ITEM 2. MANAGEMENT’S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands, except per share amounts)
In addition to current and historical information,
this Quarterly Report on Form 10-Q contains forward-looking statements. These statements relate to our future operations, prospects,
potential products, services, developments, business strategies or our future financial performance. Forward-looking statements
reflect our expectations and assumptions only as of the date of this report and are subject to risks and uncertainties. Actual
events or results may differ materially. We have included a detailed discussion of certain risks and uncertainties that could cause
actual results and events to differ materially from our forward-looking statements in the section titled “Risk Factors”
below. We undertake no obligation to update or revise publicly any forward-looking statement after the date of this report, whether
as a result of new information, future events or otherwise.
Overview
ITEX operates a virtual currency marketplace
(the “Marketplace” in which products and services are exchanged by our members for “virtual currency” (“ITEX
dollars”) only usable in the Marketplace. We service our member businesses through our independent licensed brokers and franchise
network (individually, “broker” and together, the “Broker Network”) in the United States and Canada,. Our
virtual currency payment system allows thousands of member businesses (our “members”) to acquire products and services
without exchanging cash. We administer the Marketplace and provide record-keeping and transaction processing services for our members.
We generate revenue by charging members percentage-based transaction fees, association fees, and other fees assessed in United
States dollars and Canadian dollars where applicable (collectively and as reported on our financial statements, “USD”
or “Cash”).
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”, “2014” for August 1, 2013 to July 31, 2014,
“2013” for August 1, 2012 to July 31, 2013). Our third quarter is the three-month period from February 1, 2014 to April
30, 2014 (“three-month period ended April 30”). Our first nine months is from August 1, 2013 to April 30, 2014. We
report our results as of the last day of each calendar month (“accounting cycle”). The timing of billing and collection
activities after the end of the billing cycle does not correspond with the end of the accounting period, therefore this timing
difference results in the fluctuations of the balances of cash, accounts receivable, commissions payable and accrued commissions
on the consolidated balance sheet and consolidated statement of cash flows.
Each operating cycle we generally charge
our members association fees of $20 USD ($260 USD annually) and $10 ITEX dollars ($130 ITEX dollars annually). We also charge transaction
fees in USD from both the buyer and seller computed as a percentage of the ITEX dollar value of the transaction.
The following summarizes our operational
and financial highlights for the quarter and our outlook (in thousands except per share data):
Comparative Results
. For the
three-months ended April 30, 2014, as compared to the three-months ended April 30, 2013, our revenue decreased by $261, or 8%,
from $3,475 to $3,214, our income from operations decreased by $148, or 42%, from $354 to $206, and our net income decreased by
$103, or 40% from $258 to $155. For the nine-month period ended April 30, 2014, as compared to the nine-month period ended April
30, 2013, our revenue decreased by $810, or 7%, from $11,146 to $10,336 and our income from operations decreased by $537, or 45%,
from $1,186 to $649 and our net income decreased by $370 or 43% from $864 to $494.
|
·
|
Revenue Trends
.
Compared to 2013, we experienced an 8% downturn in revenue for the nine-months ended April 30,
2014 due to the reduction in our transaction volume and a reduction in our membership base. This continues a trend in which our
revenue decreased by 6% in 2013 compared to 2012, and by 4% in 2012 compared to 2011. We believe there is a general decline in transaction volume reflecting customer access to more sales channel options, plus ease of purchasing power from big box stores
and many Internet sites featuring discounted pricing. Furthermore, as small businesses with less than ten employees, our primary
customers remain vulnerable in a difficult economic environment, with strained or insufficient cash flow being a major impediment
to growth. Although we seek to increase revenues through organic growth and the development of new revenue sources, historically
the primary driver of revenue growth has been through our business acquisitions. These acquisitions are intermittent and cannot
be relied upon as a future source of revenue growth, either because of the absence of acquisition candidates, lack of financing,
or unacceptable terms. We have approximately 30% recurring revenues from fixed association fees. Approximately two-thirds of our
net revenues each quarter come from variable transaction fees. We continue to work to expand our membership base which we believe,
if successful, will increase recurring and transactional revenues. We seek to increase our revenue by:
|
|
o
|
marketing the benefits of participation in the Marketplace
|
|
o
|
enhancing our internet applications;
|
|
o
|
developing a smart phone application to easily register new members; and
|
|
o
|
licensing our virtual currency platform to third parties.
|
|
·
|
Corporate-owned Offices
.
Since October 31, 2012 and for the period ending April 30, 2014, the ITEX Marketplace
was 100% broker managed with no corporate-owned locations. As a general operating philosophy, we depend on the ability of our brokers
to enroll new members, train them in the use of the Marketplace, grow our transactional volume by facilitating business among members,
manage member relationships, provide members with information about ITEX products and services, and assure the payment of our dues
and fees. Our broker model requires less capital investment and lower operating expenses than if we operated the offices in our
network directly. From time to time, we complement our Broker Network with corporate-owned locations, acquired either as a result
of business acquisitions or as a result of ensuring the orderly transition of broker locations. Part of our strategy when we acquire
exchange members is to incubate the asset with corporate direction and assistance, flush out non-performing members, synchronize
fee plans, and then transfer certain management rights to these members to new or existing franchisees, with the contractual rights
and revenues generated by these members remaining with ITEX. The result is a wider member base, managed by new franchisees, and
a member list asset that continues to be owned by ITEX.
|
|
·
|
Internet Applications
and Web Services
. We continually enhance our internet applications and web services
to make our online services more user friendly to our employees, brokers and members,
and to create confidence in the Marketplace. We continue to upgrade our payment processing
and team software with .NET technologies. We refresh the content at our website
www.itex.com
to better tell our story and make it more community driven. With virtual currencies
receiving increasing interest from investors, businesses and governments, we are seeking
potential revenue opportunities by licensing our virtual currency platform to third parties.
|
|
·
|
Smart Phone technology.
We seek to provide useful tools to members to enable them to expand their trading community,
find local customers and instantly complete transactions through a mobile device. During the 4
th
quarter we plan to
launch a Smart Phone application with ITEXpay
SM
which will enable our members to easily register new prospects into
our Marketplace and complete a transaction.
|
|
·
|
Financial Position
. At April 30, 2014, we had a cash balance of $3,267, compared to a balance of $3,352 at July
31, 2013. Our net cash flows provided by operating activities were $796 for the nine-month period ended April 30, 2014, compared
to $1,016 for the corresponding period the previous year. Our business model has demonstrated the ability to generate consistent
cash flows, which have historically supplied us with our primary source of liquidity. In February 2013, we increased our quarterly
cash dividend 25% to $0.05 per share. We seek to maintain a liquidity cushion sufficient to fund our business activity and handle
contingencies, while preserving the ability to return cash to our stockholders through dividends and share buybacks. However, our
Board of Directors may decide to use capital for acquisitions, revenue generating opportunities or other corporate purposes. See
Risk Factor below “
Our ability to pay dividends on our common stock is subject to the discretion of our Board of Directors
and may be limited by our lack of liquidity or access to capital.
