedings should ultimately result in any liability that would have a material adverse effect on our results of operations, cash flows or financial position. We have not established any reserves for any potential liability relating to the foregoing litigation matters. However, litigation is subject to inherent uncertainties and unfavorable rulings could occur. If so, it could have a material adverse impact on our Consolidated Financial Statements in future periods. While it is not possible to predict the ultimate outcome of these matters, historically, we have been successful in defending ourselves against claims and suits that have been brought against us, and, generally, payments made in such claims and actions have not been material to our Consolidated Financial Statements.
From time to time we are subject to claims and litigation incurred in the ordinary course of business. In our opinion, the outcome of other pending legal proceedings, separately and in the aggregate, will not have a material adverse effect on our business operations, results of operations, cash flows or financial condition.
NOTE - SHARE-BASED COMPENSATION
We account for share-based compensation in accordance with the provisions of SFAS No. 123(R), Share-Base Payment. Under the fair value recognition provisions of SFAS No. 123(R), we estimate share-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.
We have an equity incentive plan (“2004 Plan”) which allows for grants of nonqualified and incentive stock options and stock awards to eligible employees, directors, officers or consultants. Our stockholders adopted the 2004 Plan on March 15, 2004. Under the 2004 Plan, 2,000 shares of common stock are reserved and available for grant and issuance.
During 2008 and 2007, respectively, we issued 30 and 40 shares of fully vested common stock to each of our three directors as compensation for their service to ITEX Corporation in the calendar years ended December 31, 2008 and 2007. The fair value of these shares as of the grant date was $85 and $83, respectively.
As of July 31, 2008, there are 285 shares available for future grants under the 2004 Plan.
During 2008, we retained an outside company for investment advisory and financial communications assistance. As partial compensation, we granted the company warrants with a seven year life. We calculated the fair value of these warrants using the Black-Scholes model with the following assumptions:
We determined the fair value of these warrants was $66. We defer the fair value of the warrant issued and amortize the expense over the contractual service period of thirteen months.
We recorded the following in share-based compensation as a component of selling, general and administrative expense on our Consolidated Statements of Income:
NOTE 13 - STOCKHOLDERS’ EQUITY
In addition to our common stock activity described in Note - Share-Based Compensation, to reduce the number of shares of our common stock outstanding, we repurchased a total of 203 and 438 shares of ITEX common stock in 2008, 2007, respectively
NOTE 14 - INCOME TAXES
Deferred tax assets on our balance sheet primarily include Federal and State net operating loss carryforwards (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 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.
On July 31, 2008, we had NOLs of approximately $17,545 available to offset future taxable income. These are composed of approximately $15,640 from ITEX operating losses and approximately $1,905 from BXI operating losses. SFAS No. 109 requires the future utilization to be recorded as a deferred tax asset if management believes if it is more likely than not that we will generate 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. During the fourth quarter of 2008, we performed an assessment of our available NOLs because of an additional year of increased profitability and our anticipated acquisition of certain assets of a media services company which was completed subsequent to July 31, 2008 on August 1, 2008. In that assessment, we concluded that it was more likely than not that additional NOLs would result in realizable deferred tax assets. As of July 31, 2008 and 2007, we have no valuation allowance on available Federal NOLs.
The deferred tax assets recorded in 2007 represent our estimate of all deferred tax benefits to be utilized in the current year and future periods beyond 2007. The following table reflects the reconciliation of the company’s income tax expense:
Our income tax benefit is composed of the following:
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities at July 31, 2008 and 2007 are presented below:
The following components are included in net deferred tax assets in the accompanying balance sheets:
ITEX Federal NOLs of approximately $15,640 expire, if unused, from 2018 to 2023. BXI Federal NOLs of approximately $1,905 expire, if unused, from 2020 to 2024 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. Additionally, ITEX has state NOLs for California totaling approximately $4,674 which, if unused, expire from 2012 to 2015. Additionally, we have AMT credits of $88 available to offset future taxes payable.
