ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
ITEX Corporation (hereinafter referred to "ITEX" or as the "Company" or the "Registrant") was incorporated in the State of Delaware on March 8, 1901 as Magneto-Electric Company. The Registrant became inactive in 1905 and was revived in the State of Delaware on September 1, 1985. On October 1, 1985, the domicile of the Registrant was changed to the State of Nevada and the name was changed to B.I.G. Enterprises Inc. On February 14, 1986, an Agreement and Plan of Reorganization was entered into between the Registrant and The ITEX Corporation, an Arizona corporation, whereby the Registrant became the surviving corporation under the name of ITEX Barter Systems Inc. The name of the Registrant was changed, by means of an amendment to it's Nevada Articles of Incorporation filed on May 19, 1986 to ITEX Barter Systems Inc. The name was changed to ITEX Corporation on April 12, 1991.
The business practice of bartering has been used by individuals, companies, and countries throughout the world for centuries. In recent years, companies like ITEX have developed barter into an organized business practice that brings benefits to participating businesses.
The barter industry represents the exchange of goods or services for other goods or services rather than for cash. The retail industry is typically a group of merchants and professionals who purchase goods and services from others in the group. In lieu of using cash the members of the group operate with trade dollars, sometimes referred to as trade units, or trade credits. A trade dollar is a ledger entry, or medium of exchange, by which goods and services can be bought and sold. The Company handles transaction accounting between members of the group including the allocation of trade dollars and the Company attempts to maximize trade through promotion of barter transactions.
Organized commercial barter plays an increasingly important role in the way American companies do business. Barter is becoming an integral part of strategic planning for companies from small family-owned and operated businesses to Fortune 500 companies. The International Reciprocal Trade Association (IRTA) is the barter industry's leading trade association. According to IRTA, an estimated 300,000 U.S. companies participate in organized commercial barter through the services of a barter company. Currently, IRTA estimates that barter represents a $7.5 billion a year industry which is growing at an annual rate of 8%. There are over 600 barter exchanges in the U.S. Most are small operations limited to a specific city, state, or region. ITEX is one of only three companies with national stature. Management believes that the Company is the largest of the six hundred barter exchanges in the United States, Calculated either by number of offices, total customer count, client trade volume, or cash service fees billed. Financial comparisons are not available.
BarterNews, the barter industry's primary magazine, has referred to the Company as the "World's Largest Exchange".
THE COMPANY
The Company is engaged in international operations in both the retail barter exchange and corporate barter areas of the commercial barter industry. The Company administers the ITEX Retail Barter Exchange (the Exchange), which is an association of business owners and professionals who trade goods and services with other members of the Exchange. The Company promotes the maximization of trade through barter transactions that benefit members within the Exchange by: (a) generating incremental new business, (b) conserving members' cash by their ability to spend ITEX trade dollars, (c) serving effectively as an alternative source of financing, (d) enhancing the lifestyles of members, and (e) enabling the sale of slow moving or excess inventories at better values than can be realized in cash markets.
The Company acts as a third-party record-keeper of members' transactions and balances, which are denominated in ITEX trade dollars. An ITEX trade dollar is an accounting unit used by the Exchange to record the value of trades as determined by the buying and selling parties in barter transactions. ITEX trade dollars denote the right to receive goods or services available from other Exchange members or the obligation to provide goods or services to other Exchange members. ITEX trade dollars may not be redeemed for cash. ITEX trade dollars may be used only in the manner and for the purpose set forth in the ITEX Trading Rules that govern the Exchange. ITEX trade dollars are not legal tender, securities, or commodities.
Members of the Exchange pay cash and ITEX trade dollar fees and commissions to the Company. For these services, the Company typically receives a cash commission of 5% or 6% on the purchases and sales made by members of the Exchange. In addition to administering the activities and record-keeping of the Exchange, the Company, as a member of the Exchange, trades as a principal party in barter transactions with other members. The Company also engages as a principal party in trade transactions in the corporate barter area of the industry. In these transactions, the Company acquires goods and services that it either sells for cash or ITEX trade dollars or holds in inventory for further trades in the corporate barter area or for trading to members of the Exchange.
The Company owns and operates retail barter offices in Portland, Oregon; St. Louis, Missouri; and Orange County, California. All other ITEX broker offices are independently owned and operated by ITEX Licensed Brokers. There are presently 110 broker offices located in 36 states, Guam, Puerto Rico, and Vancouver, Canada. The Company bears no financial responsibility for the financing of an independent broker office.
The Company acts as an intermediary for the exchange of goods and services between major companies, through ITEX USA, Inc., a corporate barter management company, which is the Company's exclusive agent for marketing the Company's corporate and industrial trading business of the Company's corporate barter division. ITEX USA negotiates corporate barter agreements, services these agreements and sells the inventory it acquires in these transactions. In these transactions, ITEX USA issues ITEX Cash Equivalent Credits, which are separate and apart from the ITEX Retail Trade Dollar, now used in accounting for transactions in the ITEX Retail Trade Exchange System. The revenues generated from those inventories when sold for cash are divided between the Company and ITEX USA. This is the first and primary profit center in
each ITEX corporate barter transaction. The second profit center is a 12% transaction fee paid by the ITEX Corporate Barter client on the Cash Equivalent Credit portion of each purchase. This revenue is divided between the Company and ITEX USA.
The Company operates with the objectives of long-term equity-building while also ensuring availability of sufficient cash for current operating requirements. Accordingly, the Company may in any period report significant revenue, profits, and increases in net assets from transactions denominated in ITEX trade dollars or other noncash consideration. Sometimes, the Company invests in equity securities with ITEX trade dollars that have been earned by the Company in trade transactions. The companies invested in are able to use the ITEX trade dollars received in payment for the stock issued to purchase goods and services used in the operation of their businesses.
As a result of this utilization of trade dollars, the Company has accumulated an investment portfolio of equity securities totaling $3,877,000 at July 31, 1996, stated at the lower of cost or market. Also at July 31, 1996, the Company owned inventories of goods and services totaling $7,577,000, stated at the lower of cost or market, which were available for corporate trading or trading to members within the Exchange, which increases cash commissions earned by the Company, for exchange for equity securities of other companies, or for consumption by the Company in providing for its own operating needs.
In 1993 the Company purchased a 49% interest in Associated Reciprocal Traders ("ART"), a trading company located in Zug, Switzerland. ART acts as a buyer and seller of goods and services using barter, usually dealing with parties outside the U.S. Through its interest in ART, the Company has a presence in the international corporate barter marketplace. The Company's share of ART's net assets and results of operations are included in the Company's financial statements using the equity method of accounting.
During the last several years, the Company started and operated a media department, which exchanged media products owned by the Company for due bills for prepaid advertising credits on radio stations across the U.S. The four Company-owned included the Image Audio Music Production Library, , the Golden Age of Radio Theatre, the New Rock Countdown, and Flashback ... Moments in Time. During the fourth quarter of the fiscal year ended July 31, 1996, the Company sold the assets related to this media-focused business operation in order to improve the Company's ongoing cash flow. The Company realized a profit of $325,000 from the transaction.
TECHNOLOGY
The Company has developed a comprehensive training program for its brokers. New brokers come to the training center at the Company's Portland, Oregon for an intensive week of initial training before receiving the credential of "Associate Broker." They are then permitted to set up offices and act as barter brokers for the Company. After demonstrating adequate competence and achieving specified performance levels, they return to the training center for an additional week of training before receiving the credential of "ITEX Licensed Broker."
The Company has developed the largest and most innovative electronic barter exchange in the industry. The system is modeled after the NASDAQ electronic market quotation system. In a commercial barter exchange, the exchange acts as a third party recordkeeper for all parties who join the barter system. One advantage of this system is that it enables multi-lateral trade to take place.
Recent technological improvements include a software update of the Account Information Maintenance program utilized by ITEX Brokers, a software update of the BarterWire program which is utilized by both ITEX Brokers and ITEX Retail Trade Exchange Members, and developing access on the Internet. During Fiscal Year 1995, the Company completed an agreement with International Trade Exchange (ITEX) Corp, a Vancouver B.C. based company, to operate the Canadian barter company. The International Trade Exchange Corp does business in Canada under the names ITEX and Bartercard. In spite of the similarity of names, ITEX Corporation (U.S.) and ITEX/Bartercard (Canada) have never had a business relationship in the past. Under the terms of the agreement ITEX acquired the rights to the name and trademarks of International Trade Exchange together with the right to acquire its client base and assets. The addition of the affiliation with ITEX/Bartercard and TROC/Canada (described below) will more fully enable ITEX clients to do business coast-to-coast in both the U.S. and Canada.
The Company has pioneered electronic trading with its BarterWire system, introduced by the Company nearly a decade ago. Using BarterWire, Exchange members can buy and sell products and services through a personal computer and modem from anywhere in the world where telephone service is available. The Company has continued to enhance its BarterWire software so that users can trade more efficiently through the Exchange system. Latest enhanced versions are more user friendly with features familiar to those who are accustomed to the Windows environment. It also includes color and graphic capabilities for better presentation of products and services offered through the system.
The Company has also made BarterWire available to clients through the Internet, complete with its own gateway and web server. This enables Exchange members to enjoy the advantages of the latest version of BarterWire together with savings on long distance charges and a larger electronic marketplace.
Another electronic trading feature introduced by the Company is a "fax-back" system for Exchange clients, which enables Exchange members to request and receive their account records, company data, ITEX business forms, product and service lists, and other information by fax.
The ITEX Express card continues to enhance trade among ITEX clients, particularly when taken in concert with other electronic trading innovations. The ITEX Express card is the Company's debit-credit card for barter, the first of its kind in the U.S. The card can be used for identification or to make purchases using a three part voucher form or point-of-sale (POS) terminal. ITEX has encouraged the use of POS terminals as a way to speed barter transactions and increase the volume of trade.
Management believes that electronic trading systems such as BarterWire, Internet access, the ITEX Express card, and the fax-back information and trading service represent the next major step forward in the development of the barter industry. By its early involvement in the electronic marketplace, ITEX believes it will be positioned to take full advantage of future developments in this area.
The Company believes that new technologies and the emerging electronic marketplace have the potential to profoundly affect the way business is conducted. As this new marketplace emerges, the Company is positioning itself to take full advantage of this trend. The Company is already becoming recognized as an industry leader in this field. As the transition to electronic business takes place, ITEX intends to play a major role.
Research and development during the past two fiscal years has focused both on technological improvements and international expansion. During the fiscal year ended July 31, 1996, the Company spent a total of $577,000 on research and development for its communication and information systems, of which $560,000 was capitalized and $17,000 was charged to expense. During the fiscal years ended July 31, 1995 and 1994, the Company spent a total of $169,000 and $131,000, respectively, all of which was charged to expense.
The terms "Barter is Good ... Responsible Barter is Better" and "BarterWire" are registered service marks of the Company. The ITEX symbol and name are registered trademark-service marks of the Company.
ACQUISITIONS
In addition to internal expansion by increasing the Company's broker network, the Company has also expanded the scope of its operations by acquisition. Acquisitions of existing barter exchanges with in-place membership groups has enabled the Company to accelerate the growth of its presence in several markets and geographic areas.
Acquisition of Global Exchange Network. During the fiscal year ended July 31, 1996, the Company acquired the assets and business of Global Exchange Network of Irvine, California, including its membership base. The purchase price was $385,000, which was paid $200,000 in cash and by the issuance of a 6% promissory note for $185,000, payable in monthly installments of $8,331 including principal and interest, commencing with the first such payment on September 1, 1996, with monthly payments thereafter until the final payment on August 1, 1998. The acquisition has been accounted for by the purchase method. Pro forma operating data is not provided because the effects on previously reported data would be insignificant.
Acquisition of 50% Interest in Business Exchange International Corporation and Related Litigation. On January 24, 1996, the Company acquired a 100% common stock interest in SLI, Inc. ("SLI"), a Nevada corporation, in exchange for the issuance to SLI's former shareholders of 60,000 shares of its common stock valued at approximately $645,000. The Company then made a cash contribution to the capital of SLI of $1,750,000 and made a loan of $300,000 to SLI. Also on January 24, 1996, SLI purchased a 50% common stock interest in Business Exchange International Corporation ("BXI"), a Nevada corporation, pursuant to rights to purchase such interest that had been assigned to SLI by the former shareholders of SLI. SLI paid $1,750,000 for the common interest in BXI by the purchase of newly issued common stock of BXI and, in addition, SLI loaned $300,000 to BXI. BXI owns and operates one of the leading organized barter exchanges in the United States.
On February 12, 1996, a complaint was filed on behalf of the Company and its wholly owned subsidiary, SLI, Inc., against Saul Yarmak, Stephen Friedland, Business Exchange International Corp., BX International, Inc., Joel Sens, and David Lawson. The complaint, filed in the Circuit Court of the State of Oregon for Multnomah County Case No. 9602-01076, asserted claims for breach of contract, specific performance, declaratory judgment, fraud, defamation, unlawful trade practices, and interference with economic relationships. It sought to recover damages for allegedly disparaging remarks made by certain of the defendants against ITEX and for a court ruling that SLI acquired a 50% interest in the BXI trade exchange owned by one or more of the defendants.
On April 30, 1996, defendants Yarmak, Friedland, Business Exchange International Corp., and BX International, Inc., filed an answer denying the material allegations and asserting a counterclaim for attorney fees.
The potential outcome of this lawsuit is uncertain. However, the Company believes that SLI has meritorious arguments in favor of its contract positions. The Company believes that a solution will be reached either through negotiation or through completion of the litigation process. Based upon the docket in Multnomah County, Oregon, Circuit Court, the matter must go to trial within one year of the filing of the original complaint. Legal counsel is unable to evaluate the probability of a favorable or unfavorable outcome or to estimate the range of potential recovery on the plaintiff's claims or any potential loss on the defendant's counterclaim for attorney's fees.
Acquisition of Barter Exchange, Inc. (BEI) Trade Exchange. On March 1, 1995, the Company acquired the barter exchange business of Barter Exchange, Inc. ("BEI"). BEI has twelve offices located primarily in the Southwest and lower Midwest. This acquisition added significantly to the Company's client base and increased the number of Exchange offices nationwide by nearly 10%. This acquisition enabled the Company to absorbed a long-time competitor with a well defined presence in the market. It also gave the Company much improved presence in geographic areas in which the Company had not previously had a significant presence.