”
|
RESULTS OF OPERATIONS
Condensed Results (in thousands, except per share data):
|
|
Three-months ended
April 30,
|
|
|
Nine-months ended
April 30,
|
|
|
|
2014
|
|
|
2013
|
|
|
2014
|
|
|
2013
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
Marketplace revenue and other revenue
|
|
$
|
3,214
|
|
|
$
|
3,475
|
|
|
$
|
10,336
|
|
|
$
|
11,146
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of marketplace revenue
|
|
$
|
1,915
|
|
|
$
|
2,171
|
|
|
$
|
6,360
|
|
|
$
|
7,083
|
|
Operating expenses
|
|
|
1,093
|
|
|
|
950
|
|
|
|
3,327
|
|
|
|
2,877
|
|
Income from operations
|
|
|
206
|
|
|
|
354
|
|
|
|
649
|
|
|
|
1,186
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense)
|
|
|
24
|
|
|
|
24
|
|
|
|
83
|
|
|
|
84
|
|
Income before income taxes
|
|
|
230
|
|
|
|
378
|
|
|
|
732
|
|
|
|
1,270
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes
|
|
|
75
|
|
|
|
120
|
|
|
|
238
|
|
|
|
406
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
155
|
|
|
$
|
258
|
|
|
$
|
494
|
|
|
$
|
864
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.06
|
|
|
$
|
0.10
|
|
|
$
|
0.19
|
|
|
$
|
0.33
|
|
Diluted
|
|
$
|
0.06
|
|
|
$
|
0.10
|
|
|
$
|
0.19
|
|
|
$
|
0.33
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average common and equivalent shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
2,623
|
|
|
|
2,619
|
|
|
|
2,618
|
|
|
|
2,617
|
|
Diluted
|
|
|
2,628
|
|
|
|
2,622
|
|
|
|
2,618
|
|
|
|
2,620
|
|
Revenue for the three-months ended April
30, 2014, as compared to the corresponding period of fiscal 2013 decreased by $261, or 8%. Revenue for the nine-month period ended
April 30, 2014, as compared to the corresponding nine-month period of fiscal 2013, decreased by $810, or 7%. The decrease in revenues
for the three and nine-months ended April 30, 2014 was from a reduction in transaction volume along with a reduction in our membership
base.
Cost of Marketplace revenue which includes
association and transaction commissions paid to brokers, corporate-owned office expense and other Marketplace related expenses
decreased by $256, or 12% for the three-month period ended April 30, 2014, compared to the corresponding period of fiscal 2013.
Cost of Marketplace revenue decreased by $723, or 10% for the nine-month period ended April 30, 2014, compared to the corresponding
period of fiscal 2013. The cost of Marketplace revenue decreases for both periods were in line with the corresponding decrease
in revenue.
Operating expenses which include corporate
salaries, wages and employee benefits, selling, general and administrative, depreciation and amortization increased by $143, or
15% for the three-months ended April 30, 2014, compared to the corresponding period of fiscal 2013. Operating expenses increased
by $450, or 16% for the nine-month period ended April 30, 2014, compared to the corresponding period of fiscal 2013.
The increase in operating expenses in the
three-months ended April 30, 2014, as compared to the corresponding period of fiscal 2013, resulted from a $136 increase in selling,
general and administrative expense, and a $49 increase in salaries, wages and benefits offset somewhat by a $42 decrease in depreciation
and amortization.
The increase in operating expenses in the
nine-months ended April 30, 2014, as compared to the corresponding period of fiscal 2013, resulted from a $235 increase in corporate
salaries, wages and benefits and $316 increase in selling, general and administrative expense offset somewhat by a decrease of
$101 in depreciation and amortization.
Income from operations for the three-months
ended April 30, 2014, as compared to the corresponding quarter of fiscal 2013, decreased by $148, or 42%. Income from operations
for the nine-month period ended April 30, 2014, as compared to the corresponding period of fiscal 2013, decreased by $537, or 45%.
Net income for the three-months ended April
30, 2014, as compared to the corresponding period of fiscal 2013, decreased by $103, or 40%. Net income for the nine-month period
ended April 30, 2014, as compared to the corresponding period of fiscal 2013, decreased by $370, or 43%.
Earnings per share, both basic and diluted,
decreased by $0.04, or 40% to $0.06 per share in the three-months ended April 30, 2014 compared to the three-months ended April
30, 2013. Earnings per share, both basic and diluted, decreased $0.14, or 42% to $0.19 per share for the nine-month period ended
April 30, 2014 compared to the nine-month period ended April 30, 2013.
Revenue, Costs and Expenses
The following table sets forth our selected
consolidated financial information for the three-months ended April 30, 2014 and 2013 with amounts expressed as a percentage of
total revenues (in thousands) (unaudited):
|
|
Three-months ended April 30,
|
|
|
Nine-months ended April 30,
|
|
|
|
2014
|
|
|
2013
|
|
|
2014
|
|
|
2013
|
|
|
|
Amount
|
|
|
Percent
|
|
|
Amount
|
|
|
Percent
|
|
|
Amount
|
|
|
Percent
|
|
|
Amount
|
|
|
Percent
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketplace revenue and other revenue
|
|
$
|
3,214
|
|
|
|
100
|
%
|
|
$
|
3,475
|
|
|
|
100
|
%
|
|
$
|
10,336
|
|
|
|
100
|
%
|
|
$
|
11,146
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of Marketplace revenue
|
|
|
1,915
|
|
|
|
60
|
%
|
|
|
2,171
|
|
|
|
62
|
%
|
|
|
6,360
|
|
|
|
62
|
%
|
|
|
7,083
|
|
|
|
63
|
%
|
Salaries, wages and employee benefits
|
|
|
588
|
|
|
|
18
|
%
|
|
|
539
|
|
|
|
16
|
%
|
|
|
1,736
|
|
|
|
17
|
%
|
|
|
1,501
|
|
|
|
13
|
%
|
Selling, general and administrative
|
|
|
481
|
|
|
|
15
|
%
|
|
|
345
|
|
|
|
10
|
%
|
|
|
1,495
|
|
|
|
14
|
%
|
|
|
1,179
|
|
|
|
11
|
%
|
Depreciation and amortization
|
|
|
24
|
|
|
|
1
|
%
|
|
|
66
|
|
|
|
2
|
%
|
|
|
96
|
|
|
|
1
|
%
|
|
|
197
|
|
|
|
2
|
%
|
|
|
|
3,008
|
|
|
|
94
|
%
|
|
|
3,121
|
|
|
|
90
|
%
|
|
|
9,687
|
|
|
|
94
|
%
|
|
|
9,960
|
|
|
|
89
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
206
|
|
|
|
6
|
%
|
|
|
354
|
|
|
|
10
|
%
|
|
|
649
|
|
|
|
6
|
%
|
|
|
1,186
|
|
|
|
11
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income, net
|
|
|
24
|
|
|
|
1
|
%
|
|
|
25
|
|
|
|
1
|
%
|
|
|
83
|
|
|
|
1
|
%
|
|
|
85
|
|
|
|
1
|
%
|
Gain on sale of assets, net
|
|
|
0
|
|
|
|
0
|
%
|
|
|
(1
|
)
|
|
|
0
|
%
|
|
|
0
|
|
|
|
0
|
%
|
|
|
(1
|
)
|
|
|
0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
230
|
|
|
|
7
|
%
|
|
|
378
|
|
|
|
11
|
%
|
|
|
732
|
|
|
|
7
|
%
|
|
|
1,270
|
|
|
|
12
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes
|
|
|
75
|
|
|
|
2
|
%
|
|
|
120
|
|
|
|
4
|
%
|
|
|
238
|
|
|
|
2
|
%
|
|
|
406
|
|
|
|
4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
155
|
|
|
|
5
|
%
|
|
$
|
258
|
|
|
|
7
|
%
|
|
$
|
494
|
|
|
|
5
|
%
|
|
$
|
864
|
|
|
|
8
|
%
|
Marketplace revenue
Marketplace revenue consists of transaction
fees, association fees and other revenues. Other revenue includes late fees, finance charges and ITEX dollar revenue. The following
are the components of Marketplace revenue that are included in the consolidated statements of income (in thousands) (unaudited):
|
|
Three-months ended
April 30,
|
|
|
Percent
increase
|
|
|
Nine-months ended
April 30,
|
|
|
Percent
increase
|
|
|
|
2014
|
|
|
2013
|
|
|
(decrease)
|
|
|
2014
|
|
|
2013
|
|
|
(decrease)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Transaction fees
|
$
|
2,004
|
|
|
$
|
2,302
|
|
|
-13
|
%
|
|
$
|
6,627
|
|
|
$
|
7,454
|
|
|
-11
|
%
|
Association fees
|
|
|
1,039
|
|
|
|
1,094
|
|
|
|
-5
|
%
|
|
|
3,241
|
|
|
|
3,403
|
|
|
|
-5
|
%
|
Other revenue
|
|
|
171
|
|
|
|
79
|
|
|
|
116
|
%
|
|
|
468
|
|
|
|
289
|
|
|
|
62
|
%
|
|
|
$
|
3,214
|
|
|
$
|
3,475
|
|
|
|
-8
|
%
|
|
$
|
10,336
|
|
|
$
|
11,146
|
|
|
|
-7
|
%
|
Marketplace revenue decreased by $261, or
8%, for the three-months ended April 30, 2014, as compared to the corresponding period ended April 30, 2013. Marketplace revenue
decreased by $810, or 7% for the nine-month period ended April 30, 2014, as compared to the nine-month period ended April 30, 2013.