On August 1, 2007, we adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. (“FIN 48”). As of July 31, 2008, in accordance with FIN 48, we have recorded unrecognized tax benefits of $193 as follows:
We file income tax returns in the United States and Canadian federal jurisdictions as well as various United States state jurisdictions. The tax years that remain subject to examination are 2004 through 2007 in the United States. We also have available NOLs dating from 1998 which could be subject to examination by taxing authorities. The tax years that remain subject to examination in Canada are through 2007. We do not believe there will be any material changes in our unrecognized tax positions over the next twelve months.
As of July 31, 2008, accrued expenses for uncertain tax positions related primarily to state jurisdictions on our consolidated balance sheet of $193 included $49 for interest and penalties associated with unrecognized tax benefits.
NOTE 15 - 401(k) SAVINGS PLAN
Effective January 1, 2006, we established a 401(k) plan offered to all of our full-time employees. Eligible employees may contribute, through payroll deductions, up to the statutory limits. We match each dollar a participant contributes with a maximum contribution of six percent (6%) of a participant’s eligible compensation. We contributed approximately $67 and $54 to the plan during 2008 and 2007, respectively.
NOTE 16 - GOODWILL
As a result of our acquisition of BXI in 2005, we recorded $1,689 in goodwill. In 2008, we recorded an additional $1,513 in goodwill as a result of our asset purchase from Intagio which included $47 in acquisition costs. We subsequently reduced goodwill by $231 for sales of certain assets to existing franchisees (see Note 10 - Acquisitions). Pursuant to the terms of the BXI Agreement of Merger dated June 30, 2005, to the extent we and our subsidiaries (including BXI) achieve certain revenue targets during the first twelve full quarters following the signing of the Merger Agreement, a maximum of $450 additional payments may be payable based on earnings over these quarters (“BXI earnout”). The BXI earnout is calculated on quarterly revenue in excess of $3,000 less certain legal expenses. The maximum quarterly BXI earnout payment before deductions is $38. The BXI earnout payments can be reduced by one half of the amount we spend to satisfy certain BXI legal claims we assumed. Pursuant to the terms of the Asset Purchase Agreement dated July 25, 2007 with Intagio, we entered into an additional, but separate, earnout agreement with all of the same provisions of the BXI earnout except for the term and the payment reduction for amounts spent on legal claims (“Intagio earnout”). The Intagio earnout is not concurrent with the BXI earnout. Instead, the Intagio earnout period begins when the BXI earnout ends on July 31, 2008. The Intagio earnout term is four full quarters ending July 31, 2009. Payments on the Intagio earnout could be a maximum of $150.
As of July 31, 2008, we completed all earnout payments on the BXI earnout. Total BXI earnout payments we have made since the acquisition were $301. Subsequent to July 31, 2008, we entered into a new agreement with Intagio to purchase certain assets of a media services business on August 1, 2008 (see Note 19 - Subsequent Events). At the closing, we paid Intagio the purchase price for the August 1, 2008 transaction as well as a prepayment of $150 to satisfy, in full, our maximum post-closing obligation to Intagio for the Intagio earnout. After this payment, we have no further earnout obligations to Intagio.
Changes to goodwill were as follows:
NOTE 17 - SELECTED QUARTERLY FINANCIAL RESULTS (unaudited)
(1)
When circumstances warrant, we review our NOLs to assess whether it is more likely than not that additional NOLs would result in realizable deferred tax assets. Accordingly, in the fourth quarter of 2007, we reduced our valuation allowance on available Federal NOLs and increased deferred tax assets by $3,499.
(2)
Total net income per common share does not equal the sum of the quarters due to rounding of each quarter.
NOTE 18 - RELATED PARTY TRANSACTIONS
We have periodically engaged related parties for consulting and contract services. In aggregate, related party transactions did not exceed $50 in the years ended July 31, 2008 or 2007.
NOTE 19 - SUBSEQUENT EVENTS
Subsequent to July 31, 2008, on August 1, 2008, we acquired from The Intagio Group, Inc. certain assets of a media services company including approximately $5,000 of advertising credits. The advertising and media sector is currently the largest component of transaction volume in the ITEX Marketplace. With the new media services, we will expand our capabilities in this market sector. The acquisition cost included:
a)
Cash in the amount of $68
b)
A secured promissory note in the amount of $688 due to the seller with interest at the rate of 8.00% and eleven equal monthly payments of $65.