Acquisition of Name and Trademarks of International Trade Exchange of Vancouver, B.C. In March, 1995 ITEX acquired the rights to the name and trademarks of International Trade Exchange (ITEX) Corp., of Vancouver, B.C. Canada, together with the right to acquire its client base and assets. The purchase did not add to the Company's assets, but the acquisition had strategic importance for the Company's future plans. During fiscal 1994, TROC Canada, the largest barter exchange in Canada, took steps to join the ITEX barter system as an independent licensee. TROC is located in Montreal, Quebec with most of its operations in eastern Canada. Subsequently, the Company entered into an International License Agreement with 3264076 Canada, Inc., governing the use of the ITEX System in Canada. These two actions thus gave ITEX coast-to-coast name recognition in Canada as well as in the U.S.
Acquisition of Travel Agents Hotel Guide. In February 1995 the Company acquired the Travel Agents Hotel Guide, a directory of hotels and resorts across North America and the Caribbean that the Company uses to acquire room nights on trade in exchange for advertising in the Guide. The room nights are then sold to Exchange clients in exchange
for trade dollars, thus providing a highly desirable business and vacation inventory for trade to Exchange members.
Strategy
The Company plans to continue focusing on opportunities for acquisitions of pre-existing trade exchanges that enable conversion of a membership base to Company-affiliated independent brokers and continued expansion and development of the Company's independent broker network. The Company intends to continue its programs for improving the performance of brokers.
SEASONALITY
There appear to be no significant seasonal influences which affect the Company's business. However, the barter industry as a whole is viewed by some as being counter-cyclic to the regular business cycle--that is, when the economy is recessionary, businesses tend to barter more. Then, as the business cycle improves, conventional wisdom suggests that companies barter less since more cash business is available. However, the Company has experienced continued growth even during periods viewed as business "down-cycles."
EMPLOYEES
The Company employs 51 persons, of which 48 are full time employees. Additionally each of the Exchange's 110 broker offices mentioned above is managed by an ITEX Licensed Broker who is an independent contractor that employs support staff of their own. This results in a total network of approximately 500 persons working as either consultants, independent contractors, or employees of the Company.
MANAGEMENT
The following table lists the names of all Directors and Executive Officers of the Company. All Directors will serve until the next annual general meeting unless his or her office is vacated in accordance with the Articles and Bylaws of the Company. The Executive Officers serve at the discretion of the Board of Directors.
Directors and Executive Officers
Name Age Position - ------------------------ ---- -------------------------------------------------
Graham H. Norris 54 President and Chief Executive Officer, Director
Mary Scherr 59 Vice President of Broker Development, Director
Michael A. Neal 27 Vice President of Marketing
Joseph M. Morris, CPA 47 Vice President and Chief Financial Officer
Cynthia Pfaltzgraff, CMA 42 Controller
Donovan Snyder, Esq. 46 Corporate Counsel, Corporate Secretary
Dr. Evan B. Ames 57 Director
Thomas G. Baer 63 Director
Dr. Sherry L. Meinberg 55 Director
Robert Nelson 48 Director
Dr. Charles Padbury 58 Chairman of the Board of Directors
Business Experience, Directorships, and Legal Proceedings:
Mr. Norris, who was elected President and Chief Executive Officer of the Company on September 6, 1996, has over 30 years experience in management and finance. Prior to his becoming President of the Company, he had been a consultant providing a variety of management consulting services to small private and public corporations. He has been a pilot for United Airlines since 1963. He has been a director of the Company since 1986. In 1986, Mr. Norris became an ITEX Broker, operating an independent barter office in Provo, Utah, in which capacity he earned the credential of Certified Trade Broker.
Ms. Scherr has over fourteen years of experience within the barter industry. Upon joining ITEX in 1984 as an independent broker, Ms. Scherr was recognized for outstanding sales performance, including being recognized as Broker of the Year. In 1993, Ms. Scherr agreed to join the Company as Vice President of Broker Development and Director. Ms. Scherr holds a Masters Degree from the University of Iowa.
Mr. Neal has experience in many operational aspects of the Company, with primary focus on travel and media. Previously, Mr. Neal served as President of TravelGuide, Inc. and as a special projects coordinator for IBM Corporation, where he was responsible for
bidding contracts to the federal government. Mr. Neal is the son of the founder of the Company, Mr. Terry Neal. Dr. Sherry L. Meinberg, a Director of the Company, is his aunt.
Mr. Morris became Vice President and Chief Financial Officer and a Director in January 1996. Previously, he was a consultant to the Company and a Director since February 1995. He has over 15 years experience in and around the barter industry, including serving as technical liaison between the International Reciprocal Trading Association (IRTA) and the Financial Accounting Standards Board (FASB). He was Vice President-Controller of Software-Intercomp, Inc., a NASDAQ company, from 1984 through 1995, except for the period 1988 to 1990, when he was a technical project manager with the FASB. He has authored numerous books for practicing accountants and financial professionals, several of which have received recognition as Best Professional Accounting Practice Book of the Year. Earlier in his career, Mr. Morris was an audit manager with Coopers & Lybrand.
Ms. Pfaltzgraff has been Controller of the Company since 1991. Ms. Pfaltzgraff is responsible for the Company's accounting operations, risk management, budgeting, cash flow management, systems, and financial reporting. She has more than 15 years experience in accounting and financial management. Ms. Pfaltzgraff has a Bachelors of Science in Business Administration degree from Oregon State University and earned the credential of Certified Management Accountant (CMA) in 1993.
Mr. Snyder, who joined ITEX as corporate counsel in 1995, has 17 years experience as an attorney, including 10 years as corporate in-house counsel to several companies in Salt Lake City, Utah. He is a member of both the Utah and Oregon State Bar Associations. He was elected corporate secretary by the Board of Directors in May 1996.
Dr. Ames received a Ph.D. in 1971 from Princeton University, majoring in near eastern and soviet studies. He has served with the Central Intelligence Agency. In 1985 Mr. Ames became affiliated with R.L. Ball & Associates as an investment researcher, analyst, and investment strategist. He is currently a Registered Investment Adviser with the U.S. Securities & Exchange Commission. He has been a Director of the Company since August 1995.
Mr. Baer is Vice President of Operations for Patrick Industries, a manufacturing company headquartered in Elkhart, Indiana. Mr. Baer has been with that company for 27 years and has served as Vice President and member of the Board since 1970. Patrick Industries is a publicly held company with shares traded on NASDAQ. He attended Indiana University and is active in community and charitable organizations such as the United Way. He has been a Director of the Company since August 1995.
Dr. Meinberg, served as Secretary and a Director of The ITEX Corporation from 1982 to 1986, when the Company acquired the assets and liabilities of that company. She served as Secretary and a Director of the Company from 1986 to May 3, 1996, and continues to serve as a Director. Dr. Meinberg has two masters degrees and a Ph.D. in Instructional Science. She is a published author and appears widely as a professional speaker. Dr. Meinberg retired in January, 1995 after 34 years on the faculty of Long Beach Unified School.
Mr. Nelson is a Certified Public Accountant in private practice in Portland, Oregon specializing in tax accounting. He has also been an active member of the ITEX Retail Trade Exchange, and brings the advantages of both of these areas of experience to the
Board. Mr. Nelson received an MBA from Brigham Young University and is still active in the BYU Management Society. He is a member of the American Institute of CPAs and the Oregon Society of CPAs.
Dr. Padbury was elected Chairman of the Board of Directors on September 6, 1996. Dr. Padbury is a leading Beaverton, Oregon dentist and has been a member of the ITEX Retail Trade Exchange since 1985. Dr. Padbury has brought a wealth of experience to the Board in terms of the interests, perceptions, and vantage point of ITEX clients. Dr. Padbury has been a director of the Company since 1992.
Committees
The ITEX Board of Directors has had standing audit, nominating and compensation committees since May 1996. In the last fiscal year (August 1, 1995 - July 31, 1996) there were 10 meetings of the Board of Directors.
Compliance with Section 16(a) of the Exchange Act:
Section 16(a) of the Securities Exchange Act requires the Company's executive officers and directors and persons who own more than ten percent of the Company's common stock to file reports of ownership and changes in ownership of the Company's Common Stock and any other equity securities of the Company with the Securities and Exchange Commissions (SEC). Executive officers, directors and greater than ten percent shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file.
Based solely on its review of the copies of such forms received by the Company, or written representations from certain reporting persons that no Form 5s were required for those persons, the Company believes that the following persons were delinquent as listed below:
Forms 4 and 5 were not filed for Mary Scherr, Charles Padbury, or Joseph Morris. Those forms would have reflected the following transactions:
(a) Mary Scheer: Exercise of stock options and sale of shares on January 30, 1966 (30,000 shares) and March 12, 1996 (15,000 shares)
(b) Charles Padbury: Exercise of stock options on January 4, 1996 (1,000 shares)
c) Joseph Morris: Exercise of stock options and sale of shares on August 30, 1995 (6,000 shares), October 11, 1995 (1,500 shares), November 17, 1995 (1,250 shares, and November 29 (1,250 shares)
ITEM 2.

ITEM 2. PROPERTIES
All of the Company's operations are conducted in leased space as follows:
Approximate Current Location Lease Expiration Sq. Ft. Annual Rent - ------------------------ -------------------- ------------- ------------- Portland, Oregon December 31, 2001 7,400 $136,000
Westminster, California December 31, 1996 3,700 45,000
St. Louis, Missouri October 31, 1998 1,100 17,000
The Portland, Oregon lease is payable entirely in cash. The Westminster, California lease is payable in cash of $3,000 and 42,000 ITEX trade dollars per year. The St. Louis, Missouri lease is payable in cash of $8,500 and 8,500 ITEX trade dollars per year.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
On January 24, 1996, the Company acquired a 100% common stock interest in SLI, Inc. ("SLI"), a Nevada corporation, in exchange for the issuance to SLI's former shareholders of 60,000 shares of its common stock valued at approximately $645,000. The Company then made a cash contribution to the capital of SLI of $1,750,000 and made a loan of $300,000 to SLI. Also on January 24, 1996, SLI purchased a 50% common stock interest in Business Exchange International Corporation ("BXI"), a Nevada corporation, pursuant to rights to purchase such interest that had been assigned to SLI by the former shareholders of SLI. SLI paid $1,750,000 for the common interest in BXI by the purchase of newly issued common stock of BXI and, in addition, SLI loaned $300,000 to BXI. BXI owns and operates one of the leading organized barter exchanges in the United States.
On February 12, 1996, a complaint was filed on behalf of the Company and its wholly owned subsidiary, SLI, Inc., against Saul Yarmak, Stephen Friedland, Business Exchange International Corp., BX International, Inc., Joel Sens, and David Lawson. The complaint, filed in the Circuit Court of the State of Oregon for Multnomah County Case No. 9602-01076, asserted claims for breach of contract, specific performance, declaratory judgment, fraud, defamation, unlawful trade practices, and interference with economic relationships. It sought to recover damages for allegedly disparaging remarks made by certain of the defendants against ITEX and for a court ruling that SLI acquired a 50% interest in the BXI trade exchange owned by one or more of the defendants.
On April 30, 1996, defendants Yarmak, Friedland, Business Exchange International Corp., and BX International, Inc., filed an answer denying the material allegations and asserting a counterclaim for attorney fees.
Inc. The Amended Complaint restates the claims against defendants for breach of contract, specific performance, declaratory judgment and fraud. By dismissing ITEX Corporation's claims without prejudice, ITEX may, if it chooses, reinstitute its claims for business defamation, unlawful trade practices and interference with economic relationships. Proceeding under the Amended Complaint permits an expedited determination of the core contract issues raised, that is, whether BXI breached its contract with SLI by asserting that the BXI Trade Exchange is not an asset of BXI.
The potential outcome of this lawsuit is uncertain. However, the Company believes that SLI has meritorious arguments in favor of its contract positions. The Company believes that a solution will be reached either through negotiation or through completion of the litigation process. Based upon the docket in Multnomah County, Oregon, Circuit Court, the matter must go to trial within one year of the filing of the original complaint. Legal counsel is unable to evaluate the probability of a favorable or unfavorable outcome or to estimate the range of potential recovery on the plaintiff's claims or any potential loss on the defendant's counterclaims.
On September 17, 1996 the Company filed an action in the Circuit Court for Multnomah County, Oregon, against Leslie L. French and Linda French, individually and dba AlphaNet and AlphaNet, Inc., an inactive Oregon corporation. The Complaint is Breach of Contract and Action on Guaranty and seeks a total of $89,726 on three claims for breach of contract. On October 2, 1996, defendants filed an Answer denying all claims and a Counterclaim alleging malicious prosecution, abuse of process, invasion of privacy and libel. The counterclaim seeks compensatory and punitive damages of $5.5 million. A Reply to defendant's counterclaims has been filed.
The Company considers each counterclaim to be totally without merit and expects each counterclaim to be dismissed. Both the Company's claims and the defense of the counterclaims is being vigorously prosecuted by the Company. As with all litigation, the potential outcome of this lawsuit is uncertain. However, the Company believes that its claims against the defendants are meritorious and that the defendants' counterclaims are wholly without merit. In any event, this litigation does not present scenarios which would be expected to result in a materially adverse effect on the Company's financial position or results of operations.
On June 28, 1996, the Company announced in a press release that the Company was the subject of an informal inquiry from the Securities and Exchange Commission. Subsequently, the Company received a subpoena for the production of certain documents on September 19, 1996, pursuant to a formal order of private investigation. The Company is cooperating fully with the Securities and Exchange Commission.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 3, 1996, the Company held its annual meeting of shareholders. At that meeting, five items were presented for consideration by the shareholders:
(1) To elect nine directors to serve for a term of one year or until their successors are elected and qualified. The Board of Directors has nominated Michael T. Baer, Mary Scherr, Dr. Evan Ames, Graham Norris, Dr. Sherry Meinberg, Robert Nelson, Dr. Charles Padbury, Thomas Baer and Joseph Morris to serve as Directors.
(2) To ratify the appointment of Andersen, Andersen & Strong, L.C. as independent auditors of the Company for the 1995-1996 fiscal year.
(3) To approve a new Incentive Stock Option Plan for employees, officers, directors and consultants of the Company.
(4) To approve a two for one (2 for 1) forward split of the Company's issued and outstanding common stock. Approval of this action will require an amendment to the Company's Articles of Incorporation which is described in detail in the accompanying Proxy Statement.
(5) To transact any other business might properly come before the Annual Meeting or any adjournment of the Annual Meeting.
The number of common shares issued, outstanding and entitled to vote at such Annual Meeting was 6,420,555. There were present at the meeting common shareholders holding a total of 5,383,443 of the Company's common stock. Thus a quorum was present and the business of the Meeting properly proceeded.