Transaction fee revenue for the three-months
ended April 30, 2014, as compared to the corresponding quarter of fiscal 2013, decreased by $298, or 13%. Transaction fee revenue
for the nine-month period ended April 30, 2014, as compared to the corresponding period of fiscal 2013, decreased by $827, or 11%.
The decrease for both the three and the nine-month periods is the result of the decrease in the volume of transactions that took
place in the Marketplace. We believe there is a general decline in Marketplace transaction volume reflecting customer access to
more sales channel options, plus ease of purchasing power from big box stores and many Internet sites featuring discounted pricing.
Association fee revenue for the three-months
ended April 30, 2014, as compared to the corresponding quarter of fiscal 2013, decreased by $55, or 5%. Association fee revenue
for the nine-month period ended April 30, 2014, as compared to the corresponding period of fiscal 2013, decreased by $162, or 5%.
The decrease for both the three and nine-month periods is the result of a decrease in the net members participating in the Marketplace.
Other revenue for the three-months ended April 30, 2014, as
compared to the corresponding quarter of fiscal 2013, increased by $92, or 116%. Other revenue for the nine-months ended April
30, 2014, as compared to the corresponding quarter of fiscal 2013, increased by $179, or 62%. The primary reason for the increase
for both the three and nine-month periods is the result of an increase in the use of ITEX dollars used for corporate purposes (see
the next section “
ITEX Dollar Revenue”
for a discussion on how ITEX dollars are used and recorded in our financial
statements).
ITEX Dollar Revenue
As described in notes to our consolidated
financial statements, we receive ITEX dollars from members’ transaction and association fees, and, to a lesser extent, from
other member fees. ITEX dollars earned from members are later used by us as a method of payment in revenue sharing and incentive
arrangements with our Broker Network, including co-op advertising, as well as for certain general corporate and Marketplace expenses.
ITEX dollars are only usable in our Marketplace
and are not convertible to USD.
We have implemented measures to maintain
the integrity of our role in the Marketplace economy, and to protect against the misuse or misappropriation of ITEX dollars. For
example:
|
·
|
All ITEX dollar purchases for corporate and Marketplace purposes are approved by senior management.
|
Occasionally we spend ITEX dollars in the
Marketplace for our corporate needs. As discussed in the notes to our consolidated financial statements, we record ITEX dollar
revenue in the amounts equal to expenses we incurred and paid for in ITEX dollars. We recorded $112 and $20 as ITEX dollar revenue
for the three-months ended April 30, 2014 and 2013, respectively. We recorded $260 and $128 as ITEX dollar revenue for the nine-months
ended April 30, 2014 and 2013, respectively.
The corresponding ITEX dollar expenses in
the three and nine-month periods ending April 30, 2014 were for equipment, legal services, printing, outside services, marketing
and miscellaneous expenses. We plan to continue to utilize ITEX dollars for our corporate purposes in future periods.
Costs of Marketplace Revenue
Cost of Marketplace revenue consists of
commissions paid to brokers, salaries and employee benefits of our corporate-owned offices, payment of processing fees and other
expenses directly correlated to Marketplace revenue. The following are the main components of cost of Marketplace revenue that
are included in the consolidated statements of income (in thousands) (unaudited):
|
|
Three-months ended
April 30,
|
|
|
Percent
increase
|
|
|
Nine-months ended
April 30,
|
|
|
Percent
|
|
|
|
2014
|
|
|
2013
|
|
|
(decrease)
|
|
|
2014
|
|
|
2013
|
|
|
(decrease)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Transaction fee commissions
|
|
$
|
1,485
|
|
|
$
|
1,717
|
|
|
|
-14
|
%
|
|
$
|
4,978
|
|
|
$
|
5,618
|
|
|
|
-11
|
%
|
Association fee commissions
|
|
|
366
|
|
|
|
395
|
|
|
|
-7
|
%
|
|
|
1,162
|
|
|
|
1,239
|
|
|
|
-6
|
%
|
Corporate-owned office costs
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
7
|
|
|
|
-100
|
%
|
Other costs of revenue
|
|
|
64
|
|
|
|
59
|
|
|
|
8
|
%
|
|
|
220
|
|
|
|
219
|
|
|
|
0
|
%
|
|
|
$
|
1,915
|
|
|
$
|
2,171
|
|
|
|
-12
|
%
|
|
$
|
6,360
|
|
|
$
|
7,083
|
|
|
|
-10
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Costs of Marketplace revenue as percentage of total revenue
|
|
|
60
|
%
|
|
|
62
|
%
|
|
|
|
|
|
|
62
|
%
|
|
|
64
|
%
|
|
|
|
|
Costs of Marketplace revenue for the three-months
ended April 30, 2014, as compared to the three-months ended April 30, 2013, decreased by $256, or 12%. Costs of Marketplace revenue
for the nine-month period ended April 30, 2014, as compared to nine-month period ended April 30, 2013, decreased by $723, or 10%.
The overall decrease in costs of Marketplace revenue corresponds to the decrease in total Marketplace revenue for the same periods.
Costs of Marketplace revenue as a percentage of total revenue decreased slightly for both the three and nine-month periods ended
April 2014 primarily due to the increase in other revenue during 2014 as other revenue has no associated cost of marketplace revenue.
Transaction fee commissions decreased by
$232 or 14% for the three-months ended April 30, 2014, as compared to the corresponding period of fiscal 2013. Transaction fee
commissions decreased by $640 or 11% for the nine-month period ended April 30, 2014 as compared to the corresponding period of
fiscal 2013. The decrease in transaction fee commissions for both the three and nine-month periods is due to similar decreases
in the transaction fee revenue.
Association fee commissions decreased by
$29 and $77, or 7% and 6%, respectively for the three and nine-month periods ended April 30, 2014 as compared to the corresponding
periods of fiscal 2013. The decrease in association commissions was primarily due to the decrease in association fee revenue for
the same periods.
Corporate-owned office costs consist of
compensation and operating expenses. Corporate-owned office costs decreased by $7 for the nine-month periods ended April 30, 2014
as compared to the corresponding period of fiscal 2013. The decrease is due to elimination of expenses associated with the costs
of managing our corporate-owned stores as a result of the sale of these offices in the prior period.
Other costs of revenue consist of miscellaneous
Marketplace-related expenses such as broker computer upgrades, marketing and credit card processing fees along with other commissions
not associated with association or transaction revenue. Other costs of revenue increased by $5 and $1 or 8% and 0%, respectively
for the three and nine-month periods ended April 30, 2014 as compared to the corresponding periods of fiscal 2013.
