ITEX ITEX Corporation (PK)

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” in Item 1A of our Form 10-K filed with the Securities and Exchange Commission (“SEC”) on October 19, 2016. We undertake no obligation to update or revise publicly any forward-looking statement after the date of this report, whether as a result of new information, future events or otherwise.

Overview

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

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”, “2017” for August 1, 2016 to July 31, 2017, “2016” for August 1, 2015 to July 31, 2016). Our first quarter is the three-month period from August 1, 2016 to October 31, 2016 (“three-month period ended October 31”). We report our results as of the last day of each calendar month (“accounting cycle”). The timing of billing and collection activities after the end of the billing cycle does not correspond with the end of the accounting period, therefore this timing difference results in the fluctuations of the balances of cash, accounts receivable, commissions payable and accrued commissions on the consolidated balance sheets and consolidated statements of cash flows.

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

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

In order to add new brokers we are sustaining our broker recruiting incentives. Through our Broker Mentor program, existing brokers recruit prospective brokers and provide ongoing training to the prospective broker until certain performance thresholds are met. Upon meeting the performance thresholds, the prospective broker is offered a franchise for a reduced fee.

Revenue for the three-months ended October 31, 2016, as compared to the corresponding three-months ended October 31, 2015, decreased by $250, or 9%. The decrease in revenues during the three-months ended October 31, 2016 was from a reduction in members and a reduction in transaction and association fees generated from our members.

Cost of Marketplace revenue consists of commissions paid to brokers, payment of processing fees and other expenses directly correlated to Marketplace revenue, decreased by $173, or 10% for the three-month period ended October 31, 2016, as compared to the corresponding three-months ended October 31, 2015.

Operating expenses which include corporate salaries, wages and employee benefits, selling, general and administrative, depreciation and amortization decreased by $70, or 8% for the three-months ended October 31, 2016, compared to the corresponding period of fiscal 2016.

Income from operations for the three-months ended October 31, 2016, as compared to the corresponding three-months ended October 31, 2015, decreased by $7 or 3%. This net decrease is primarily the result of the $77 decrease in gross profit offset by the $70 decrease in operating expenses for the period ended October 31, 2016.

Net income for the three-months ended October 31, 2016, as compared to the corresponding three-months ended October 31, 2015, decreased by $19, or 12%.

Earnings per share, both basic and diluted, decreased by $0.01 to $0.07 per share in the three-months ended October 31, 2016 compared to the three-months ended October 31, 2015.

Marketplace revenue

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

Marketplace revenue for the three-months ended October 31, 2016 decreased by $250, or 9% to $2,564 as compared to $2,814 for the three-months ended October 31, 2015.

Transaction fees for the three-months ended October 31, 2016 decreased by $180, or 10%, to $1,582 from $1,762 for the three-months ended October 31, 2015. The decrease in transaction fees was due to lower transaction volume for the three-months ended October 31, 2016, as compared to the three-months ended October 31, 2015.

Association fees for the three-months ended October 31, 2016 decreased by $63, or 6%, to $909 from $972 for the three-months ended October 31, 2015. The decrease in association fees is due to a decrease in net active membership accounts for the comparable periods.

Other revenue for the three-months ended October 31, 2016 decreased by $7, or 9% to $73 as compared to $80 for the three-months ended October 31, 2015.

ITEX Dollar Revenue

As described in the 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 in revenue sharing and incentive arrangements with our Broker Network, including co-op advertising for members, as well as for certain general corporate expenses. ITEX dollars are only usable in our Marketplace.

Occasionally we spend ITEX dollars in the Marketplace for our corporate needs. As discussed in the notes to our consolidated financial statements in our most recent form 10-K filed with the SEC on October 19, 2016, we record ITEX dollar revenue in the amounts ultimately equal to expenses we incurred and paid for in ITEX dollars, resulting in an overall net effect of $0 on the operating and net income lines. We recorded $21 and $23 as ITEX dollar revenue for the three-months ended October 31, 2016 and 2015, respectively.

The corresponding ITEX dollar expenses in the period ended October 31, 2016 was for equipment, legal services, printing, outside services and miscellaneous expenses. We plan to continue to utilize ITEX dollars for our corporate purposes in future periods.

Cost of Marketplace Revenue

Cost of Marketplace revenue consists of commissions paid to brokers, 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):

Cost of Marketplace revenue for the three-months ended October 31, 2016 was $1,568 as compared to $1,741 for the three-months ended October 31, 2015, a decrease of $173, or 10%.