(1) The votes cast in person or by proxy on the resolution to elect a Board of Directors was: Abstain/ Nominee For Against Withhold - ------------------------- --------- ---------- ------------------
Michael T. Baer 4,319,473 0 22,678
Mary Scherr 4,003,507 0 338,553
Graham H. Norris, Sr. 4,004,798 0 337,353
Dr. Sherry L. Meinberg 4,004,798 0 337,353
Dr. Charles Padbury 3,987,415 0 354,645
Robert Nelson 3,987,415 0 354,645
Dr. Evan B. Ames 3,987,415 0 354,645
Thomas G. Baer 4,001,007 0 340,953
Joseph Morris 4,003,007 0 339,053
(2) The votes cast in person and by proxy on the resolution to ratify and approve the selection of Andersen, Andersen & Strong L.C. to serve as auditor of the accounts of the Company for the 1995-96 fiscal year were common shares voted 4,324,682 For the resolution; 8,203 common shares voted Against the resolution; and 7,765 common shares abstained or withheld votes on the resolution.
(3) The votes cast in person and by proxy on the resolution to approve an Incentive Stock Option Plan adopted by the Board of Directors on December 15, 1995 were 1,994,304 common shares voted For the resolution; 123,536 common shares voted Against the resolution; and 70,480 common shares abstained or withheld votes on the resolution.
(4) The votes cast in person and by proxy on the resolution to approve an amendment to the articles of incorporation of the Company to effect a two-for-one (2 for 1) forward split of the Company's issued and outstanding common stock were 3,963,603 common shares voted For the resolution; 123,536 common shares voted Against the resolution; and 15,040 common shares abstained or withheld votes on the resolution.
(5) No further business was transacted at the Annual Meeting.
PART II
ITEM 5.

ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Registrant's common stock trades in the United States via the NASDAQ Stock Market, under the symbol "ITEX". Trading was initiated on April 18, 1994. Previously the Registrant's common stock traded "over-the counter" in the United States via the NASD Bulletin Board, under the symbol "ITXE". Trading was initiated on June 11, 1992.
Quarter Ended Sale Prices - -------------------------------- ------------------------------------------- High Low --------------------- --------------------- Fiscal Quarters Ended: July 31, 1996............. $12.50 4.25 April 9, 1996............. 9.00 6.13 January 15, 1996.......... 8.13 6.13 October 23, 1995.......... 6.75 4.00 July 31, 1995............. 6.78 4.00 April 9, 1995............. 4.63 2.38 January 15, 1995.......... 2.63 1.88 October 23, 1994.......... 3.88 2.00
A stockholder's list was prepared by the transfer agent, OTR Inc. in Portland Oregon, as of July 31, 1996. The list indicated showed 829 registered shareholders of the 6,804,000 shares issued and outstanding. It is estimated another 3,000 individual shareholders own stock in the Company which is held "in street name" by brokerage firms. This results in a total estimated number of shareholders of 3,829.
The Registrant has not declared any dividends from its inception. Management anticipates that any future profits will be retained to finance corporate growth and that no dividends will be declared in the foreseeable future.
ITEM 6.

ITEM 6. SELECTED CONSOLIDATED DATA (unaudited--see Note (a) following table.)
The following table sets forth a summary of selected consolidated financial data for the Company as of the dates and for the periods indicated. The data should be read in conjunction with such financial statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Except for historical information contained herein, the statements in this report are forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties that may cause the Company's actual results in future periods to differ materially from forecasted results.
Note (a):
The financial data is derived from the audited Consolidated Financial Statements of the Company and Notes thereto for all years presented except for the year ended July 31, 1996. The information for the year ended July 31, 1996, has been derived from the
Company's unaudited Consolidated Financial Statements included in this Form 10-K. As of November 12, 1996, the Company's independent auditor, Andersen, Andersen & Strong, L.C., had not completed the audit procedures related to audit of the Company's July 31, 1996 financial statements. Andersen, Andersen & Strong, L.C. is continuing its audit. When the auditors have completed their audit, the Company will file an amended Form 10-K that includes the auditors' report and any changes to the financial statements and related disclosures that are determined as a result of completion of the audit procedures.
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS, LIQUIDITY, AND CAPITAL RESOURCES
Business and Plan of Operation
The Company is engaged in international operations in both the retail barter exchange and corporate barter areas of the commercial barter industry. The Company administers the ITEX Retail Barter Exchange (the Exchange), which is an association of business owners and professionals who trade goods and services with other members of the Exchange. The Company promotes the maximization of trade through barter transactions that benefit members within the Exchange by: (a) generating incremental new business, (b) conserving members' cash by their ability to spend ITEX trade dollars, (c) serving effectively as an alternative source of financing, (d) enhancing the lifestyles of members, and (e) enabling the sale of slow moving or excess inventories at better values than can be realized in cash markets.
The Company acts as a third-party record-keeper of members' transactions and balances, which are denominated in ITEX trade dollars. An ITEX trade dollar is an accounting unit used by the Exchange to record the value of trades as determined by the buying and selling parties in barter transactions. ITEX trade dollars denote the right to receive goods or services available from other Exchange members or the obligation to provide goods or services to other Exchange members. ITEX trade dollars may not be redeemed for cash. ITEX trade dollars may be used only in the manner and for the purpose set forth in the ITEX Trading Rules that govern the Exchange. ITEX trade dollars are not legal tender, securities, or commodities.
Members of the Exchange pay cash and ITEX trade dollar fees and commissions to the Company. For these services, the Company typically receives a cash commission of 5% or 6% on the purchases and sales made by members of the Exchange. In addition to administering the activities and record-keeping of the Exchange, the Company, as a member of the Exchange, trades as a principal party in barter transactions with other members. The Company also engages as a principal party in trade transactions in the corporate barter area of the industry. In these transactions, the Company acquires goods and services that it either sells for cash or ITEX trade dollars or holds in inventory for further trades in the corporate barter area or for trading to members of the Exchange.
The Company owns and operates retail barter offices in Portland, Oregon; St. Louis, Missouri; and Orange County, California. All other ITEX broker offices are independently owned and operated by ITEX Licensed Brokers. There are presently 110 broker offices located in 36 states, Guam, Puerto Rico, and Vancouver, Canada. The Company bears no financial responsibility for the financing of an independent broker office.
The Company acts as an intermediary for the exchange of goods and services between major companies, through the formation of ITEX USA, Inc., a corporate barter management company, which is the Company's exclusive agent for marketing the Company's corporate and industrial trading business of the Company's corporate barter division. ITEX USA negotiates corporate barter agreements, services these agreements and sells the inventory it acquires in these transactions. In these transactions, ITEX USA issues ITEX Cash Equivalent Credits, which are separate and apart from the ITEX Retail Trade Dollar, now used in accounting for transactions in the ITEX Retail Trade Exchange System. The revenues generated from those inventories when sold for cash will be divided between the Company and ITEX USA. This is the first and primary profit center in each ITEX corporate barter transaction. The second profit center is a 12% transaction fee paid by the ITEX Corporate Barter client on the Cash Equivalent Credit portion of each purchase. This revenue will also be divided between the Company and ITEX USA.
The Company operates with the objectives of long-term equity-building while also ensuring availability of sufficient cash for current operating requirements. Accordingly, the Company may in any period report significant revenue, profits, and increases in net assets from transactions denominated in ITEX trade dollars or other noncash consideration. Sometimes, the Company invests in equity securities with ITEX trade dollars that have been earned by the Company in trade transactions. The companies invested in are able to use the ITEX trade dollars received in payment for the stock issued to purchase goods and services used in the operation of their businesses.
As a result of this utilization of trade dollars, the Company has accumulated an investment portfolio of marketable equity securities totaling $3,877,000 at July 31, 1996, stated at the lower of cost or market. Also at July 31, 1996, the Company owned inventories of goods and services totaling $7,577,000, stated at the lower of cost or market, which was available for corporate trading or trading to members within the Exchange, which increases cash commissions earned by the Company, for exchange for equity securities of other companies, or for consumption by the Company in providing for its own operating needs.
In 1993 the Company purchased a 49% interest in Associated Reciprocal Traders ("ART"), a trading company located in Zug, Switzerland. ART acts as a buyer and seller of goods and services using barter, usually dealing with parties outside the U.S. Through its interest in ART, the Company has a presence in the international corporate barter marketplace. The Company's share of ART's net assets and results of operations are included in the Company's financial statements using the equity method of accounting.
During the last several years, the Company started and operated a media department, which exchanged media products owned by the Company for due bills for prepaid advertising credits on radio stations across the U.S. The four Company-owned included the Image Audio Music Production Library, , the Golden Age of Radio Theatre, the New Rock Countdown, and Flashback ... Moments in Time. During the fourth quarter of the fiscal year ended July 31, 1996, the Company sold the assets of this media-focused business operation in order to improve the Company's ongoing cash flow. The Company realized a profit of $325,000 from the transaction.
Although the Statement of Cash Flows indicates negative cash flow from operations, the Company believes that cash fees and commissions, cash that can be obtained from the sale of inventories and available-for-sale equity securities at the discretion of the Company, and cash that would be available from the sale of equity and debt securities of the Company will be sufficient to fund cash operating needs of the Company while continuing
to follow the strategy of mixing cash and trade activities so as to maximize long-term wealth building and shareholder value. Furthermore, the Company is presently incurring negative cash flow with respect to several areas of business development that would be expected to contribute in the future to long-range wealth building. At the Company's discretion, it could conserve cash by suspending or terminating these activities. However, there can be no assurance that operating conditions will enable the Company to continue to operate as described above or that adequate funds from any sources will continue to be available on terms acceptable to the Company.
Development Activities
The Company has developed a comprehensive training program for its brokers. New brokers come to the training center at the Company's Portland, Oregon for an intensive week of initial training before receiving the credential of "Associate Broker." They are then permitted to set up offices and act as barter brokers for the Company. After demonstrating adequate competence and achieving specified performance levels, they return to the training center for an additional week of training before receiving the credential of "ITEX Licensed Broker."
The Company has developed the largest and most innovative electronic barter exchange in the industry. The system is modeled after the NASDAQ electronic market quotation system. In a commercial barter exchange, the exchange acts as a third party recordkeeper for all parties who join the barter system. One advantage of this system is that it enables multi-lateral trade to take place.
Recent technological improvements include a software update of the Account Information Maintenance program utilized by ITEX Brokers, a software update of the BarterWire program which is utilized by both ITEX Brokers and ITEX Retail Trade Exchange Members, and developing access on the Internet. During the fiscal year of Fiscal Year 1995, the Company completed an agreement with International Trade Exchange Corp, a Vancouver B.C. based company, to operate the Canadian barter company. The International Trade Exchange Corp does business in Canada under the names ITEX and Bartercard. In spite of the similarity of names, ITEX Corporation (U.S.) and ITEX/Bartercard (Canada) have never had a business relationship in the past. Under the terms of the agreement ITEX acquired the rights to the name and trademarks of the International Trade Exchange of Vancouver, B.C. Canada together with the right to acquire its client base and assets. The addition of the affiliation with ITEX/Bartercard and TROC/Canada will more fully enable ITEX clients to do business coast-to-coast in both the U.S. and Canada.
The Company has pioneered electronic trading with its BarterWire system, introduced by the Company nearly a decade ago. Using BarterWire, Exchange members can buy and sell products and services through a personal computer and modem from anywhere in the world where telephone service is available. The Company has continued to enhance its BarterWire software so that users can trade more efficiently through the Exchange system. Latest enhanced versions are more user friendly with features familiar to those who are accustomed to the Windows environment. It also includes color and graphic capabilities for better presentation of products and services offered through the system.
The Company has also made BarterWire available to clients through the Internet, complete with its own gateway and web server. This enables Exchange members to enjoy the advantages of the latest version of BarterWire together with savings on long distance charges and a larger electronic marketplace.
Another electronic trading feature introduced by the Company is a "fax-back" system for Exchange clients, which enables Exchange members to request and receive their account records, company data, ITEX business forms, product and service lists, and other information by fax.
The ITEX Express card continues to enhance trade among ITEX clients, particularly when taken in concert with other electronic trading innovations. The ITEX Express card is the Company's debit-credit card for barter, the first of its kind in the U.S. The card can be used for identification or to make purchases using a three part voucher form or point-of-sale (POS) terminal. ITEX has encouraged the use of POS terminals as a way to speed barter transactions and increase the volume of trade.
Management believes that electronic trading systems such as BarterWire, Internet access, the ITEX Express card, and the fax-back information and trading service represent the next major step forward in the development of the barter industry. By its early involvement in the electronic marketplace, ITEX believes it will be positioned to take full advantage of future developments in this area.
The Company believes that new technologies and the emerging electronic marketplace have the potential to profoundly affect the way business is conducted. As this new marketplace emerges, the Company is positioning itself to take full advantage of this trend. The Company is already becoming recognized as an industry leader in this field. As the transition to electronic business takes place, ITEX intends to play a major role.
At July 31, 1996, Other assets includes costs of purchasing and developing certain of the Company's information and communication systems. During fiscal 1996, the Company continued work on development projects that had been commenced in prior years. Since these are mature projects and systems, technological feasibility was present, resulting in the capitalization of most of the development costs incurred in fiscal 1996, in accordance with the Company's accounting policy. The increase in the level of research and development costs was attributable to the nature of the activities in fiscal 1996, which essentially consisted of coding and other activities connected with constructing the systems. A large portion of the development costs were paid to independent consultants and specialists in the particular systems areas and are not fixed costs of the Company.
Research and development during the past two fiscal years has focused both on technological improvements and international expansion. During the fiscal year ended July 31, 1996, the Company spent a total of $577,000 on research and development for its communication and information systems, of which $560,000 was capitalized and $17,000 was charged to expense. During the fiscal years ended July 31, 1995 and 1994, the Company spent a total of $169,000 and $131,000, respectively, all of which was charged to expense.
The terms "Barter is Good ... Responsible Barter is Better" and "BarterWire" are registered service marks of the Company. The ITEX symbol and name are registered trademark-service marks of the Company.
Liquidity and Capital Resources
Overall Financial Position. The information for the year ended July 31, 1996, has been derived from the Company's unaudited Consolidated Financial Statements included in this Form 10-K. As of November 12, 1996, the Company's independent auditor, Andersen, Andersen & Strong, L.C., had not completed the audit procedures related to audit of the Company's July 31, 1996 financial statements. Andersen, Andersen & Strong, L.C. is continuing its audit. When the auditors have completed their audit, the Company will file an amended Form 10-K that includes the auditors' report and any changes to the financial statements and related disclosures that are determined as a result of completion of the audit procedures.