Corporate Salaries, Wages and Employee
Benefits
Salaries, wages and employee benefits include
expenses for corporate employee salaries and wages, payroll taxes, payroll related insurance, healthcare benefits, stock-based
compensation, recruiting costs and other personnel related items. As discussed above in “ITEX Dollar Revenue,” certain
ITEX dollar expenses are also included. Comparative results are as follows (in thousands) (unaudited):
|
|
Three-months ended
April 30,
|
|
|
Percent
|
|
|
Nine-months ended
April 30,
|
|
|
Percent
|
|
|
|
2014
|
|
|
2013
|
|
|
increase
|
|
|
2014
|
|
|
2013
|
|
|
increase
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate salaries, wages and employee benefits
|
|
$
|
588
|
|
|
$
|
539
|
|
|
|
9
|
%
|
|
$
|
1,736
|
|
|
$
|
1,501
|
|
|
|
16
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate salaries, wages and employee benefits as percentage of total revenue
|
|
|
18
|
%
|
|
|
16
|
%
|
|
|
|
|
|
|
17
|
%
|
|
|
13
|
%
|
|
|
|
|
Salaries, wages and employee benefits increased
by $49, or 9%, for the three-month period ended April 30, 2014 and increased by $235 or 16%, for the nine-month period ended April
30, 2014 as compared to the corresponding periods of fiscal 2013. The increase in both periods is primarily related to a stock
grant issued to an executive during the second quarter of 2014 and adding one employee who was previously a contractor in the prior
period.
Selling, General and Administrative Expenses
Selling, general and administrative expenses
include consulting, legal and professional services, as well as expenses for rent and utilities, marketing, business travel, insurance,
bad debts, business taxes, and other expenses. As discussed above in “ITEX Dollar Revenue”, certain ITEX dollar expenses
are also included. Comparative results are as follows (in thousands) (unaudited):
|
|
Three-months ended
April 30,
|
|
|
Percent
|
|
|
Nine-months ended
April 30,
|
|
|
Percent
|
|
|
|
2014
|
|
|
2013
|
|
|
increase
|
|
|
2014
|
|
|
2013
|
|
|
increase
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative expenses
|
|
$
|
481
|
|
|
$
|
345
|
|
|
|
39
|
%
|
|
$
|
1,495
|
|
|
$
|
1,179
|
|
|
|
27
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative expenses as percentage of total revenue
|
|
|
15
|
%
|
|
|
10
|
%
|
|
|
|
|
|
|
14
|
%
|
|
|
11
|
%
|
|
|
|
|
Selling, general and administrative
expenses increased by $136 and by $316, or 39% and 27%, respectively, for the three and nine-month periods ended April 30, 2014,
as compared to the three and nine-month periods ended April 30, 2013.
The increase is due primarily
to an increase in legal fees, supplies, unfavorable foreign currency exchange rates and bad debt. Legal fees for the three and
nine-month periods ended April 30, 2014 increased by $56 and by $122, or 160% and 81%, respectively, compared to the three and
nine-months ended April 30, 2013 as we incurred additional legal expenses surrounding intellectual property rights. Supplies, which
primarily includes costs associated with our use of ITEX dollars for business purposes, for the three and nine-month periods ended
April 30, 2014 increased by $90 and by $139, or 300% and 100%, foreign currency expense for the nine-month period ended April 30,
2014 increased by $44 due to the Canadian dollar declining in value against the US dollar, and bad debt expense for the nine-month
period ended April 30, 2014 increased by $50, or 33%.
Depreciation and Amortization
Depreciation and amortization expenses include
depreciation on our fixed assets and amortization of our intangible assets, including intangible assets obtained in business combinations.
Comparative results are as follows (in thousands) (unaudited):
|
|
Three-months ended
April 30,
|
|
|
Percent
|
|
|
Nine-months ended
April 30,
|
|
|
Percent
|
|
|
|
2014
|
|
|
2013
|
|
|
decrease
|
|
|
2014
|
|
|
2013
|
|
|
decrease
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
$
|
24
|
|
|
$
|
66
|
|
|
|
-64
|
%
|
|
$
|
96
|
|
|
$
|
197
|
|
|
|
-51
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization as percentage of total revenue
|
|
|
1
|
%
|
|
|
2
|
%
|
|
|
|
|
|
|
1
|
%
|
|
|
2
|
%
|
|
|
|
|
Depreciation and amortization decreased
by $42 and $101, or 64% and 51%, respectively for the three and the nine-month periods ended April 30, 2014, as compared to the
three and the nine-month periods ended April 30, 2013. There have been no material additions of property and equipment and intangible
assets in 2014, which along with expiring intangible asset amortization periods has resulted in a decreased amount of depreciation
and amortization.
Other income
Other income includes interest received
on notes receivable and promissory notes, and certain one-time gains.
Comparative results are as follows (in thousands)
(unaudited):
|
|
Three-months ended
April 30,
|
|
|
Percent
|
|
|
Nine-months ended
April 30,
|
|
|
Percent
|
|
|
|
2014
|
|
|
2013
|
|
|
decrease
|
|
|
2014
|
|
|
2013
|
|
|
decrease
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
$
|
24
|
|
|
$
|
25
|
|
|
|
-4
|
%
|
|
$
|
83
|
|
|
$
|
85
|
|
|
|
-2
|
%
|
Loss on sale of assets
|
|
|
-
|
|
|
|
(1
|
)
|
|
|
-100
|
%
|
|
|
-
|
|
|
|
(1
|
)
|
|
|
-100
|
%
|
Other income
|
|
$
|
24
|
|
|
$
|
24
|
|
|
|
0
|
%
|
|
$
|
83
|
|
|
$
|
84
|
|
|
|
-1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income, as percentage of total revenue
|
|
|
1
|
%
|
|
|
1
|
%
|
|
|
|
|
|
|
1
|
%
|
|
|
1
|
%
|
|
|
|
|
Interest income is derived primarily from
our notes receivable for corporate office sales and general loans to brokers. From time to time, as part of our initiative to support
brokers and as a way to generate return on capital; we provide loans to our brokers. Each loan is primarily secured by the broker’s
ITEX office. Other income for the three and nine-month periods ended April 30, 2013 includes a loss of $1 on the disposition of
fixed assets.
Income Taxes
Comparative results are as follows (in thousands)
(unaudited):
|
|
Three-Months ended April 30
|
|
|
Nine-months ended April 30,
|
|
|
|
2014
|
|
|
2013
|
|
|
2014
|
|
|
2013
|
|
|
|
Amount
|
|
|
Rate
|
|
|
Amount
|
|
|
Rate
|
|
|
Amount
|
|
|
Rate
|
|
|
Amount
|
|
|
Rate
|
|
Expected tax provison at federal statutory rate
|
|
$
|
80
|
|
|
|
35
|
%
|
|
$
|
130
|
|
|
|
34
|
%
|
|
$
|
256
|
|
|
|
35
|
%
|
|
$
|
439
|
|
|
|
35
|
%
|
State income taxes
|
|
|
(5
|
)
|
|
|
-2
|
%
|
|
|
(10
|
)
|
|
|
-2
|
%
|
|
|
(18
|
)
|
|
|
-2
|
%
|
|
|
(33
|
)
|
|
|
-3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes
|
|
$
|
75
|
|
|
|
33
|
%
|
|
$
|
120
|
|
|
|
32
|
%
|
|
$
|
238
|
|
|
|
33
|
%
|
|
$
|
406
|
|
|
|
32
|
%
|
The Federal effective tax rate related to
our provision for income taxes in the three and nine-months ended April 30, 2014 is similar to that used in the same periods ending
April 30, 2013. The State effective tax rate related to our provision for income taxes in the three and nine-months ended April
30, 2014 is lower than that used in the three and nine-month periods ending April 30, 2013, due to the resolution of certain state
tax positions which led to a reduction in the accrued expenses on our consolidated balance sheet for uncertain tax positions related
primarily to state jurisdictions.
We recognized a $75 and $238 provision for
income taxes, in the three and nine-month periods ended April 30, 2014, respectively, as compared to the $120 and $406 provision
for income taxes in the three and nine-month periods ended April 30, 2013. Provision for income taxes decreased by $45 for the
three-months ended April 30, 2014, as compared to the corresponding period of fiscal 2013. The provision for income taxes decreased
by $168 for the nine-month period ended April 30, 2014, as compared to the corresponding period of fiscal 2013, due to the corresponding
decrease in pre-tax income due to the resolution of certain state tax positions.