Transaction fee commissions for the three-months ended October 31, 2016 decreased by $130 or 10% to $1,186 as compared to $1,316 for the three-months ended October 31, 2015. The decrease in transaction fee commissions is due to the reduction in transaction fee revenue which is similar to the 10% reduction is transaction fee revenues for the comparable period.

Association fee commissions for the three-months ended October 31, 2016 decreased by $22, or 6% to $326 as compared to $348 for the three-months ended October 31, 2015. The decrease in association fee commissions is due to a similar reduction in association fee revenue.

Other costs of revenue consist of miscellaneous Marketplace-related expenses such as marketing and credit card processing fees and other commissions not associated with association or transaction revenue. Other costs of revenue decreased by $21 or 27% to $56 as compared to $77 for the three-months ended October 31, 2015.

Corporate Salaries, Wages and Employee Benefits

Salaries, wages and employee benefits include expenses for employee salaries and wages, payroll taxes, payroll related insurance, healthcare benefits, stock-based compensation, recruiting costs and other personnel related items.

Salaries, wages and employee benefits expenses for the three-months ended October 31, 2016, as compared to the three-months ended October 31, 2015, decreased by $26, or 6%. The decrease is primarily due to a reduction in stock compensation expense.

Selling, General and Administrative Expenses

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

SG&A expenses for the three-months ended October 31, 2016, as compared to the three-months ended October 31, 2015, decreased by $41 or 10%. The decrease is due primarily to a decrease in legal fees, foreign currency expense and accounting fees. Legal fees decreased by $11, foreign currency expense decreased by $4 and accounting fees decreased by $15 for the three-months ended October 31, 2016.

Depreciation and Amortization

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

Depreciation and amortization for the three-months ended October 31, 2016, as compared to the three-months ended October 31, 2015, decreased by $3, or 14%.

Other income

Other income includes interest received on notes receivable and promissory notes. Interest income is derived primarily from our notes receivable for corporate-owned office sales and general loans to brokers.

Income Taxes

We recognized an $85 provision for income taxes, in the three-month period ended October 31, 2016, as compared to the $80 provision for income taxes in the three-month period ended October 31, 2015.

The effective federal tax rate related to our provision for income taxes in the three-month period ended October 31, 2016 is similar to that used in the period ended October 31, 2015. The effective state tax rate related to our provision for income taxes in the three-months ended October 31, 2016 is 1% higher than the three month period ended October 31, 2015 due to uncertain tax positions related primarily to state jurisdictions.

LIQUIDITY AND CAPITAL RESOURCES

We finance our ongoing operations primarily from existing cash, investing activities, and cash flows from operations. As of October 31, 2016, and July 31, 2016, we had $3,655 and $3,235, respectively, in cash.

The following table presents a summary of our cash flows for the three-months ended October 31, 2016 and 2015 (in thousands) (unaudited):

We believe that our financial condition is stable and that our cash balances, other liquid assets, and cash flows from operating activities provide adequate resources to fund ongoing operating requirements.

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

Operating Activities

For the three-months ended October 31, 2016, net cash provided by operating activities was $363 compared with $360 in the three-months ended October 31, 2015 an increase of $3, or 1%.

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):

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

Investing Activities

Net cash provided by investing activities was primarily the result of collections on notes receivable from corporate office sales and broker loans.

For the three-months ended October 31, 2016, net cash provided by investing activities was $63 compared with $67 provided by investing activities in the three-months ended October 31, 2015, a decrease of $4, or 6%. In the three-months ended October 31, 2016, the net cash provided by investing activities was related to $63 in note receivable principal collections. In the three-months ended October 31, 2015, the net cash provided by investing activities was related to $67 in note receivable principal collections.

Financing Activities

Our net cash used in financing activities consists of cash dividends to stockholders and discretionary repurchases of our common stock.

For the three-months ended October 31, 2016, net cash used in financing activities was $6 compared with $2 used in financing activities in the three-months ended October 31, 2015, an increase of cash used in financing activities of $4. In the three-months ended October 31, 2016, we purchased $7 of shares. In the three-months ended October 31, 2015, we purchased $3 of shares .

Commitments

The Company leases office space under operating leases. Lease commitments include a lease for the Company’s corporate headquarters in Bellevue, Washington. In July 2016, we signed a 5-year lease for a new location in Bellevue, Washington, with a lease commencement date of September 15, 2016. The lease expiration date is March 31, 2022.

The lease expense for our executive office space for the three-months ended October 31, 2016 and 2015 was $33 and $21, respectively.

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. (“GAAP”). The preparation of financial statements in conformity with GAAP 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:

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 2016 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 this Form 10-Q.