At July 31, 1996, the Company's working capital ratio was 3.1 to 1, based on current assets of $3,941,000 and current liabilities of $1,258,000. The Company's working capital ratio at July 31, 1995, was 2.0 to 1, based on current assets of $3,016,000 and current liabilities of $1,509,000. The improvement in the working capital ratio resulted primarily from continued profitable operations and private placements of stock
Total stockholders' equity increased by $8,443,000 to $22,225,000 at July 31, 1996, from $13,783,000 at July 31, 1995. The primary increases in stockholders' equity were from continued profitable operations and private placements of the Company's equity securities.
Even though the Statement of Cash Flows indicates negative cash flow from operations, the Company believes that cash fees and commissions, cash that can be obtained from the sale of inventories and available-for-sale equity securities at the discretion of the Company, and cash that would be available from the sale of equity and debt securities of the Company will be sufficient to fund cash operating needs of the Company while continuing to follow the strategy of mixing cash and trade activities so as to maximize long-term equity building and shareholder value. Furthermore, the Company is presently incurring negative cash flow with respect to several development projects. At the Company's discretion, it could conserve cash by suspending or terminating these activities. However, there can be no assurance that adequate funds from operations or any other sources will continue to be available on terms acceptable to the Company.
Private Placements. During the fiscal year ended July 31, 1996, the Company completed a private placement with Newcastle Services Ltd. ("Newcastle"), a foreign corporation, pursuant to which Newcastle purchased 200,000 shares of the Company's common stock for $750,000. The Company also completed a private placement pursuant to which an individual purchased 56,000 shares of the Company's common stock for $210,000. The Company also completed a private placement pursuant to which an officer of the Company purchased 25,000 shares of the Company's common stock for $94,000. In each of these private placements, the Company issued for each share of common stock purchased a warrant to purchase one share of common stock at an exercise price of $4.50 per share and one share of common stock at an exercise price of $5.50 per share. The warrants were exercisable from date of issuance and expired on July 31, 1996.
Effective January 1, 1996, the Company entered into a Regulation S transaction with Wycliff Fund, Inc. ("Wycliff"), a foreign corporation. Wycliff agreed to purchase 1,022,495 units of the Company's equity securities over a two-year period for $4.89 per unit, equaling a total of $5,000,000. Each unit consists of one share of common stock and warrants to purchase two shares of common stock. One warrant entitles the holder to purchase one share of common stock at an exercise price of $4.89 per share, is
exercisable from and after two years from the date of issuance, and expires five years from the date of issuance. The other warrant entitles the holder to purchase one share of common stock at an exercise price of $6.12 per share, is exercisable from and after four years from the date of issuance, and expires ten years from the date of issuance. Wycliff was required to pay the purchase price of the units at a minimum rate of $625,000 per quarter.
Through July 31, 1996, the Company received $1,250,000 from Wycliff and issued 255,624 shares of common stock and the Company also issued warrants to purchase 255,624 shares of common stock at an exercise price of $4.89 per share, exercisable from and after two years from the date of issuance, with expiration five years from the date of issuance, and warrants to purchase 255,624 shares of common stock at an exercise price of $6.12 per share, exercisable from and after four years from the date of issuance, with expiration ten years from the date of issuance.
Under the terms of the Wycliff private placement, if the entire purchase price of $5,000,000 was paid no later than December 31, 1996, the Company would have been required to issue to Wycliff warrants to purchase an additional 250,000 shares of common stock at an exercise price of $4.89 per share. The private placement terms also provided that Wycliff would pay to the Company additional amounts equal to 8% per annum for any portion of the purchase price that was not paid on or before December 31, 1996. Further, the private placement provided that if Wycliff failed to pay at least $625,000 in any calendar quarter, the Company could, at its sole option, decline to thereafter sell any of the then unpurchased units to Wycliff. Wycliff did not pay the purchase price that would have been due for the calendar quarter ended September 30, 1996, and therefore the Company has canceled the remaining portion of the private placement.
In addition, during the fiscal year ended July 31, 1996, the Company issued 350,000 shares of common stock as compensation for services and in connection with the acquisition of SLI, Inc.
Stock Option Plan. During the fiscal year ended July 31, 1996, the Company received proceeds totaling $875,000 from the exercise of stock options to purchase 475,000 shares of common stock pursuant to previously existing stock option plans. Effective December 15, 1995, the Board of Directors adopted a new stock option plan pursuant to which options to purchase up to 1,300,000 shares of the Company's common stock may be granted to employees, officers, directors, and consultants of the Company Exercise prices for options granted under the plans are equal to market value on the date of grant and options may be exercisable for up to ten years from the date of grant at the discretion of the Board of Directors. During the fiscal year ended July 31, 1996, pursuant to the new stock option plan, options to purchase 1,295,000 shares were granted at an exercise price of $6.13 per share. The plan was approved by the Company's shareholders at the annual meeting of the Company's shareholders held on May 3, 1996. It is the intention of the Company to file a Form S-8 registration with the Securities and Exchange Commission with respect to the shares of common stock underlying options to be issued pursuant to the plan.
Warrants. During the fiscal year ended July 31, 1996, the Company received proceeds totaling $656,000 from the exercise of previously outstanding warrants to purchase 250,000 shares of common stock.
Stock Split. At the annual meeting of the Company's shareholders on May 3, 1996, the Company's shareholders approved a two-for-one forward stock split with respect to the Company's common stock. The stock split has not yet been implemented by the Company. Upon implementation of the stock split, all share and per share data included in the Company's financial statements would be restated to give effect to the stock split.
Bank Line of Credit. The Company had a line of credit facility with a bank that expired on May 31, 1996. Pursuant to the line of credit, the Company was able to borrow up to $200,000 on a short-term basis for working capital purposes. The interest rate applicable to borrowings pursuant to the facility is equal to the bank's prime rate of interest plus 2%. The maximum amount of cash borrowings that may be outstanding at any time is determined by a borrowing base formula related to available collateral. Borrowings are collateralized by the Company's accounts receivable, fixed assets and inventory. As of July 31, 1996, the Company had no borrowings outstanding under the bank credit facility. The Company is presently discussing the terms of a new line of credit with the bank.
Acquisition of Global Exchange Network. During the fiscal year ended July 31, 1996, the Company acquired the assets and business of Global Exchange Network of Irvine, California, including its membership base. The purchase price was $385,000, which was paid $200,000 in cash and by the issuance of a 6% promissory note for $185,000, payable in monthly installments of $8,331 including principal and interest, commencing with the first such payment on September 1, 1996, with monthly payments thereafter until the final payment on August 1, 1998. The acquisition has been accounted for by the purchase method. Pro forma operating data is not provided because the effects on previously reported data would be insignificant.
Acquisition of 50% Interest in Business Exchange International Corporation and Related Litigation. On January 24, 1996, the Company acquired a 100% common stock interest in SLI, Inc. ("SLI"), a Nevada corporation, in exchange for the issuance to SLI's former shareholders of 60,000 shares of its common stock valued at approximately $645,000. The Company then made a cash contribution to the capital of SLI of $1,750,000 and made a loan of $300,000 to SLI. Also on January 24, 1996, SLI purchased a 50% common stock interest in Business Exchange International Corporation ("BXI"), a Nevada corporation, pursuant to rights to purchase such interest that had been assigned to SLI by the former shareholders of SLI. SLI paid $1,750,000 for the common interest in BXI by the purchase of newly issued common stock of BXI and, in addition, SLI loaned $300,000 to BXI. BXI owns and operates one of the leading organized barter exchanges in the United States.
Subsequent to the transactions described above, the owner of the other 50% interest in BXI issued a series of press releases and widespread communications throughout the commercial barter industry stating, among other things, that BXI was not the owner of the assets of the BXI barter exchange, which assertion is in direct contradiction to explicit contractual representations made by that party. Despite having made such assertion and despite having made what the Company considers to be unjustified negative statements about the Company, the owner of the other 50% and the Company engaged in extensive negotiations with regard to one party purchasing a 1% interest from the other and future management and operation of the BXI barter exchange. On several occasions, the Company believed that resolution was imminent. However, each time, the subsequent actions of the owner of the other 50% interest in BXI demonstrated unwillingness to abide by the contractual terms of the applicable agreement, accompanied by the contradictory action of unwillingness to refund to the Company the funds that had been paid for the
50% interest in BXI and the loan that was made to BXI. Also, the owner of the other 50% interest in BXI continued to publicly make what the Company considers to be hostile and unjustified allegations about the Company and its actions.
On February 12, 1996, the Company filed suit in the Circuit Court of Multnomah County, Oregon against BXI, BX International, Inc., the company which BXI alleged in its press releases was the actual owner of the BXI Trade Exchange, Saul Yarmak, president of BXI and author of the hostile allegations against the Company and Stephen Friedland, an officer of BXI. The suit seeks damages for breach of contract, fraud, business defamation (disparagement), unlawful trade practices and interference with economic relationships and includes claims for specific performance of the contract to acquire the 50% interest in BXI and a request for a declaratory judgment. The defendants answered the Complaint on April 30, 1996 by denying all allegations and asking for their attorney's fees.
On October 11, 1996, ITEX Corporation moved for dismissal of its claims (business defamation, unlawful trade practices and interference with economic relationships), without prejudice, against defendants. On that same date the motion was granted and leave granted to file an Amended Complaint. That complaint is styled SLI, Inc. v. Saul Yarmak, Stephen Friedland, Business Exchange International Corp. and BX International, Inc. The Amended Complaint restates the claims against defendants for breach of contract, specific performance, declaratory judgment and fraud. By dismissing ITEX Corporation's claims without prejudice, ITEX may, if it chooses, reinstitute its claims for business defamation, unlawful trade practices and interference with economic relationships. Proceeding under the Amended Complaint permits an expedited determination of the core contract issues raised, that is, whether BXI breached its contract with SLI by asserting that the BXI Trade Exchange is not an asset of BXI.
As with all litigation, the potential outcome of this lawsuit is uncertain. However, the Company believes that SLI has meritorious arguments in favor of its contract positions. The Company believes that a solution will be reached either through negotiation or through completion of the litigation process. Based upon the docket in Multnomah County, Oregon, Circuit Court, the matter must go to trial within one year of the filing of the original complaint. In any event, this litigation does not present scenarios which would be expected to result in a materially adverse effect on the Company's financial position or results of operations.
Acquisition of Barter Exchange, Inc. (BEI) Trade Exchange. On March 1, 1995, the Company acquired the barter exchange business of Barter Exchange, Inc. ("BEI"). BEI has twelve offices located primarily in the Southwest and lower Midwest. This acquisition added significantly to the Company's client base and increased the number of Exchange offices nationwide by nearly 10%. This acquisition enabled the Company to absorb a long-time competitor with a well defined presence in the market. It also gave the Company much improved presence in geographic areas in which the Company had not previously had a significant presence.
Acquisition of Name and Trademarks of International Trade Exchange of Vancouver, B.C. In March, 1995 ITEX acquired the rights to the name and trademarks of International Trade Exchange (ITEX) Corp., of Vancouver, B.C. Canada, together with the right to acquire its client base and assets. The purchase did not add to the Company's assets, but the acquisition had strategic importance for the Company's future plans. During fiscal 1994, TROC Canada, the largest barter exchange in Canada, took steps to join the ITEX barter system as an independent licensee. TROC is located in Montreal, Quebec with most
of its operations in eastern Canada. Subsequently, the Company entered into an International License Agreement with 3264076 Canada, Inc., governing the use of the ITEX System in Canada. These two actions thus gave ITEX coast-to-coast name recognition in Canada as well as in the U.S.
Acquisition of Travel Agents Hotel Guide. In February 1995 the Company acquired the Travel Agents Hotel Guide, a directory of hotels and resorts across North America and the Caribbean that the Company uses to acquire room nights on trade in exchange for advertising in the Guide. The room nights are then sold to Exchange clients in exchange for trade dollars, thus providing a highly desirable business and vacation inventory for trade to Exchange members.
RESULTS OF OPERATIONS The information for the year ended July 31, 1996, has been derived from the Company's unaudited Consolidated Financial Statements included in this Form 10-K. As of November 12, 1996, the Company's independent auditor, Andersen, Andersen & Strong, L.C., had not completed the audit procedures related to audit of the Company's July 31, 1996 financial statements. Andersen, Andersen & Strong, L.C. is continuing its audit. When the auditors have completed their audit, the Company will file an amended Form 10-K that includes the auditors' report and any changes to the financial statements and related disclosures that are determined as a result of completion of the audit procedures.
Comparison of Fiscal Years Ended July 31, 1996 and July 31, 1995
Overall Operating Results
Total revenue increased 29% to $30,452,000 in the fiscal year ended July 31, 1996 ("fiscal 1996") from $23,629,000 in the fiscal year ended July 31, 1995 ("fiscal 1995"). Income from operations increased to $2,024,000 in fiscal 1996 from $945,000 in fiscal 1995. Equity in net income from foreign affiliate was $1,176,000 in fiscal 1996 as compared to $958,000 in fiscal 1995.
Net income increased 41% to $2,586,000, or $0.35 per share in fiscal 1996 from $1,836,000, or $0.41 per share, in fiscal 1995. Net income per share was lower in fiscal 1996, despite the increase in net income, because of a greater number of shares outstanding in the current year and because of more incremental shares from options and warrants in computing income per share caused by increases in the market price of the Company's stock during part of fiscal 1996.
Revenue
Total Revenue. Total revenue increased 29% to $30,452,000 in fiscal 1996 from $23,629,000 in fiscal 1995. Corporate trading revenue increased 15% to $16,327,000 in fiscal 1996 from $14,211,000 in fiscal 1995. Trade exchange revenue increased 50% to $14,125,000 in fiscal 1996 from $9,418,000 in fiscal 1995.
The following table summarizes the cash and trade (consisting of ITEX trade dollars and other noncash consideration) components of revenue for fiscal years 1996 and 1995:
Fiscal Years Ended July 31, ------------------------------------ 1996 1995 ------------- -------------- (in thousands) Corporate Trading Revenue Trade $ 11,643 $ 12,403 Cash 4,684 1,808 -------------- -------------- 16,327 14,211 -------------- -------------- Trade Exchange Revenue Trade 5,532 4,204 Cash 8,593 5,214 -------------- -------------- 14,125 9,418 -------------- -------------- Total Revenue Trade 17,175 16,607 Cash 13,277 7,022 -------------- -------------- $ 30,452 $ 23,629 ============== ==============
Corporate Trading Revenue. The continued increased level of corporate trade revenue was attributable to continued operation of the Company's corporate trade department, which was established in fiscal 1994 and continued corporate barter transactions by the Company's agent for corporate barter, ITEX USA. Management expects continuing significant contributions to revenue from its corporate trading activities.