LIQUIDITY AND CAPITAL RESOURCES
We finance ongoing
operations primarily with cash provided by our operating activities. Our principal sources of liquidity are cash flows provided
by operating activities, existing cash and cash equivalents, and a line of credit facility. As of April 30, 2014 and July 31, 2013,
we had $3,267 and $3,352, respectively, in cash. Additionally, we have a revolving credit agreement to establish a $1,000 line
of credit facility from our primary banking institution, U.S. Bank (“line of credit”). The current line of credit agreement
expires in November 2014. We had no outstanding balance on our line of credit as of April 30, 2014.
The following table
presents a summary of our cash flows for the nine-months ended April 30, 2014 and 2013 (in thousands) (unaudited):
|
|
Nine-months ended April 30,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
Cash provided by operating activities
|
|
$
|
796
|
|
|
$
|
1,016
|
|
Cash (used in) provided by investing activities
|
|
|
(138
|
)
|
|
|
127
|
|
Cash used in financing activities
|
|
|
(743
|
)
|
|
|
(398
|
)
|
(Decrease)/ increase in cash
|
|
$
|
(85
|
)
|
|
$
|
745
|
|
We have financed our operational needs through
cash flow generated from operations. We used operational cash flow for routine operating expenses, membership list purchases, loans
to brokers, stock buybacks and quarterly dividend payments to common stockholders.
As part of our contemplated future expansion
activities and our evaluation of strategic alternatives and opportunities, we may seek to acquire certain competitors or other
business to business enterprises, or consider partnering or other collaboration agreements, or a merger or other strategic transaction.
Such alliances, mergers or acquisitions or dispositions could result in potentially dilutive issuances of our equity securities,
the expenditure of our cash or the incurrence of debt or contingent liabilities. We expect that our current working capital would
be adequate for this purpose. However, we may seek to finance a portion of the acquisition cost subject to the consent of any secured
creditors. We believe that our financial condition is stable and that our cash balances, other liquid assets, and cash flows from
operating activities provide adequate resources to fund ongoing operating requirements.
Inflation has not had a material impact
on our business. Inflation affecting the U.S. dollar is not expected to have a material effect on our operations in the foreseeable
future.
Operating Activities
For the nine-months ended April 30, 2014, net cash provided by operating activities was $796 compared
with $1,016 in the nine-months ended April 30, 2013 a decrease of $220, or 22%. The decrease in net cash provided by the operating
activities is primarily the result of a decrease in net income and accounts receivable, offset by a decrease in commission payable
and accrued commissions to brokers.
The difference
between our net income and our net cash provided by operating activities was attributable to non-cash expenses included in net
income, and changes in the operating assets and liabilities, as presented below (in thousands) (unaudited):
|
|
Nine-months ended April 30,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
494
|
|
|
$
|
864
|
|
Add: non-cash expenses
|
|
|
634
|
|
|
|
841
|
|
Add: changes in operating assets and liabilities
|
|
|
(332
|
)
|
|
|
(689
|
)
|
Net cash provided by operating activities
|
|
$
|
796
|
|
|
$
|
1,016
|
|
Non-cash expenses
are primarily associated with the amortization of intangible assets, depreciation and amortization of property and equipment, stock-based
compensation, changes in the deferred portion of the provision (benefit) for income taxes and gain on sale of assets.
Changes in operating assets and liabilities
primarily reflect changes in working capital components of the balance sheet apart from cash and cash equivalents. Net cash provided
by operating activities also reflects changes in some non-current components of the balance sheet, such as long-term deferred rent
and non-current prepaid expenses and deposits.
As discussed earlier in the overview section
of our Management’s Discussion and Analysis of Financial Condition and Results of Operations, for each calendar year, we
divide our operations into 13 four-week billing and commission cycles always ending on a Thursday, while we report our financial
results as of the last day of each calendar month. The timing of billing and collection activities after the end of the billing
cycle does not correspond with the end of the accounting period, therefore this timing difference results in the fluctuations of
the balances of cash, accounts receivable, commissions payable and accrued commissions.
Investing Activities
Net cash (used in) provided by investing
activities was primarily the result of business acquisitions or sales, purchase of property and equipment and intangible assets,
the collections on notes receivable from corporate office sales and broker loans.
For the nine-months ended April 30, 2014,
net cash provided used in investing activities was $138 compared with $127 provided by investing activities in the nine-months
ended April 30, 2013, a decrease of $265, or 209%. In the nine-months ended April 30, 2014, the net cash used in investing activities
was primarily related to $442 in loans made to brokers and $47 used for the purchase of property and equipment offset by $353 in
note receivable principal collections. In the nine-months ended April 30, 2013, the net cash provided by investing activities was
primarily related to $261 in note receivable principal collections offset by $146 in loans made to brokers.
Financing Activities
Our net cash used in financing activities
consists of cash dividends to stockholders, discretionary repurchases of our common stock and principal payments on stockholders’
notes receivable.
For the nine-months ended April 30, 2014, net cash used in financing activities was $743 compared with
$398 used in financing activities in the nine-months ended April 30, 2013, an increase of cash used in financing activities of
$345, or 86%.
In the nine-months ended April 30, 2014,
the net cash used in investing activities was $435 in cash dividends to our stockholders and $351 to repurchase 83 shares of our
common stock through our stock repurchase program offset by $44 received in principal payments on stockholder notes receivable.
In the nine-months ended April 30, 2013, the net cash used in investing activities was $384 in
cash
dividends to our stockholders, and $89 to repurchase 24 shares of our common stock through our stock repurchase program, offset
by $44 received in principal payments on stockholders notes receivable.
Commitments
We lease office
space under operating leases. Lease commitments include the lease for our corporate headquarters in Bellevue, Washington. The lease
for the corporate headquarters expires on April 30, 2015.
In addition to
the lease commitments, we are a party to several non-cancelable and non-refundable purchase commitments. Those purchase obligations
consist primarily of arrangements for telecommunications and co-location services for our network operations. Our contractual commitments
at April 30, 2014 are presented below (in thousands) (unaudited):
Year ending July 31,
|
|
Operating
leases
|
|
|
Purchase
commitments
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
2014 (1)
|
|
|
42
|
|
|
|
3
|
|
|
|
45
|
|
2015
|
|
|
127
|
|
|
|
2
|
|
|
|
129
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
169
|
|
|
$
|
5
|
|
|
$
|
174
|
|
———-
(1)
|
|
The expected payments for 2014 reflect future minimum payments for the three-month period from May 1, 2014 to July 31, 2014.
|
We also have a revolving credit agreement
to establish a $1,000 line of credit facility from our primary banking institution, U.S. Bank (“line of credit”). The
current line of credit agreement expires in November 2014. We had no outstanding balance on our line of credit as of April 30,
2014.
Critical Accounting Policies and Estimates
Our discussion
and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of financial statements
in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions
that affect the amounts reported in the consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate
significant estimates used in preparing our financial statements, including those related to:
|
·
|
revenue recognition, including allowances for uncollectible accounts;
|
|
·
|
accounting for ITEX dollar activities;
|
|
·
|
the allocation of purchase price in business combinations;
|
|
·
|
valuation of notes receivable;
|
|
·
|
accounting for goodwill and other long-lived intangible assets;
|
|
·
|
accounting for income taxes;
|
|
·
|
share-based compensation; and
|
We base our estimates on historical experience
and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis
for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates if our assumptions change or if actual circumstances differ from those in our assumptions.
For a summary of all of our significant
accounting policies, including the critical accounting policies discussed above, see
Note 1, Summary of Significant Accounting
Policies, to our consolidated financial statements
filed with our 2013 annual report on Form 10-K.
Recent Accounting Pronouncements
For a discussion of new accounting pronouncements
and their impact on the Company, see
Note 1 of the Notes to Consolidated Financial Statements
included in Item 1 of this
Form 10-Q.
FACTORS THAT MAY AFFECT FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains
statements that are forward-looking such as estimates, projections, statements relating to our business plans, objectives and
expected operating results. These statements are based on current expectations and assumptions that are subject to risks and uncertainties.