The following table summarizes the purchase consideration and fair values of the assets acquired at the date of acquisition:
While the purchase price allocation above is from a third-party valuation, it is preliminary and subject to final adjustment. The expected life of the membership list is ten years and the non-compete agreement is one year. At the closing, we paid Intagio the $68 cash purchase price as well as a prepayment of $150 to satisfy, in full, our maximum post-closing obligation to Intagio for the August 1, 2007 transaction (see “Note 10 - Acquisitions”). We will include the results of operations for this acquisition in our financial statements beginning August 1, 2008.
Item 9.
Item 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Item 9A(T).
Item 9A(T).
CONTROLS AND PROCEDURES
(a) Disclosure controls and procedures.
Under the supervision and with the participation of our management, including our Chief Executive Officer, who is also our interim Chief Financial Officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Disclosure controls and procedures are defined under SEC rules as controls and other procedures that are designed to ensure that information required to be disclosed by a company in reports that it files under the Exchange Act are recorded, processed, summarized and reported within the required time periods. Based on that evaluation, our Chief Executive Officer and interim Chief Financial Officer concluded that our disclosure controls and procedures are effective.
(b) Management’s Report on Internal Control over Financial Reporting.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as such term is defined in Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) which are designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management including our CEO and our CFO, as appropriate to allow timely decisions regarding required disclosure.
Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of July 31, 2008 based on the framework published by the Committee of Sponsoring Organizations of the Treadway Commission, referred to as the Internal Control-Integrated Framework. The objective of this assessment is to determine whether the Company’s internal control over financial reporting was effective as of July 31, 2008. Based on its assessment using the criteria in the Internal Control-Integrated Framework, management believes that, as of July 31, 2008, the Company’s internal control over financial reporting was effective.
This Annual Report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this Annual Report.
There are inherent limitations to the effectiveness of any system of internal control over financial reporting. Accordingly, even an effective system of internal control over financial reporting can only provide reasonable assurance with respect to financial statement preparation and presentation in accordance with accounting principles generally accepted in the United States of America. Our internal controls over financial reporting are subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of our systems, the possibility of human error and the risk of fraud. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate over time.
(c) Changes in internal control over financial reporting.
There have been no changes in our internal controls over financial reporting during our most recent quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
Item 9B.
Item 9B.
OTHER INFORMATION
None.
PART III
Item 10.
Item 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information with respect to our Directors and executive officers may be found under the captions “Election of Directors” and “Executive Officers” of our Proxy Statement for the Annual Meeting of Shareholders (the “Proxy Statement”). Information about our audit committee financial expert, audit committee and other committees of the Board may be found under the caption “Committees of the Board of Directors” in the Proxy Statement. This information is incorporated herein by reference.
The information in the Proxy Statement set forth under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” is also incorporated herein by reference.
We have adopted the ITEX Code of Ethics (the “Code of Ethics”), a code of ethics that applies to our executive officers, including financial officers, and other finance organization employees. The Code of Ethics is publicly available on our website at www.itex.com under the Investor Relations tab. If we make any substantive amendments to the Code of Ethics or grant any waiver, including any implicit waiver, from a provision of the code to our Chief Executive Officer, Chief Financial Officer or Corporate Controller, we will disclose the nature of such amendment or waiver on that website or in a report on Form 8-K.
Item 11.
Item 11.
EXECUTIVE COMPENSATION
The information in the Proxy Statement set forth under the captions “Executive Compensation” and “Compensation of Directors” is incorporated herein by reference.
Item 12.
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 “Security Ownership of Certain Beneficial Owners and Management” is incorporated herein by reference.
Item 13.
Item 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information set forth under the captions “Transactions with Related Persons” of the Proxy Statement is incorporated herein by reference.
Item 14.
Item 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information concerning principal accountant fees and services appears in the proxy statement under the heading “Fees Paid to Ehrhardt Keefe Steiner & Hottman PC” and is incorporated herein by reference.
Item 15.
Item 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
EXHIBIT INDEX
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.
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 1, 2008
By:
/s/ Steven White
Steven White, Chief Executive Officer, Interim
Chief Financial Officer and Chairman of the Board
Date: October 1, 2008
By:
/s/ John Wade
John Wade, Secretary, Treasurer, Director
Date: October 1, 2008
By:
/s/ Eric Best
Eric Best, Director