Trade Exchange Revenue. The increase in trade exchange revenue was attributable to an array of factors. During fiscal 1996, the Company recognized one-time retail exchange license revenue from a foreign licensee and a significant amount of enrollment fees for new clients joining as members of the Exchange. The Company has continued its commitment to improved broker training programs, which is having the effect of increased rates of new clients joining as members of the Exchange. The Company has also continued its internal expansion by opening more broker offices. The Company has continued its ongoing broad-based marketing and advertising program targeted at recruitment of additional brokers and members of the Exchange.
Costs and Expenses
Costs of Corporate Trading. Costs of corporate trading increased to $13,083,000 in fiscal 1996 from $11,138,000 in fiscal 1995 because of the higher revenue level. Costs of corporate trading revenue were 80% in fiscal 1996 and 78% in fiscal 1995.
Costs of Trade Exchange Revenue. Costs of trade exchange revenue increased to $7,192,000 in fiscal 1996 from $4,361,000 in fiscal 1995. Costs of trade exchange revenue, which consists of brokers' fees and commissions, were 51% of trade exchange revenue in fiscal 1996 and 46% in fiscal 1995. The resulting variance of 5% in gross margin percentage was due to specific commission rates applicable to transactions completed in each period.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased to $8,153,000 in fiscal 1996 from $7,185,000 in fiscal 1995. The increase resulted from the Company's higher scope of operations, including expansion of Company-owned and operated local trade exchanges.
Total advertising and promotion was $2,597,000 in fiscal 1996 as compared to $2,985,000 in fiscal 1995. One of the advantages available to barter businesses is the ability to fund a significant portion of advertising costs using trade dollars or by other trade consideration. During fiscal 1996, the Company paid $2,312,000 of its advertising costs by ITEX trade dollars or other trade consideration, representing 89% of total advertising costs for the period.
Comparison of Fiscal Years Ended July 31, 1995 and July 31, 1994
Overall Operating Results
Total revenue increased 60% to $23,629,000 in the fiscal year ended July 31, 1995 ("fiscal 1995") from $14,766,000 in the fiscal year ended July 31, 1994 ("fiscal 1994"). Income from operations increased to $945,000 in fiscal 1995 from $294,000 in fiscal 1994. Equity in net income from foreign affiliate was $958,000 in fiscal 1995 as compared to $632,000 in fiscal 1994.
Net income more than doubled to $1,836,000, or $0.41 per share in fiscal 1995 from $844,000, or $0.26 per share, in fiscal 1995. The rate of increase in income per share was less than the rate of increase in net income because of a greater number of shares outstanding in fiscal 1995.
Revenue
Total Revenue. Total revenue increased 60% to $23,629,000 in fiscal 1995 from $14,766,000 in fiscal 1994. Corporate trading revenue increased 69% to $14,211,000 in fiscal 1995 from $8,427,000 in fiscal 1994. Trade exchange revenue increased 49% to $9,418,000 in fiscal 1995 from $6,339,000 in fiscal 1994.
The following table summarizes the cash and trade (consisting of ITEX trade dollars and other noncash consideration) components of revenue for fiscal years 1995 and 1994:
Fiscal Years Ended July 31, ------------------------------------- 1995 1994 -------------- -------------- (in thousands) Corporate Trading Revenue Trade $ 12,403 $ 8,266 Cash 1,808 161 ------------- --------------- 14,211 8,427 ------------- --------------- Trade Exchange Revenue Trade 4,204 1,941 Cash 5,214 4,398 ------------- --------------- 9,418 6,339 ------------- --------------- Total Revenue Trade 16,607 10,207 Cash 7,022 4,559 ------------- --------------- $ 23,629 $ 14,766 ============= ===============
Corporate Trading Revenue. The increase in corporate trading revenue was attributable to continued operation of the Company's corporate trade department, which was established in fiscal 1994 and continued corporate barter transactions by the Company's agent for corporate barter, ITEX USA. Management expects continuing significant contributions to revenue from its corporate trading activities.
Trade Exchange Revenue. The increase in trade exchange revenue was attributable to an array of factors. The Company has continued its commitment to improved broker training programs, which is having the effect of increased rates of new clients joining as members of the Exchange. The Company has also continued its external expansion by acquisitions and its internal expansion by opening more broker offices. The Company has continued its ongoing broad-based marketing and advertising program targeted at recruitment of additional brokers and members of the Exchange.
Costs and Expenses
Costs of Corporate Trading. Costs of corporate trading increased to $11,138,000 in fiscal 1995 from $6,409,000 in fiscal 1994 because of the increase in corporate trading revenue. Costs of corporate trading revenue were 78% in fiscal 1995 and 76% in fiscal 1994.
Costs of Trade Exchange Revenue. Costs of trade exchange revenue increased to $4,361,000 in fiscal 1995 from $2,806,000 in fiscal 1994. Costs of trade exchange revenue, which consists of brokers' fees and commissions, were 46% of trade exchange revenue in fiscal 1995 and 44% in fiscal 1994.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by $1,928,000 to $7,185,000 in fiscal 1995 from $5,257,000 in fiscal 1994. The increase resulted from the Company's higher scope of operations, including expansion of Company-owned and operated local trade exchanges.
Total advertising and promotion was $2,985,000 in fiscal 1995 as compared to $1,591,000 in fiscal 1994. One of the advantages available to barter businesses is the ability to fund a significant portion of advertising costs using trade
dollars or by other trade consideration. During fiscal 1995, the Company paid $2,746,000 of its advertising costs by ITEX trade dollars or other trade consideration, representing 92% of total advertising costs for the period.
INFLATION
The Company's results of operations have not been affected by inflation and management does not expect inflation to have a significant effect on its operations in the future.
FORWARD-LOOKING INFORMATION
From time to time, the Company or its representatives have made or may make forward-looking statements, orally or in writing. Such forward-looking statements may be included in, but not limited to, press releases, oral statements made with the approval of an authorized executive officer or in various filings made by the Company with the Securities and Exchange Commission. Words or phrases "will likely result", "are expected to", "will continue", "is anticipated", "estimate", "project or projected", or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 (the Reform Act"). The Company wishes to ensure that such statements are accompanied by meaningful cautionary statements, so as to maximize to the fullest extent possible the protections of the safe harbor established in the Reform Act. Accordingly, such statements are qualified in their entirety by reference to and are accompanied by the following discussion of certain important factors that could cause actual results to differ materially from such forward-looking statements.
Management is currently unaware of any trends or conditions that could have a material adverse effect on the Company's consolidated financial position, future results of operations, or liquidity.
However, investors should also be aware of factors that could have a negative impact on the Company's prospects and the consistency of progress in the areas of revenue generation, liquidity, and generation of capital resources. These include: (i) variations in the mix of corporate trading and trade exchange revenue, (ii) possible inability of the Company to attract investors for its equity securities or otherwise raise adequate funds from any source, (iii) increased governmental regulation of the barter business, (iv) a decrease in the cash fees and commissions realized by the Company based upon a substantial decrease in corporate or retail trade exchange transactions.
The risks identified here are not all inclusive. Furthermore, reference is also made to other sections of this report that include additional factors that could adversely impact the Company's business and financial performance. Moreover, the Company operates in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for Management to predict all of such risk factors, nor can it assess the impact of all such risk factors on the Company's business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. Accordingly, forward-looking statements should not be relied upon as a prediction of actual results.
ITEX CORPORATION FORM 10-K For the Fiscal Year Ended July 31, 1996
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page --------
REPORT OF INDEPENDENT AUDITORS 32
CONSOLIDATED BALANCE SHEETS AT JULY 31, 1996 AND 1995 33
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE YEARS ENDED JULY 31, 1996, 1995, AND 1994 34
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY FOR THE THREE YEARS ENDED JULY 31, 1996, 1995, AND 1994 35
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE YEARS ENDED JULY 31, 1996, 1995, AND 1994 36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 37
All other schedules have been omitted because they are not applicable or the required information is shown in the consolidated financial statements or the notes thereto.
Note: The information for the year ended July 31, 1996, has been derived from the Company's unaudited Consolidated Financial Statements included in this Form 10-K. As of November 12, 1996, the Company's independent auditor, Andersen, Andersen & Strong, L.C., had not completed the audit procedures related to audit of the Company's July 31, 1996 financial statements. Andersen, Andersen & Strong, L.C. is continuing its audit. When the auditors have completed their audit, the Company will file an amended Form 10-K that includes the auditors' report and any changes to the financial statements and related disclosures that are determined as a result of completion of the audit procedures.
REPORT OF INDEPENDENT AUDITORS
The information for the year ended July 31, 1996, has been derived from the Company's unaudited Consolidated Financial Statements included in this Form 10-K. As of November 12, 1996, the Company's independent auditor, Andersen, Andersen & Strong, L.C., had not completed the audit procedures related to audit of the Company's July 31, 1996 financial statements. Andersen, Andersen & Strong, L.C. is continuing its audit. When the auditors have completed their audit, the Company will file an amended Form 10-K that includes the auditors' report and any changes to the financial statements and related disclosures that are determined as a result of completion of the audit procedures.
ITEX CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share amounts )
July 31, --------------------- 1996 1995 --------------------- ASSETS (unaudited) Current Assets Cash ............................................... $ 1,301 $ 1,524 Accounts receivable, net of allowance for doubtful accounts of $105 and $132....................... 1,071 1,117 Notes receivable.................................... 611 --- Deferred tax asset.................................. 3 51 Prepaids and other current assets................... 955 324 -------- -------- Total current assets............................ 3,941 3,016
Inventory for Principal Party Trading.................... 7,577 5,696
Available for Sale Equity Securities..................... 3,877 3,332
Investment in Foreign Equity Affiliate................... 3,216 2,040
Investment in SLI, Inc................................... 2,843 ---
Goodwill and Purchased Member Lists, net................. 1,299 1,067
Deferred Tax Asset....................................... --- 26
Other Assets............................................. 1,159 401 -------- --------
$23,912 $15,578 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable.................................... $ 183 $ 133 Portion of receivables due to brokers .............. 547 580 Trade credits issued in excess of earned............ 41 4 Income taxes payable................................ --- 474 Deferred tax liability.............................. --- 43 Current portion of long-term indebtedness........... 138 61 Other current liabilities........................... 349 214 -------- -------- Total current liabilities....................... 1,258 1,509
Deferred Income Taxes.................................... 237 130
Long-term Indebtedness................................... 192 156
Stockholders' Equity Common stock, $.01 par value; 20,000,000 shares authorized; 6,804,000 and 5,212,000 shares issued and outstanding........................... 68 52 Paid-in capital..................................... 16,386 10,624 Common stock subscribed............................. 1 Net unrealized gain on marketable equity securities...................................... 132 92 Treasury stock, at cost (10,000 and 20,000 shares).. (29) (68) Retained earnings................................... 5,668 3,082 -------- -------- Total stockholders' equity...................... 22,225 13,783 $23,912 $15,578 ======== ========
The accompanying notes are an integral part of the consolidated financial statements.
The accompanying notes are an integral part of the consolidated financial statements.
The accompanying notes are an integral part of the consolidated financial statements.
ITEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of November 12, 1996, the Company's independent auditor, Andersen, Andersen & Strong, L.C., had not completed the audit procedures related to audit of the Company's July 31, 1996 financial statements. Andersen, Andersen & Strong, L.C. is continuing its audit. When the auditors have completed their audit, the Company will file an amended Form 10-K that includes the auditors' report and any changes to the financial statements and related disclosures that are determined as a result of completion of the audit procedures.
NOTE 1 - DESCRIPTION OF BUSINESS
The Company is engaged in international operations in both the retail barter exchange and corporate barter areas of the commercial barter industry. The Company administers the ITEX Retail Barter Exchange (the Exchange), which is an association of business owners and professionals who trade goods and services with other members of the Exchange. The Company promotes the maximization of trade through barter transactions that benefit members within the Exchange by: (a) generating incremental new business, (b) conserving members' cash by their ability to spend ITEX trade dollars, (c) serving effectively as an alternative source of financing, (d) enhancing the lifestyles of members, and (e) enabling the sale of slow moving or excess inventories at better values than can be realized in cash markets.
The Company acts as a third-party record-keeper of members' transactions and balances, which are denominated in ITEX trade dollars. An ITEX trade dollar is an accounting unit used by the Exchange to record the value of trades as determined by the buying and selling parties in barter transactions. ITEX trade dollars denote the right to receive goods or services available from other Exchange members or the obligation to provide goods or services to other Exchange members. ITEX trade dollars may not be redeemed for cash. ITEX trade dollars may be used only in the manner and for the purpose set forth in the ITEX Trading Rules that govern the Exchange.
ITEX trade dollars are not legal tender, securities, or commodities.
Members of the Exchange pay cash and ITEX trade dollar fees and commissions to the Company. For these services, the Company typically receives a cash commission of 5% or 6% on the purchases and sales made by members of the Exchange. In addition to administering the activities and record-keeping of the Exchange, the Company, as a member of the Exchange, trades as a principal party in barter transactions with other members. The Company also engages as a principal party in trade transactions in the corporate barter area of the industry. In these transactions, the Company acquires goods and services that it either sells for cash or ITEX trade dollars or holds in inventory for further trades in the corporate barter area or for trading to members of the Exchange.
The Company owns and operates retail barter offices in Portland, Oregon; St. Louis, Missouri; and Orange County, California. All other ITEX broker offices are independently owned and operated by ITEX Licensed Brokers. There are presently 110 broker offices located in 36 states, Guam, Puerto Rico, and Vancouver, Canada. The Company bears no financial responsibility for the financing of an independent broker office.
The Company acts as an intermediary for the exchange of goods and services between major companies, through the formation of ITEX USA, Inc., a corporate barter management company, which is the Company's exclusive agent for marketing the Company's corporate and industrial trading business of the Company's corporate barter division. ITEX USA negotiates corporate barter agreements, services these agreements and sells the inventory it acquires in these transactions. In these transactions, ITEX USA issues ITEX Cash Equivalent Credits, which are separate and apart from the ITEX Retail Trade Dollar, now used in accounting for transactions in the ITEX Retail Trade Exchange System. The revenues generated from those inventories when sold for cash will be divided between the Company and ITEX USA. This is the first and primary profit center in each ITEX corporate barter transaction. The second profit center is a 12% transaction fee paid by the ITEX Corporate Barter client on the Cash Equivalent Credit portion of each purchase. This revenue will also be divided between the Company and ITEX USA.