All statements that express expectations and projections with respect to future matters may be affected by changes in our strategic
direction, as well as developments beyond our control. We cannot assure you that our expectations will necessarily come to pass.
Actual results could differ materially because of issues and uncertainties such as those listed below, in the section entitled
“Management’s Discussion and Analysis of Financial Condition and Results of Operations”, ITEM 2
and elsewhere
in this report. These factors, among others, may adversely impact and impair our business and should be considered in evaluating
our financial outlook.
Our revenue growth and success is tied to the operations
of our independent Broker Network, and as a result the loss of our brokers or the financial performance of our brokers can negatively
impact our business
We service
our member businesses primarily through our independent licensed broker and franchise network (individually, “broker”,
together, the “Broker Network”) as well as through any corporate-owned offices we may
operate from time to time. Our financial success primarily depends on our brokers and the manner in which they operate and develop
their offices. We depend on the ability of our brokers to enroll new members, train them in the use of the Marketplace, grow our
transactional volume by facilitating business among members, manage member relationships, provide members with information about
ITEX products and services, and assure the payment of our fees. Brokers are independently owned and operated and have a contractual
relationship with ITEX, typically for a renewable five-year term. Our inability to renew a significant portion of these agreements
on terms satisfactory to our brokers and us could have a material adverse effect on our business, financial condition and results
of operations. Further, our brokers may not be successful in increasing the level of revenues generated compared to prior years,
or even sustaining their own business activities, which depends on many factors, including industry trends, the strength of the
local economy, the success of their marketing activities, control of expense levels, the employment and management of personnel,
and being able to secure adequate financing to operate their businesses. There can be no assurance that our brokers will be successful
in adding members or increasing the volume of transactions through the Marketplace, or that if they do not renew their agreements
or terminate operations we will be able to attract new brokers at rates sufficient to maintain a stable or growing revenue base.
If our brokers are unsuccessful in generating revenue, enrolling new members to equalize the attrition of members leaving the Marketplace,
or if a significant number of brokers become financially distressed and terminate operations, our revenues could be reduced and
our business operating results and financial condition may be materially adversely affected.
Future revenue growth remains uncertain
and our operating results and profitability may decline
Marketplace revenue decreased 7% for the
nine-month period ended April 30, 2014, compared to the nine-month period ended April 30, 2013. Although we seek to increase revenues
through organic growth and the development of new revenue streams, we cannot assure you that our revenues will increase in future
quarters or future years. We may be unable to add revenue through acquisitions, either because of the absence of acquisition candidates,
lack of financing, or unacceptable terms. We have approximately 30% recurring revenues. We do not have an order backlog, and approximately
two-thirds of our revenues each quarter come from variable transaction fees computed as a percentage of the ITEX dollar value of
the transactions occurring during that quarter. Our operating results in one or more future quarters may fall below the expectations
of investors.
We cannot assure you that we can continue
to be operated profitably, which depends on many factors, including the overall development and expansion of the barter industry,
our success in expanding our market share of the industry, the control of our expense levels and the success of our business activities.
We have been subject to increased expense levels in recent years as a result of responding to proxy contests, litigation and other
actions initiated by dissident stockholders. We may make investments in marketing, broker and member support, technology and further
development of our operating infrastructure which entail long-term commitments. The barter industry as a whole may be adversely
affected by industry trends and economic factors. Despite our efforts to expand our revenues, we may not be successful. We experience
a certain amount of attrition from members leaving the Marketplace. If new member enrollments do not continue or are insufficient
to offset attrition, we will increasingly need to focus on keeping existing members active and increasing their activity level
in order to maintain or grow our business. We cannot assure you that this strategy would be successful to offset declining revenues
or profits.
Our ability to pay dividends on our common stock is subject
to the discretion of our Board of Directors and may be limited by our lack of liquidity or access to capital.
Our dividend policy is subject to the discretion of our Board
of Directors and depends upon a number of factors, including our earnings, financial condition, cash and capital needs and general
economic or business conditions. Although we are currently declaring cash dividends on our common stock as a way to return value
to our stockholders, we are not required to do so and we cannot assure you that we will continue to pay dividends in the future.
We have sought to maintain a liquidity cushion sufficient to fund our business activities and handle contingencies, while preserving
the ability to return cash to our stockholders through dividends and share buybacks. However, our Board of Directors may decide
to use capital for acquisitions, revenue generating opportunities or other corporate purposes. If liquidity from our cash flow
is inadequate or unavailable, we may be required to scale back or eliminate the dividends we pay to our stockholders. Any reduction
of, or the elimination of, our common stock dividend in the future could adversely affect the market price of our common stock.
Our brokers could take actions that could harm our business,
our reputation and adversely affect the ITEX Marketplace
Our agreements with our brokers require
that they understand and comply with all laws and regulations applicable to their businesses, and operate in compliance with our
Marketplace Rules. Brokers are independently owned and operated and are not our employees, partners, or affiliates. We set forth
operational standards and guidelines; however, we have limited control over how our broker businesses are run. Our brokers have
individual business strategies and objectives, and may not operate their offices in a manner consistent with our philosophy and
standards. We cannot assure that our brokers will avoid actions that adversely affect the reputation of ITEX or the Marketplace.
Improper activity stemming from one broker can generate negative publicity which could adversely affect our entire Broker Network
and the Marketplace. Our image and reputation and the image and reputation of other brokers may suffer materially, and system-wide
sales could significantly decline if our brokers do not operate their businesses according to our standards. While we ultimately
can take action to terminate brokers and franchisees that do not comply with the standards contained in our agreements, and even
though we may implement compliance and monitoring functions, we may not be able to identify problems and take action quickly enough
and, as a result, our image and reputation may suffer, causing our revenues or profitability to decline. Further, the success and
growth of our Broker Network depends on our maintaining a satisfactory working relationship with our existing brokers and attracting
new brokers to our network. Lawsuits and other disputes with our brokers could discourage our brokers from expanding their business
or lead to negative publicity, which could discourage new brokers from entering our network or existing brokers from renewing their
agreements, and could have a material adverse effect on our business, financial condition and results of operations.
Significant stockholders or investors may attempt to effect
changes or acquire control over our business, which could adversely affect our results of operations and financial condition.
Recent developments in corporate
governance indicate there is lack of agreement between boards of directors and stockholders as to the relative balance of authority
in the corporate decision-making process, and shareholders
are challenging the longstanding legal
principle that directors, rather than the stockholders, manage the business and affairs of the corporation. During the past several
years, U.S. companies have seen a high and increasing level of insurgent campaigns, proxy solicitations, and shareholder derivative
actions or other attempts to acquire control of companies or effect operational changes. Since 2010, we have been the subject of
two proxy contests to replace the majority of our directors, as well as a derivative lawsuit. We cannot assure you that we will
not be subject to further proxy contests, litigation or other activity or demands in the future. If we are, such activity or demands
could harm the Company because:
|
·
|
Responding to proxy contests, litigation and other actions by dissident shareholders can interfere with our ability to execute
our strategic plan, disrupt our operations, be costly and time-consuming, and divert the attention of our management and employees
from the pursuit of business strategies;
|
|
·
|
Perceived uncertainties as to our future direction diverts the attention of, damages morale and creates instability among members
of our Broker Network, and adversely impact our existing and potential strategic and operational relationships and opportunities;
|
|
·
|
We may experience difficulties in hiring, retaining and motivating personnel during the resulting uncertain and turbulent times;
|
|
·
|
If individuals are elected or appointed to our Board of Directors with a specific agenda, it may adversely affect our ability
to effectively implement our business strategy and create additional value for our stockholders;
|
|
·
|
We would experience substantial increases in legal fees, insurance, administrative and associated costs incurred in connection
with responding to proxy contests and related litigation;
|
|
·
|
A successful change in control of the Company would result
in substantial compensation charges and other expenses, and potentially allow an insurgent shareholder to reimburse his proxy
or takeover expenses, resulting in substantial charges.
|
We may be held responsible by members,
third parties, regulators or courts for the actions of, or failures to act by, our brokers or their employees, which exposes us
to possible adverse judgments, other liabilities and negative publicity
From time to time we are subject to claims for the conduct of
our brokers in situations where a broker is alleged to have caused injury to a member as a result of a transaction in the Marketplace.