The Company operates with the objectives of long-term equity-building while also ensuring availability of sufficient cash for current operating requirements. Accordingly, the Company may in any period report significant revenue, profits, and increases in net assets from transactions denominated in ITEX trade dollars or other noncash consideration. Sometimes, the Company invests in equity securities with ITEX trade dollars that have been earned by the Company in trade transactions. The companies invested in are able to use the ITEX trade dollars received in payment for the stock issued to purchase goods and services used in the operation of their businesses.
As a result of this utilization of trade dollars, the Company has accumulated an investment portfolio of marketable equity securities totaling $3,877,000 at July 31, 1996, stated at the lower of cost or market. Also at July 31, 1996, the Company owned inventories of goods and services totaling $7,577,000, stated at the lower of cost or market, which was available for corporate trading or trading to members within the Exchange, which increases cash commissions earned by the Company, for exchange for equity securities of other companies, or for consumption by the Company in providing for its own operating needs.
In 1993 the Company purchased a 49% interest in Associated Reciprocal Traders ("ART"), a trading company located in Zug, Switzerland. ART acts as a buyer and seller of goods and services using barter, usually dealing with parties outside the U.S. Through its interest in ART, the Company has a presence in the international corporate barter marketplace. The Company's share of ART's net assets and results of operations are included in the Company's financial statements using the equity method of accounting.
During the last several years, the Company started and operated a media department, which exchanged media products owned by the Company for due bills for prepaid advertising credits on radio stations across the U.S. The four Company-owned included the Image Audio Music Production Library, , the Golden Age of Radio Theatre, the New Rock Countdown, and Flashback ... Moments in Time. During the fourth quarter of the fiscal year ended July 31, 1996, the Company sold the this media-focused business operation in order to improve the Company's ongoing cash flow. The Company realized a profit of $325,000 from the transaction.
Although the Statement of Cash Flows indicates negative cash flow from operations, the Company believes that cash fees and commissions, cash that can be obtained from the sale of inventories and available-for-sale equity securities at the discretion of the Company, and cash that would be available from the sale of equity and debt securities of the Company will be sufficient to fund cash operating needs of the Company while continuing to follow the strategy of mixing cash and trade activities so as to maximize
long-term wealth building and shareholder value. Furthermore, the Company is presently incurring negative cash flow with respect to several areas of business development that would be expected to contribute in the future to long-range wealth building. At the Company's discretion, it could conserve cash by suspending or terminating these activities. However, there can be no assurance that operating conditions will enable the Company to continue to operate as described above or that adequate funds from any sources will continue to be available on terms acceptable to the Company.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation The consolidated financial statements include the accounts of the Company and Barter Exchange, Inc., a wholly owned subsidiary. Intercompany transactions have been eliminated.
Trade Dollar Transactions
Normal Valuation of Trade Dollars. The Company uses the ratio of one trade dollar to one United States dollar in measuring and accounting for purchases and sales. This one-for-one ratio is the pervasive standard within the ITEX Retail Barter Exchange and throughout the barter industry. The Company does not recognize any accounting implications if differences are observed between trade dollar and U.S. dollar prices that are within reasonable ranges that might exist between prices of similar U.S. dollar transactions.
Abnormal Valuation of Trade Dollars. For those few significant trade dollar transactions in which fair market values are determined to be materially different from the ratio of $1 to one trade dollar, the fair market values are used in determining the accounting result of the transaction instead of amounts equal to the number of trade dollars exchanged. Abnormal valuations most often occur in certain acquisitions of bulk inventories, such as those entered into by the Company for principal party trading or for trading to and for the benefit of members of the ITEX Retail Barter Exchange. In such situations, an accounting adjustment is recorded to decrease the carrying value of the inventory to fair market value along with a decrease to income for the period.
Trade Dollar Valuation in the Statement of Operations. The ratio of $1 per trade dollar is applicable to revenue and costs and expenses in the statement of operations with the exception of the effects of additional costs and expenses recorded as a result of the circumstances described under the preceding section "Abnormal Valuation of Trade Dollars." It should be noted that to a significant extent, any adjustments to trade dollar revenue would be offset by corresponding adjustments to expenses paid when corresponding trade dollars are spent for goods and services that are charged to costs and expenses.
Trade Dollar Valuation in the Balance Sheet. The Company has expertise in trading. The Company has a blended cash-trade purchasing program in which it spends trade dollars that have been earned or issued by the Company and U.S. dollars--in tandem--to pay for goods and services used by the Company in its operations. Because of the effectiveness of its purchasing programs, the Company has not accumulated significant trade dollar balances on its balance sheets.
Any negative trade dollar balance of the Company is shown as a liability in the balance sheet. The contractual relationship between the Company and members of the ITEX Retail Barter Exchange permit the Company to essentially "borrow" trade dollars through the
issuance of trade dollars in excess of the amount specifically earned by the Company, within certain specified limitations.
At each balance sheet date, in accordance with generally accepted accounting principles, any positive trade dollar balance of the Company would be evaluated for net realizable value. The Company would adjust the carrying value of the trade dollars if the fair value of the trade dollars is less than the carrying value or it is probable that not all trade dollars will be used.
Information that would be used to support the net realizable value of a significant positive trade dollar balance at a balance sheet date would include the Company's past track record of utilizing trade dollars, evident ability and intent to utilize the trade dollars in a reasonable time, indicated by the quantity of trade dollars relative to the size of the Company's procurement budget for items the trade dollars may be used for, and preparation of a trade plan for timely utilization on a $1 per trade dollar basis for goods and services that will be available.
Inventory for Principal Party Trading
General. Inventories are stated at the lower of cost (first-in, first-out basis) or market.
Inventory Purchased and Sold for Trade Dollars. Purchases of inventory for principal party trading paid for in trade dollars are valued at the amount of trade dollars paid unless the circumstances described in the preceding section "Abnormal Valuation of trade dollars" are present. For significant purchases of inventory for principal party trading paid for in trade dollars in which fair market values are determined to be materially different from the ratio of $1 per trade dollar, the fair market values are used in determining the accounting result of the transaction and the carrying value of the inventory. In such situations, an accounting adjustment is recorded to decrease the carrying value of the inventory to fair market value along with a decrease to income for the period.
Determination and Substantiation of Fair Market Value. The Company's procedures for inventory for principal party trading include obtaining appraisals of fair market, comparison to equivalent cash market prices that would be required for similar purchases, or both.
Revenue Recognition. Revenue is recognized for sales of inventory for principal party trading when the buyer has made an unconditional commitment to convey the applicable consideration to the Company and the Company has culminated the earnings process by having shipped the inventory to the buyer or performed such other acts necessary to have completed its required performance pursuant to the applicable transaction. For any transaction resulting in revenue to the Company, if any material contingencies are present, revenue recognition is delayed until all material contingencies are eliminated. Further, no revenue is recognized unless collection of the applicable consideration is probable.
Trading With Cash Equivalent Credits
Nature of Transactions. In addition to and separate from principal party trading transactions in which the Company purchases and sells inventories for trade dollars, the Company enters into transactions in which it exchanges "Cash Equivalent Credits" for bulk inventory of corporations. These transactions occur completely outside the ITEX Retail Barter Exchange and do not involve trade dollars, which are completely different from Cash Equivalent Credits. The Company arranges the sale of the inventory for cash, which is retained by the Company subject to no future contingencies.
Holders of Cash Equivalent Credits may only use them in purchases of goods and services from specific vendors identified by the Company in a blend of mostly cash and a smaller proportion of Cash Equivalent Credits. Because of bulk purchasing arrangements the Company has with these vendors, the vendors accept the cash portion of the price and essentially grant a special discount to the client equal to the number of Cash Equivalent Credits utilized in the cash-trade blended purchases. ITEX will assist the client in executing transactions in which the client utilizes its Cash Equivalent Credits, but the Company does not guarantee the utilization of the Cash Equivalent Credits and it is the client's responsibility to utilize its Cash Equivalent Credits. The Company earns transaction fees equal to a percentage of the Cash Equivalent Credits utilized by the client.
Revenue Recognition. The Company recognizes revenue equal to the cash to be received from the sale of the inventory when the buyer has made an unconditional commitment to pay and the earnings process has been completed by the shipment of the inventory or such other acts necessary to have completed required performance pursuant to the applicable transaction.
Transaction fee revenue associated with clients' utilization of Cash Equivalent Credits is recognized when Cash Equivalent Credits are utilized and the client is obligated to pay the transaction fee to the Company.
For any transaction resulting in revenue to the Company, if any material contingencies are present, revenue recognition is delayed until all material contingencies are eliminated. Further, no revenue is recognized unless collection of the applicable consideration is probable.
Available for Sale Securities
Nature of Transactions. The Company operates with the objectives of long-term wealth-building while also ensuring availability of sufficient cash for current operating requirements. In this respect, the Company sometimes exchanges ITEX Corporation common stock for stock of other publicly-traded companies. The Company also invests trade dollars that have been earned or issued by the Company or inventories for principal party trading in equity securities of other publicly-traded companies. The investee companies are able to use the trade dollars received in payment for the stock issued to purchase needed goods and services or to use the inventory items received as payment for the stock in the operation of their businesses.
Accounting Principles. Effective August 1, 1994, the Company changed its method of accounting for equity securities to conform to the requirements of financial Accounting Standards Board Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The change had no effect on retained earnings. The noncurrent portfolio of available-for-sale securities is stated at fair market value at balance sheet dates. Realized gains and losses are determined on the specific identification method and recognized in net income. Net unrealized gains or losses on noncurrent available-for-sale securities are recorded in a separate stockholders' equity account, except for unrealized losses that are considered to be other than temporary, which are recognized as losses in determining net income.
Determination of Fair Market Value. In accordance with advice received from the SEC Office of the Chief Accountant (see Attachment A), investments in restricted stock of publicly-traded companies are stated at the current quoted market price of freely-trading stock of the investee. Also consistent with such advice, convertible preferred stocks are
stated at the current quoted market price of common shares that the preferred stock is convertible into.
Income Taxes
Income taxes are provided for the tax effects of transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the bases of certain assets and liabilities for financial and tax reporting. The deferred taxes represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. The Company accounts for investment tax credits using the flow-through method, and thus, they reduce income tax in the year the related assets are placed in service or qualified progress payments are made.
For years prior to July 31, 1995, the Company filed its income tax returns on the cash basis whereby, trade accounts receivable and various operating payables had no tax basis. Revenue associated with trade accounts receivable was recognized when payments were received and the various operating payables were deductible when payments were made. For fiscal years 1996 and 1995, the Company is required to file its income tax returns on the accrual basis.
The provision for income taxes includes federal, foreign, state and local income taxes currently payable and those deferred because of temporary differences between the financial statements and tax bases of assets and liabilities. All of the undistributed earnings of the foreign affiliate have been reinvested and are not expected to be remitted to the parent company. Accordingly, no federal income taxes have been provided on such earnings, and at July 31, 1996 and 1995, the cumulative amounts of reinvested income was approximately $2,766,000 and $1,590,000, respectively.
Income Per Share
Income per share of common stock is computed on the basis of the weighted average shares of common stock outstanding, plus common equivalent shares arising from the effect of dilutive stock options using the modified treasury stock method, and net income increased for debt reduction and investment in short-term paper from the hypothetical exercise of options.
Costs of Communication and Information Systems
The Company capitalizes costs of purchasing and internal costs of developing and enhancing its communication and information systems. The Company capitalizes only direct costs of development after technological feasibility has been determined. Other costs related to development are expenses as incurred as research and development expenditures. Capitalized costs of communication and information systems are amortized over a 4 year period.
Depreciation and Amortization
Property and equipment are stated at cost. Depreciation is computed on the straight-line method for financial statement purposes. Estimated useful lives range from 3 to 10 years. Intangible assets, consisting of "excess of cost over net assets of company acquired," "noncompete covenants," and "member lists", are stated at cost and are being amortized over 20 and 5-year periods, respectively.
Capitalized Equipment Leases
Vehicle and equipment leases have been recorded at the present value of the net minimum lease payments. These assets are being depreciated using the straight-line method over lease terms of 3 to 5 years.
Allowance for Uncollectible Accounts
The Company provides an allowance for accounts receivable which are doubtful of collection. The allowance is based upon management's periodic analysis of receivables, evaluation of current economic conditions, and other pertinent factors. Ultimate losses may vary from the current estimates and, as additions to the allowance become necessary, they are charged against earnings in the period in which they become known. Losses are charged and recoveries are credited to the allowance.
Estimates and Assumptions
Management uses estimates and assumptions in preparing financial statements in accordance with generally accepted accounting principles. those estimates and assumptions affect the reported amounts of assets, liabilities, revenue, expenses, gains and losses, and also disclosures about contingent assets and liabilities. Actual results may vary from estimates and assumptions that were used in preparing the financial statements.
NOTE 3 - REVENUE
The following table summarizes the cash and trade (consisting of ITEX trade dollars and other noncash consideration) components of revenue for each of the fiscal years ended July 31, 1996, 1995, and 1994:
Fiscal Years Ended July 31, ----------------------------------------- 1996 1995 1994 ---------- ---------- ---------- (in thousands) Corporate Trading Revenue Trade $ 11,643 $ 12,403 $ 8,266 Cash 4,684 1,808 161 ---------- ---------- ---------- 16,327 14,211 8,427 ---------- ---------- ---------- Trade Exchange Revenue Trade 5,532 4,204 1,942 Cash 8,593 5,214 4,398 ---------- ---------- ---------- 14,125 9,418 6,340 ---------- ---------- ---------- Total Revenue Trade 17,175 16,607 10,208 Cash 13,277 7,022 4,559 ---------- ---------- ----------
$ 30,452 $ 23,629 $ 14,767 ========== ========== ==========
NOTE 5 - PREPAIDS AND OTHER CURRENT ASSETS
At July 31, 1995 and 1994, prepaid expenses consisted of the following:
July 31, ------------------------------------------ 1996 1995 ------------------- ------------------ (in thousands)
Prepaid printing $ 640 $ 270 Prepaid rent --- 14 Prepaid services and other 315 40 =================== ================== $ 955 $ 324 =================== ==================
NOTE 6 - INVENTORY FOR PRINCIPAL PARTY TRADING
Following are the components of inventory for principal party trading:
July 31, ------------------------------------------ 1996 1995 ------------------- ------------------ (in thousands)
Prepaid media advertising duebills $ 2,977 $ 3,402 Image production inventory --- 292 Art work 2,963 245 Foreign hotel roomnights --- 226 Domestic hotel roomnights 1,447 1,531 Miscellaneous inventory 190 --- ------------------- ------------------ $ 7,577 $ 5,696 =================== ==================
NOTE 7 - AVAILABLE-FOR-SALE SECURITIES
Following is information about the value of available-for-sale securities at July 31, 1996 and 1995:
Effective August 1, 1994, the Company changed its method of accounting for equity securities to conform to the requirements of Financial Accounting Standards Board Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities. The change had no effect on retained earnings.
The Company recognizes realized gains and losses from the disposition of available-for-sale securities in results of operations. The Company recognized gains of $470,000 and losses of $248,000 in the year ended July 31, 1995. The Company recognized gains of $231,000 and losses of $219,000 in the year ended July 31, 1994.
In May 1994, the Company acquired $2,500,000 face value of Class A Convertible Preferred Stock of Sky Scientific Financial Services, Inc. The terms of the preferred stock include a 4 3/4% cumulative annual dividend rate payable quarterly. The stock is convertible one-third of face value every twelve months to common stock of Sky Scientific, Inc. (the parent company). The conversion rate is 80% of the average bid price of the common stock. Sky Scientific Financial Services, Inc. has the right to call any stock not converted. The preferred stock is valued at the face value, discounted by the present value of shares convertible into common in the future. Included in unrealized gains is the value of the lapse of one year of a conversion restriction of $91,670 in fiscal 1995 and the value of the lapse of the final conversion restriction of $138,000 in fiscal 1996.
In July 1995, the Company acquired $1,650,000 face value of Class A Convertible Preferred Stock (of which $1,500,000 was sold during the same month) of North American Resorts, Inc. ("NAR"). Such shares accrue interest at the rate of 9% per annum payable in common shares. The preferred shares are convertible one-fourth of the original face value any time after each consecutive twelve-month period, at 80% of the average traded price of NAR's common stock.
In August 1994, the Company acquired $500,000 face value of Class B Preferred Stock of Softpoint, Inc. Such shares accrue interest at the rate of 9% per annum, payable in cash or common shares at Softpoint's discretion. The preferred shares are convertible any time, after one year until ten years for shares of restricted common stock of Softpoint, Inc. at the average bid price. The preferred stock is valued at the face value, discounted by the present value of shares convertible into common in the future.
In April 1996, the Company acquired 15,121 shares of preferred stock of North American Resorts, Inc. The preferred shares are convertible to common shares in 18 month based on the 30-day average stock price at the time of conversion.
In April 1995, the Company agreed to subordinate its preferred stock position in Softpoint, Inc. to that of another investor. In exchange for the subordination, Softpoint agreed to issue 25,000 common shares to the Company. The shares were received by the Company during fiscal 1996.
Also included in the noncurrent marketable equity securities for fiscal 1994, are investments in restricted or legend stock. Quoted prices for unrestricted shares of the same class of stock that is restricted are used in determining fair market value. market values. Market values of other noncurrent marketable equity securities are determined based on quoted prices.
NOTE 8 - INVESTMENT IN FOREIGN EQUITY AFFILIATE
The Company owns a 49% interest in Associated Reciprocal Traders, Inc. ("ART"), a foreign corporation based in Switzerland with international commercial barter operations. ART engages in commercial barter transactions as a buyer and seller of goods and services with companies and businesses that are based in countries outside the United States, as well as U.S. companies. The Company accounts for its investment in and share of net income or loss of ART by the equity method. The Company's equity share of ART's net income, after amortization of the difference between investment cost and the Company's proportionate share of underlying assets, was $1,176,000 for the fiscal year ended July 31, 1996, $958,000 for the fiscal year ended July 31, 1995, and $632,000 for the fiscal year ended July 31, 1994.
Following is summary balance sheet data of ART as of July 31, 1996 and July 31, 1995:
July 31, ------------------------------------------------ 1996 1995 -------------------- -------------------- (in thousands) Total assets $ 6,510 $ 4,543 ===================== ==================== Current liabilities $ 568 $ 469 Stockholders' equity 5,942 4,074 --------------------- -------------------- Total liabilities and equity $ 6,510 $ 4,543 ===================== ====================
The assets of ART as of July 31, 1996 consist primarily of available-for-sale securities, none of which are securities of ITEX Corporation.
NOTE 9 - INVESTMENT IN SLI, INC. AND RELATED LITIGATION
On January 24, 1996, the Company acquired a 100% common stock interest in SLI, Inc. ("SLI"), a Nevada corporation, in exchange for the issuance to SLI's former shareholders of 60,000 shares of its common stock valued at approximately $645,000. The Company then made a cash contribution to the capital of SLI of $1,750,000 and made a loan of $300,000 to SLI. Also on January 24, 1996, SLI purchased a 50% common stock interest in Business Exchange International Corporation ("BXI"), a Nevada corporation, pursuant to rights to purchase such interest that had been assigned to SLI by the former shareholders of SLI. SLI paid $1,750,000 for the common interest in BXI by the purchase of newly issued common stock of BXI and, in addition, SLI loaned $300,000 to BXI. BXI owns and operates one of the leading organized barter exchanges in the United States.
On February 12, 1996, a complaint was filed on behalf of the Company and its wholly owned subsidiary, SLI, Inc., against Saul Yarmak, Stephen Friedland, Business Exchange International Corp., BX International, Inc., Joel Sens, and David Lawson. The complaint, filed in the Circuit Court of the State of Oregon for Multnomah County Case No. 9602-01076, asserted claims for breach of contract, specific performance, declaratory judgment, fraud, defamation, unlawful trade practices, and interference with economic relationships. It sought to recover damages for allegedly disparaging remarks made by certain of the defendants against ITEX and for a court ruling that SLI acquired a 50% interest in the BXI trade exchange owned by one or more of the defendants.
On April 30, 1996, defendants Yarmak, Friedland, Business Exchange International Corp., and BX International, Inc., filed an answer denying the material allegations and asserting a counterclaim for attorney fees.
On October 11, 1996, ITEX Corporation moved for dismissal of its claims (business defamation, unlawful trade practices and interference with economic relationships), without prejudice, against defendants. On that same date the motion was granted and leave granted to file an Amended Complaint. That complaint is styled SLI, Inc. v. Saul Yarmak, Stephen Friedland, Business Exchange International Corp. and BX International, Inc. The Amended Complaint restates the claims against defendants for breach of contract, specific performance, declaratory judgment and fraud. By dismissing ITEX Corporation's claims without prejudice, ITEX may, if it chooses, reinstitute its claims for business defamation, unlawful trade practices and interference with economic relationships. Proceeding under the Amended Complaint permits an expedited determination of the core contract issues raised, that is, whether BXI breached its contract with SLI by asserting that the BXI Trade Exchange is not an asset of BXI.
The potential outcome of this lawsuit is uncertain. However, the Company believes that SLI has meritorious arguments in favor of its contract positions. The Company believes that a solution will be reached either through negotiation or through completion of the litigation process. Based upon the docket in Multnomah County, Oregon, Circuit Court, the matter must go to trial within one year of the filing of the original complaint. Legal counsel is unable to evaluate the probability of a favorable or unfavorable outcome or to estimate the range of potential recovery on the plaintiff's claims or any potential loss on the defendant's counterclaims.
NOTE 10 - GOODWILL AND PURCHASED MEMBER LISTS
On September 20, 1993, ITEX acquired the clients (member lists) of a trade exchange for $67,000 and subsequently, on January 10, 1995, the Company acquired additional clients for $76,000. The cost of the member lists is being amortized over a five-year period.
At July 31, 1996 and 1995, the unamortized balance of member lists consisted of the following: July 31, ------------------------------------------ 1996 1995 ----------------- ----------------- (in thousands) Cost $ 142 $ 142 Accumulated amortization (60) (32) ----------------- ----------------- $ 82 $ 110 ================= =================
Amortization expense for member lists was $28,000, $21,000 and $11,000 for the fiscal years ended July 31, 1996, 1995, and 1994, respectively.
On February 10, 1995, the Company acquired the assets and clients of the Travel Agent's Hotel Guide (TAHG) for $329,000, of which $293,000 represented the value of the clients (member lists). Previously, the Company had acquired a lodging commitment from TAHG for $96,000. The unamortized cost of the commitment of $55,000 was added to the acquisition basis and is being amortized over a five-year period.
At July 31, 1996 and 1995, the unamortized balance consisted of the following:
July 31, ------------------------------------------- 1996 1995 ----------------- ----------------- (in thousands) Cost $ 348 $ 348 Accumulated amortization (104) (35) ----------------- ----------------- $ 244 $ 313 ================= =================
Amortization expense was $75,000, $35,000 and $10,000 for the fiscal years ended July 31, 1996, 1995, and 1994, respectively.
On March 1, 1995, the Company acquired 100% of the common stock of Barter Exchange, Inc. (BEI) for $900,000, of which $657,825 represented the excess of cost over the fair value of net assets acquired (see Note 22). The excess of cost over net assets of the Company acquired is amortized on a straight-line basis over 20 years.
At July 31, 1996 and 1995, the unamortized cost consisted of the following:
July 31, ------------------------------------------- 1996 1995 ----------------- ----------------- (in thousands) Cost $ 658 $ 658 Accumulated amortization (47) (14) ----------------- ----------------- $ 611 $ 644 ================= =================
Amortization expense was $33,000 and $14,000 for the fiscal years ended July 31, 1996 and 1995, respectively.
On April 27, 1996, the Company acquired the assets and clients of Global Exchange Network, Inc. for $385,000, of which $257,000 represented the value of a noncompete agreement and $128,000 represented the value of the member list. At July 31, 1996, the unamortized balance consisted of the following:
(in thousands)
Cost $ 385 Accumulated amortization (23) ----------------- $ 362 =================
Amortization expense was $22,000 for the fiscal year ended July 31, 1996.
NOTE 11 - OTHER ASSETS
At July 31, 1996 and 1995, property and equipment, which are included in Other assets, consisted of the following:
July 31, ----------------------------------------- 1996 1995 ------------------ ------------------ (in thousands)
Office furniture and fixtures $ 111 $ 110 Computer equipment 486 446 Vehicles 29 --- Leasehold improvements 118 151 ------------------ ------------------ 744 707 Less, accumulated depreciation (491) (487) ================== ================== $ 253 $ 220 ================== ==================
Depreciation expense for property and equipment was $91,000, $68,000 and $91,000 for the fiscal years ended July 31, 1996, 1995, and 1994, respectively.
At July 31, 1996 and 1995, capitalized equipment leases, which are included in Other assets, consisted of the following:
July 31, --------------------------------------- 1996 1995 ------------------- --------------- (in thousands)
Vehicles $ --- $ 69 Computer equipment 175 193 ----------------- ----------------- 175 262 Less, accumulated depreciation (72) (92) ================= ================= $ 103 $ 170 ================= =================
Depreciation expense for capitalized equipment leases was $41,000, $31,000 and $11,000 for the fiscal years ended July 31, 1996, 1995, and 1994, respectively.
At July 31, 1996, Other assets includes costs of purchasing and developing certain of the Company's information and communication systems. During fiscal 1996, the Company continued work on development projects that had been commenced in prior years. Since these are mature projects and systems, technological feasibility was present, resulting in the capitalization of most of the development costs incurred in fiscal 1996, in accordance with the Company's accounting policy. The increase in the level of research and development costs was attributable to the nature of the activities in fiscal 1996, which essentially consisted of coding and other activities connected with constructing the systems. A large portion of the development costs were paid to independent consultants and specialists in the particular systems areas and are not fixed costs of the Company.
Research and development during the past two fiscal years has focused both on technological improvements and international expansion. During the fiscal year ended July 31, 1996, the Company spent a total of $577,000 on research and development for its communication and information systems, of which $560,000 was capitalized and $17,000 was charged to expense. During the fiscal years ended July 31, 1995 and 1994, the
Company spent a total of $169,000 and $131,000, respectively, all of which was charged to expense.
The projects were still in progress at July 31, 1996. Several of the systems and enhancement projects were nearing completion at the end of fiscal 1996. When the projects are completed and ready for general use, the costs will be amortized over a four-year period.
NOTE 12 - BROKER PORTION OF ACCOUNTS RECEIVABLE
The Company maintains brokers in offices around the country to service its customers. The broker is entitled to a split of any collections the Company makes on that broker's customers, which is then payable within 35 days. The liability for amounts estimated to be collected in the future was $547,000,000 and $580,000 at July 31, 1996 and 1995.
NOTE 13 - EXCESS OF TRADE DOLLARS ISSUED OVER TRADE CREDITS EARNED
At July 31, 1996, the Company had expended 41,000 ITEX trade dollars in excess of the amount of trade dollars earned by the Company. This situation is commonly referred to in the commercial barter industry as a "negative trade balance."
Trade dollars issued in excess of earned by the Company is specifically provided for in the ITEX Trading Rules that govern the Exchange. Such provisions allow the Company to issue trade dollars in excess of earned within certain guideline amounts. This provides the Company with additional liquidity and the opportunity to complete advantageous purchase transactions that benefit the Company and Exchange members. The Company would be ultimately obligated to provide goods and services to Exchange members to offset any amounts of trade dollars issued in excess of earned. This could be accomplished by the sale for trade dollars of the inventories for which the acquisition resulted in the trade dollars issued in excess of earned or other inventories, by otherwise earning trade dollars, or a combination of both.
NOTE 14 - BANK LINE OF CREDIT
Bank Line of Credit. The Company had a line of credit facility with a bank that expired on May 31, 1996. Pursuant to the line of credit, the Company was able to borrow up to $200,000 on a short-term basis for working capital purposes. The interest rate applicable to borrowings pursuant to the facility is equal to the bank's prime rate of interest plus 2%. The maximum amount of cash borrowings that may be outstanding at any time is determined by a borrowing base formula related to available collateral. Borrowings are collateralized by the Company's accounts receivable, fixed assets and inventory. As of July 31, 1996, the Company had no borrowings outstanding under the bank credit facility. The Company is presently discussing the terms of a new line of credit with the bank.