Third parties, regulators or courts may seek to hold us responsible for the actions or failures to act by our brokers or their
employees. The failure to comply with laws and regulations by our brokers, or litigation involving potential liability for broker
activities could be costly and time consuming for us, divert management attention, result in increased costs of doing business,
lead to adverse judgments, expose us to possible fines and negative publicity, or otherwise harm our business.
Failure to deal effectively with
member disputes could result in costly litigation, damage our reputation and harm our business
ITEX faces risks with respect to transactional
disputes between members of the Marketplace. From time to time we receive complaints from members who may not have received the
products or services that they had purchased, concerning the quality of the products or services, or who believe they have been
defrauded by other members. We also receive complaints from sellers because a buyer has changed his or her mind and decided not
to honor the contract to purchase the item. While ITEX does, in some cases, as part of its transaction dispute resolution process,
reverse transactions, reduce or eliminate credit lines, suspend accounts, or take other measures with members who fail to fulfill
their payment or delivery obligations to other members, the determination as to whether a transaction is reversed or how to resolve
a specific dispute is made by ITEX in its sole discretion. Measures we may take to resolve transactional disputes or combat risks
of fraud have the potential to damage relations with our members or brokers or decrease transactional activity in the Marketplace
by restricting the activities of certain members. Furthermore, negative publicity and member sentiment generated as a result of
member complaints or fraudulent or deceptive conduct by members of our Marketplace could damage our reputation, or reduce our ability
to attract new members or retain our current members.
We occasionally receive communications from
members requesting reimbursement or threatening or commencing legal action against us if no reimbursement is made. In addition,
because we service our member businesses through our Broker Network, we are subject to claims and could potentially be found liable
for the conduct of our brokers in a situation where that broker has caused injury to a member. Litigation involving disputes between
members and liability for broker actions could be costly and time consuming for us, divert management attention, result in increased
costs of doing business, lead to adverse judgments, or otherwise harm our business. In addition, affected members may complain
to regulatory agencies that could take action against us, including imposing fines or seeking injunctions.
Use of our services for illegal purposes
could damage our reputation and harm our business
Our members, typically small businesses,
actively market products and services through the Marketplace and our website. We may be unable to prevent our members from selling
unlawful or stolen goods or unlawful services, or selling goods or services in an unlawful manner, and we could be subject to allegations
of civil or criminal liability for unlawful activities carried out by users through our services. It is possible that third parties,
including government regulators and law enforcement officials, could allege that our services aid and abet certain violations of
certain laws, for example, laws regarding the sale of counterfeit items, the fencing of stolen goods, selective distribution channel
laws, and the sale of items outside of the U.S. that are regulated by U.S. export controls.
Although we have prohibited the listing
of illegal goods and services and implemented other protective measures, we may be required to spend substantial resources to take
additional protective measures or discontinue certain service offerings, any of which could harm our business. Any costs incurred
as a result of potential liability relating to the alleged or actual sale of unlawful goods or services could harm our business.
In addition, negative media publicity relating to the listing or sale of unlawful goods and stolen goods using our services could
damage our reputation, diminish the value of our brand, and make members reluctant to use our services.
ITEX’s virtual currency, ITEX dollars,
is also susceptible to potentially illegal or improper uses. Recent changes in law have increased the penalties for intermediaries
providing payment services for certain illegal activities. Despite measures taken by ITEX as administrator and as transaction processor
and record-keeper to detect and lessen the risk of this kind of conduct, illegal activities could still be funded using ITEX dollars.
Any resulting claims or liabilities could harm our business.
Our business is subject to online security risks, including
security breaches and identity theft
We host confidential information as part
of our client relationship management and transactional processing platform. Our security measures may not detect or prevent security
breaches that could harm our business. Currently, a significant number of our members authorize us to bill their credit card or
bank accounts directly for fees charged by us. We take a number of measures to ensure the security of our hardware and software
systems and member and client information. Advances in computer capabilities, new discoveries in the field of cryptography or other
developments may result in the technology used by us to protect transaction data being breached or compromised. Other companies
have been the subject of sophisticated and highly targeted attacks on portions of their websites. In addition, any party who is
able to illicitly obtain a members’ password could access the members’ transaction data. An increasing number of websites
have reported breaches of their security. Any compromise of our security could harm our reputation and, therefore, our business,
and could result in a violation of applicable privacy and other laws. In addition, a party that is able to circumvent our security
measures could misappropriate proprietary information, cause interruption in our operations, damage our computers or those of our
users, or otherwise damage our reputation and business. Under credit card rules and our contracts with our card processors, if
there is a breach of credit card information that we store, we could be liable to the credit card issuing banks for their cost
of issuing new cards and related expenses. In addition, if we fail to follow credit card industry security standards, even if there
is no compromise of customer information, we could incur significant fines or lose our ability to give customers the option of
using credit cards to pay their fees. If we were unable to accept credit cards, our business would be seriously damaged.
We continue to enhance our systems for
data management and protection, and intrusion detection and prevention. In the period ended April 30, 2014 we upgraded our software
platform with .Net technology. However, our servers may be vulnerable to computer viruses, physical or electronic break-ins, and
similar disruptions. We may need to expend significant resources to protect against security breaches or to address problems caused
by breaches. Security breaches, including any breach by us or by parties with which we have commercial relationships that result
in the unauthorized release of our members’ personal information, could damage our reputation and expose us to a risk of
loss or litigation and possible liability. Our insurance policies carry coverage limits which may not be adequate to reimburse
us for losses caused by security breaches.
Unplanned system interruptions or system failures could
harm our business and reputation
Any interruption in the availability of
our transactional processing services due to hardware and operating system failures will reduce our revenues and profits. Our revenue
depends on members using our processing services. Any unscheduled interruption in our services results in an immediate, and possibly
substantial, loss of revenues. Frequent or persistent interruptions in our services could cause current or potential members to
believe that our systems are unreliable, leading them to switch to our competitors or to avoid our website or services, and could
permanently harm our reputation. Furthermore, any system failures could result in damage to our members’ and brokers’
businesses. These persons could seek compensation from us for their losses. Even if unsuccessful, this type of claim likely would
be time-consuming and costly for us to address.
Although our systems have been designed
around industry-standard architectures to reduce downtime in the event of outages or catastrophic occurrences, they remain vulnerable
to damage or interruption from earthquakes, floods, fires, power loss, telecommunication failures, terrorist attacks, computer
viruses, computer denial-of-service attacks, and similar events or disruptions. Some of our systems are not fully redundant, and
our disaster recovery planning may not be sufficient for all eventualities. Our systems are also subject to break-ins, sabotage,
and intentional acts of vandalism. Despite any precautions we may take, the occurrence of a natural disaster, a decision by any
of our third-party hosting providers to close a facility we use without adequate notice for financial or other reasons, or other
unanticipated problems at our hosting facilities could cause system interruptions, delays, and loss of critical data, and result
in lengthy interruptions in our services. Our business interruption insurance may not be sufficient to compensate us for losses
that may result from interruptions in our service as a result of system failures.
Failure to comply with laws and regulations that protect
our members’ and brokers’ personal and financial information could result in liability and harm our reputation
We store personal and financial information
for members of the Marketplace and our brokers. Privacy concerns relating to the disclosure and safeguarding of personal and financial
information have drawn increased attention from federal and state governments. Federal and state law requires us to safeguard our
members’ and brokers’ financial information, including credit card information. Although we have established security
procedures to protect against identity theft and the theft of this personal and financial information, breaches of our privacy
may occur. To the extent the measures we have implemented are breached or if there is an inappropriate disclosure of confidential
or personal information or data, we may become subject to litigation or administrative sanctions, which could result in significant
fines, penalties or damages and harm to our brand and reputation. Even if we were not held liable, a security breach or inappropriate
disclosure of confidential or personal information or data could harm our reputation. In addition, we may be required to invest
additional resources to protect us against damages caused by these actual or perceived disruptions or security breaches in the
future. Changes in these federal and state regulatory requirements could result in more stringent requirements and could result
in a need to change our business practices. Establishing systems and processes to achieve compliance with these new requirements
may increase our costs and could have a material adverse effect on our business, financial condition and results of operations.