NOTE 15 - LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Notes Payable
At July 31, 1996 and 1995, long-term debt consisted of the following:
The annual maturities of long-term debt for the next five years are as follows:
(in thousands)
Fiscal Year Ending July 31, 1997 $ 96 1998 102 1999 14 2000 7 2001 3
Capital Leases
The Company leases vehicles and equipment under seven noncancellable capital leases. The leases, which expire during the years 1996 through 1999, have terms from three to five years and provide for aggregate monthly payments of $4,600. The Company is obligated under the vehicle leases to pay executory costs such as insurance, maintenance and other related expenses.
Minimum future lease payments under capital leases for the next five years are as follows:
(in thousands)
Fiscal Year Ending July 31, 1997 $ 54 1998 45 1999 24 2000 4 ------------------ Less, imputed interest (19) ------------------ Present value of minimum lease payments 108 Less, current portion (42) ------------------ $ 66 ==================
NOTE 16 - CAPITAL STOCK
Private Placements. During the fiscal year ended July 31, 1996, the Company completed a private placement with Newcastle Services Ltd. ("Newcastle"), a foreign corporation, pursuant to which Newcastle purchased 200,000 shares of the Company's common stock for $750,000. The Company also completed a private placement pursuant to which an individual purchased 56,000 shares of the Company's common stock for $210,000. The Company also completed a private placement pursuant to which an officer of the Company purchased 25,000 shares of the Company's common stock for $94,000. In each of these private placements, the Company issued for each share of common stock purchased a warrant to purchase one share of common stock at an exercise price of $4.50 per share and one share of common stock at an exercise price of $5.50 per share. The warrants were exercisable from date of issuance and expired on July 31, 1996.
Effective January 1, 1996, the Company entered into a Regulation S transaction with Wycliff Fund, Inc. ("Wycliff"), a foreign corporation. Wycliff agreed to purchase 1,022,495 units of the Company's equity securities over a two-year period for $4.89 per unit, equaling a total of $5,000,000. Each unit consists of one share of common stock and warrants to purchase two shares of common stock. One warrant entitles the holder to purchase one share of common stock at an exercise price of $4.89 per share, is exercisable from and after two years from the date of issuance, and expires five years from the date of issuance. The other warrant entitles the holder to purchase one share of common stock at an exercise price of $6.12 per share, is exercisable from and after four years from the date of issuance, and expires ten years from the date of issuance. Wycliff was required to pay the purchase price of the units at a minimum rate of $625,000 per quarter.
Through July 31, 1996, the Company received $1,250,000 from Wycliff and issued 255,624 shares of common stock and the Company also issued warrants to purchase 255,624 shares of common stock at an exercise price of $4.89 per share, exercisable from and after two years from the date of issuance, with expiration five years from the date of issuance, and warrants to purchase 255,624 shares of common stock at an exercise price of $6.12 per share, exercisable from and after four years from the date of issuance, with expiration ten years from the date of issuance.
Under the terms of the Wycliff private placement, if the entire purchase price of $5,000,000 was paid no later than December 31, 1996, the Company would have been
required to issue to Wycliff warrants to purchase an additional 250,000 shares of common stock at an exercise price of $4.89 per share. The private placement terms also provided that Wycliff would pay to the Company additional amounts equal to 8% per annum for any portion of the purchase price that was not paid on or before December 31, 1996. Further, the private placement provided that if Wycliff failed to pay at least $625,000 in any calendar quarter, the Company could, at its sole option, decline to thereafter sell any of the then unpurchased units to Wycliff. Wycliff did not pay the purchase price that would have been due for the calendar quarter ended September 30, 1996, and therefore the Company has canceled the remaining portion of the private placement.
In addition, during the fiscal year ended July 31, 1996, the Company issued 350,000 shares of common stock as compensation for services and in connection with the acquisition of SLI, Inc.
Stock Option Plan. Effective April 19, 1993, the Company adopted a Key Employee's Incentive Stock Option Plan (the 1993 Plan) that provides for the grant of options intended to meet the requirements of Internal Revenue Code Section 422, to purchase shares of the Company's common stock. Under the Plan, the Company may grant to the Optionee during the period ending on a date not more than ten years from the date of the grant of the option, the option to purchase common stock of the Company at a price per share equal to the bid price of the Company's traded common stock on the date of the grant of the option. The Company filed a Form S-8 registration with the Securities and Exchange Commission with respect to the shares of common stock underlying options issued or to be issued pursuant to the 1993 Plan. During the fiscal year ended July 31, 1996, the Company received proceeds totaling $875,000 from the exercise of stock options to purchase 475,000 shares of common stock pursuant to 1993 Plan.
Effective December 15, 1995, the Board of Directors adopted a new stock option plan pursuant to which options to purchase up to 1,300,000 shares of the Company's common stock may be granted to employees, officers, directors, and consultants of the Company. Exercise prices for options granted under the plans are equal to market value on the date of grant and options may be exercisable for up to ten years from the date of grant at the discretion of the Board of Directors. During the fiscal year ended July 31, 1996, pursuant to the new stock option plan, options to purchase 1,295,000 shares were granted at an exercise price of $6.13 per share. The plan was approved by the Company's shareholders at the annual meeting of the Company's shareholders held on May 3, 1996. It is the intention of the Company to file a Form S-8 registration with the Securities and Exchange Commission with respect to the shares of common stock underlying options to be issued pursuant to the plan.
Following is a summary of activity under both stock option plans for the three year period ended July 31, 1996:
Option Price (equal to Market Number of Value) at Date of Grant ----------------------------- Shares Per Share Total ------------- ----------------------------- Balance at August 1, 1993....... 305,000 $ 305,000 Grants...................... 203,000 $3.38 686,000 Exercises................... 1.00 (130,000) (130,000) ------------- -------------- Balance at July 31, 1994........ 378,000 1.00-3.38 861,000 Grants...................... 730,000 1.94-2.50 1,517,000 Exercises................... 1.00 (10,000) (10,000) ------------- -------------- Balance at July 31, 1995........ 1,098,000 1.00-3.38 2,368,000 Grants...................... 1,295,000 6.13 7,938,000 Exercises................... (470,000) 1.94-2.50 ( 895,000) ------------- -------------- Balance at July 31, 1996........ 1,923,000 1.00-6.13 $ 9,411,000 ============= ==============
Number of shares exercisable: July 31, 1996............... 1,923,000 ================ July 31, 1995............... 928,000 ================
Warrants. During the fiscal year ended July 31, 1996, the Company received proceeds totaling $656,000 from the exercise of previously outstanding warrants to purchase 250,000 shares of common stock.
Stock Split. At the annual meeting of the Company's shareholders on May 3, 1996, the Company's shareholders approved a two-for-one forward stock split with respect to the Company's common stock. The stock split has not yet been implemented by the Company. Upon implementation of the stock split, all share and per share data included in the Company's financial statements would be restated to give effect to the stock split.
NOTE 17 - INCOME TAXES
Comparative analysis of the provisions for income taxes follows:
Fiscal Years Ended July 31, ---------------------------------------------------- 1996 1995 1994 -------------- ------------- ------------- (in thousands) Current: Federal $ 556 $ 475 $ 76 State 113 94 16 -------------- ------------- -------------
669 569 92 -------------- ------------- ------------- Deferred Federal 114 (40) 8 State 23 (7) 1 -------------- ------------- ------------- 137 (47) 9 -------------- ------------- ------------- $ 806 $ 522 $ 101 ============== ============= =============
A reconciliation of the consolidated income tax expense on income per the U.S. Federal Statutory rate to the reported income tax follows:
Fiscal Years Ended July 31, ---------------------------------------------------- 1996 1995 1994 -------------- ------------- ------------- (in thousands) Taxes at U.S. Federal statutory rate $ 1,111 $ 746 $ 307 Nondeductible items (47) (45) (25) Share of net income of foreign equity affiliate (470) (316) (209) State income taxes 212 137 28 -------------- ------------- ============ $ 806 $ 522 $ 101 ============== ============= ============
At July 31, 1996 and 1995, deferred tax (assets) liabilities consisted of the following:
July 31, ---------------------------------------- 1996 1995 ------------------ ----------------- (in thousands) Current deferred tax liabilities $ --- $ 43 Noncurrent deferred tax liabilities 237 130 Current deferred tax assets (3) (51) Noncurrent deferred tax assets --- (26) Valuation allowance --- --- ================== ================= $ 234 $ 96 ================== =================
NOTE 18 - ACQUISITIONS
Acquisition of Global Exchange Network. During the fiscal year ended July 31, 1996, the Company acquired the assets and business of Global Exchange Network of Irvine, California, including its membership base. The purchase price was $385,000, which was paid $200,000 in cash and by the issuance of a 6% promissory note for $185,000, payable in monthly installments of $8,331 including principal and interest, commencing with the first such payment on September 1, 1996, with monthly payments thereafter until the final payment on August 1, 1998. The acquisition has been accounted for by the purchase method. The purchase price was allocated to the following:
(in thousands)
Member lists $ 128 Noncompete covenant 257 ------------------ $ 385 ==================
The accompanying consolidated financial statements include operations of Global from April 27, 1996, the date of acquisition.
Acquisition of Barter Exchange, Inc. (BEI) Trade Exchange. Effective March 1, 1995, ITEX entered into an Agreement to acquire all of the issued and outstanding capital stock of Barter Exchange, Inc. (BEI) (a newly formed corporation), from Inventory Merchandising Services, Inc. (IMS). Pursuant to the Agreement, ITEX agreed to transfer and deliver to
IMS 300,000 shares of authorized but previously unissued common stock of ITEX. BEI is involved in the retail barter industry in the Texas region.
The exchange of stock was accounting for using the purchase method of accounting, and the results of operations of BEI have been included in ITEX's consolidated financial statements subsequent to March 1, 1995. As of March 31, 1995, the fair market value of the 300,000 shares of ITEX common stock approximated $900,000 and, accordingly, ITEX has used the fair market value of the ITEX shares exchanged for purposes of purchase accounting. Goodwill resulting from the acquisition is being amortized over 20 years on a straight-line basis. The price was allocated as follows:
(in thousands)
Accounts receivable $ 242 Goodwill 658 ----- $ 900
The accompanying consolidated financial statements include operations of the subsidiary from March 1, 1995, the date of acquisition.
Acquisition of Travel Agents Hotel Guide. Effective February 10, 1995, ITEX acquired all of the business assets of Travel Agent's Hotel Guide (TAHG) in exchange for 125,000 shares of ITEX common stock valued at $328,125. The purchase price was allocated as follows:
(in thousands)
Fixed assets $ 35 Goodwill 293 ---- $ 328
The accompanying consolidated financial statements include operations of TAHG for the period from February 10, 1995, the date of acquisition.
NOTE 19 - 401(k) SAVINGS PLAN
Employees of the Company may participate in a 401(k) savings plan, whereby the employees may elect to make contributions pursuant to a salary reduction agreement upon meeting age and length of service requirements. The Company makes matching contributions of 50% of electing employees' deferrals, up to a ceiling amount of 3% of gross annual wages. Matching contributions to the plan were $10,000, $7,000 and $5,000 for the plan years ended December 31, 1995, 1994, and 1993, respectively.
NOTE 20 - BUSINESS CONCENTRATIONS
One customer accounted for approximately $3,200,000 or 20% of corporate trading revenue and 20% of total revenue. for the year ended July 31, 1996.
Three customers accounted for approximately $6,200,000 or 48% of corporate trade revenue and 26% of total operating revenues for the year ended July 31, 1995.
One customer accounted for approximately $2,361,000 or 28% of corporate trade revenue and 16% of total operating revenues (not including revenues included in the net income of the foreign affiliate) for the year ended July 31, 1994.
N0TE 21 - COMMITMENTS AND CONTINGENCIES
The Company leases office facilities in Portland, Oregon; Orange County, California; and St. Louis, Missouri. Future minimum rental commitments pursuant to these leases are as follows:
(in thousands)
Fiscal Year Ending July 31, 1997 4 170 1998 151 1999 140 2000 140 2001 140
Of the minimum rental commitment due in fiscal 1997, $144,000 is payable in cash and $26,000 is payable in ITEX trade dollars.
On April 9, 1994, the Company issued 150,000 shares of common stock as partial payment for a 49% interest in a foreign affiliate. (See Notes 9 and 20.) The Company shall pay the seller a maximum of $1,650,000. In addition to the common stock, the remaining amount due shall be paid by the issuance of up to 400,000 shares of a new class of stock to be issued upon the approval of a shareholders meeting and referred to as Class "A" Convertible Preferred Stock. Delivery of the shares is subject to the foreign affiliate fulfilling specified performance criteria.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
a) 1. Financial Statements. The following financial statements are filed as a part off this Form 10-K:
The Index to Consolidated Financial Statements is set out in Item 8 herein.
3. Exhibits Articles of Incorporation and Bylaws (incorporated by reference for Form 10 filed February 7, 1990)
10. Barter Exchange, Inc. contract dated March 1, 1995)
21. Subsidiaries of the Company Barter Exchange, Inc., incorporated in Nevada SLI, Inc., incorporated in Nevada
23. Consent of Independent Auditors
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
As of November 12, 1996, the Company's independent auditor, Andersen, Andersen & Strong, L.C., had not completed the audit procedures related to audit of the Company's July 31, 1996 financial statements. Andersen, Andersen & Strong, L.C. is continuing its audit. When the auditors have completed their audit, the Company will file an amended Form 10-K that includes the auditors' report and any changes to the financial statements and related disclosures that are determined as a result of completion of the audit procedures.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: November 12, 1996
ITEX CORPORATION
November 12, 1996 /s/ Graham H. Norris, Sr. - ------------------------------ ------------------------------------ Graham H. Norris, President and Chief Executive Officer principal executive officer and director)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.
/s/ Graham H. Norris, Sr. November 12, 1996 - ---------------------------------------------- Graham H. Norris, President and Chief Executive Officer (principal executive officer and director)
/s/ Joseph M. Morris November 12, 1996 - ---------------------------------------------- Joseph M. Morris, Vice President and Chief Financial Officer (principal accounting officer and director)
/s/ Mary Sherr November 12, 1996 - ---------------------------------------------- Vice President of Broker Development, Director
/s/ Dr. Evan B. Ames November 12, 1996 - ---------------------------------------------- Director
/s/ Thomas G. Baer November 12, 1996 - ---------------------------------------------- Director
/s/ Dr. Sherry L. Meinberg November 12, 1996 - ---------------------------------------------- Director
/s/ Robert Nelson November 12, 1996 - ---------------------------------------------- /s/ Director
/s/ Dr. Charles Padbury November 12, 1996 - ---------------------------------------------- Chairman of the Board of Directors