We have claims and lawsuits
against us that may result in adverse outcomes
From time to
time we are subject to a variety of claims and lawsuits. See Note 3 ― “
Legal Proceedings and Litigation Contingencies”
included in the “Notes to Consolidated Financial Statements”.
Adverse outcomes in one or more claims could occur
which may result in significant monetary damages that could adversely affect our ability to conduct our business. Although management
does not believe resolving any pending matter, individually or in the aggregate, would have a material adverse impact on our financial
statements, litigation and other claims are subject to inherent uncertainties and management’s view of these matters may
change in the future. A material adverse impact on our financial statements could occur for the period in w
hich the effect
of an unfavorable final outcome becomes probable and reasonably estimable.
If we lose the services of our chief executive officer,
our business could suffer
Our board places heavy reliance on the continued
services of our Chief Executive Officer, Steven White, and his industry experience and relationships, management and operational
skills. We have not entered into an employment agreement with Mr. White. If we were to lose the services of Mr. White, we could
face substantial difficulty in hiring a qualified successor or successors, and could experience a loss in performance while any
successor obtains the necessary training and experience. Corporate staff and our franchisees and brokers could lose confidence
in the direction and stability of the Company and choose to pursue other opportunities. In addition, in connection with a management
transition we may need to attract, train, retain and motivate additional financial, technical, managerial, marketing or support
personnel. We face the risk that if we are unable to attract and integrate new personnel, or retain and motivate existing personnel,
our business, financial condition and results of operations will be adversely affected.
Alliances, mergers and acquisitions could result in operating
difficulties, dilution and other harmful consequences
We have acquired 11 exchange membership
lists since 2005 and integrated them into the Marketplace. We expect to continue to evaluate and consider other potential strategic
transactions, including business combinations, acquisitions and dispositions of businesses, technologies, services, products and
other assets and strategic investments. At any given time we may be engaged in discussions or negotiations with respect to one
or more of these types of transactions. Any of these transactions could be material to our financial condition and results of operations.
The process of integrating an acquired company, business or technology may create unforeseen operating difficulties and expenditures
and is risky. The areas where we may face difficulties include:
|
•
|
|
Diversion of management time, as well as a shift of focus from operating the businesses to challenges related to integration and administration;
|
|
•
|
|
Challenges associated with integrating employees from the acquired company into the acquiring organization. These may include declining employee morale and retention issues resulting from changes in, or acceleration of, compensation, or changes in management, reporting relationships, future prospects, or the direction of the business;
|
|
•
|
|
The need to integrate each company’s accounting, management, information, human resource and other administrative systems to permit effective management, and the lack of control if such integration is delayed or not implemented;
|
|
•
|
|
The need to implement controls, procedures and policies appropriate for a public company at companies that prior to acquisition had lacked such controls, procedures and policies;
|
|
•
|
|
The need to transition operations, members, and customers onto our existing platforms; and
|
|
•
|
|
Liability for activities of the acquired company before the acquisition, including violations of laws, rules and regulations, commercial disputes, tax liabilities and other known and unknown liabilities.
|
The expected benefit of any of these strategic
relationships may not materialize and the cost of these efforts may negatively impact our financial results. Future alliances,
mergers or acquisitions or dispositions could result in potentially dilutive issuances of our equity securities, the expenditure
of our cash or the incurrence of debt, contingent liabilities or amortization expenses, or write-offs of goodwill, any of which
could adversely affect our results of operations and dilute the economic and voting rights of our stockholders. Future acquisitions
may require us to obtain additional equity or debt financing, which may not be available on favorable terms or at all.
We may need additional financing; current funds may be
insufficient to finance our plans for growth or our operations
We believe that our financial condition is stable and that our
cash balances and operating cash flows provide adequate resources to fund our ordinary operating requirements. However, our existing
working capital may not be sufficient to allow us to execute our business plan as fast as we would like or may not be sufficient
to take full advantage of all available strategic opportunities. We believe our current core operations reflect a scalable business
strategy, which will allow our business model to be executed with limited outside financing. However, we also may expand our operations,
enter into a strategic transaction, or acquire competitors or other business to business enterprises. We have a line of credit
with our primary banking institution, which will provide additional reserve capacity for general corporate and working capital
purposes, and if necessary, enable us to make certain expenditures related to the growth and expansion of our business model. However,
if adequate capital 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 be certain that we will be able to implement various financing alternatives or otherwise obtain required
working capital if needed or desired.
We are dependent on the value of foreign currency.
We transact business in Canadian dollars
as well as USD. Revenues denominated in Canadian dollars comprised 7.6% and 7.2% in the years ended July 31, 2013 and 2012, 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 USD could affect our revenues, cost of sales, operating margins and result in exchange
losses.
Our Brokers may default on their loans
From time to time we finance the operational
and expansion activities of our brokers. We loan brokers funds for general operational purposes, to acquire the management rights
to select member accounts, and for other reasons. These loans are repaid from regular deductions from broker commissions. We had
outstanding loans to brokers of $1,554 at April 30, 2014 and $1,438 at July 31, 2013. In the event one or more brokers default
on their loans, it may adversely affect our financial condition.
The emergence of “virtual currencies” could
result in competitive trading platforms which may reduce transaction volume and revenues
Virtual currencies are receiving increasing
interest from investors, businesses and governments. Examples include private virtual currency or payment systems such as BitCoin,
Ripple, and Litecoin. As peer-to-peer currencies, they rely on a system of mutual trust and do not rely on a central bank, a third
party or other intermediary to effect transactions or act as guarantor in the event the currency collapses. They do not have the
status of legal tender. However, increased popularity or government acceptance of virtual currencies could encourage competitors
to utilize virtual or community currencies or the exchange of online credits for goods and services. Our potential competitors
could enjoy advantages, including greater financial resources and access to capital, a wider geographic presence, more accessible
branch office locations, more aggressive marketing campaigns, better brand recognition, the ability to offer a wider array of services
or more favorable pricing alternatives. If other virtual or community currencies gain widespread merchant acceptance, to the extent
that we cannot compete effectively, it may adversely affect our business operations and financial performance.
The emergence of increased regulation related to virtual
currencies could increase our costs by requiring us to update our products and services; or subject us to operational requirements
that result in substantial compliance costs which would adversely affect our business
Innovation in the payments industry has
led to a variety of virtual currencies, community currencies and reward points, and federal and state regulatory regimes are seeking
to revise antiquated currency provisions. The increased attention to virtual currencies could result in changes in federal or state
regulations or the adoption of new regulations that could affect us as well as many companies transacting in credits that might
be called “virtual currency.” For example, the Financial Crimes Enforcement Network (“FinCEN”), a bureau
of the U.S. Treasury, as the delegated administrator of the Bank Secrecy Act (“BSA”) issued interpretive guidance in
March 2013 to clarify the applicability of regulations to persons creating, obtaining, distributing, exchanging, accepting, or
transmitting virtual currencies. Although we do not believe we as a payment processor are currently subject to the BSA requirements
that could potentially change with new regulation. Registering with FinCEN and complying with FinCEN’s regulations would
be burdensome, as would getting licensed as a money transmitter and complying with the money transmission regulatory regimes in
each state. Changes to existing laws or regulations or adoption of new laws or regulations relating to the use of virtual currencies
could require us to incur significant costs to update our products and services, significantly increase our compliance costs or
may impose conditions that we are unable to meet. This could make our business cost-prohibitive in the affected state or states
and could materially adversely affect our business.