UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C.  20549

FORM 10 - K

(Mark One)

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

For the fiscal year ended July 31, 2011.

or

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

For the transition period from  to

Commission File Number 0-18275

ITEX CORPORATION

(Name of small business issuer in its charter)

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

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

(Address of principal executive offices)

(425) 463-4000

(Issuer’s telephone number including area code)

Securities registered under Section 12 (b) of the Exchange Act	None
Securities registered pursuant to Section 12 (g) of the Exchange Act	Common Stock  $0.01 par value
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act	Yes ¨  No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act	Yes ¨  No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.	Yes þ  No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).	Yes¨No¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K	Yes þ  No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨	Accelerated filer ¨
Non-accelerated filer   ¨	Smaller Reporting Company þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ¨  No þ

The aggregate market value of the common stock held by non-affiliates of the Company as of September 30, 2011 was approximately $12,823,844 based upon 3,197,966 shares held by such persons and the closing bid price of $4.01 as reported by the OTC Bulletin Board for that date.  Shares of common stock held by each officer and director and by each person who owns 10.0% or more of the outstanding common stock have been excluded because these people may be deemed to be affiliates.  This determination of affiliate status is not necessarily a conclusive determination for any other purpose.

As of September 30, 2011, we had 3,648,567 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

No documents are incorporated by reference.

ITEX CORPORATION

FORM 10-K

For The Fiscal Year Ended July 31, 2011

INDEX

		Page
PART I
ITEM 1.	Business	1
ITEM 1A.	Risk Factors	9
ITEM 1B.	Unresolved Staff Comments	17
ITEM 2.	Properties	17
ITEM 3.	Legal Proceedings	17
PART II
ITEM 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	18
ITEM 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
ITEM 8.	Financial Statements and Supplementary Data	41
ITEM 9.	Changes In and Disagreements With Accountants on Accounting and Financial Disclosure	70
ITEM 9A.	Controls and Procedures	70
ITEM 9B.	Other Information	70
PART III
ITEM 10.	Directors, Executive Officers and Corporate Governance	71
ITEM 11.	Executive Compensation	73
ITEM 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	76
ITEM 13.	Certain Relationships and Related Transactions, and Director Independence	78
ITEM 14.	Principal Accountant Fees and Services	79
PART IV
ITEM 15.	Exhibits and Financial Statement Schedules	80
	Signatures	82

 

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PART I

Special Note Regarding Forward-Looking Statements

In addition to current and historical information, this Annual Report on Form 10-K contains forward-looking statements.  These statements relate to our future operations, prospects, potential products, services, developments, business strategies or our future financial performance.  Forward-looking statements reflect our expectations and assumptions only as of the date of this report and are subject to risks and uncertainties.  Actual events or results may differ materially.  We have included a discussion of certain risks and uncertainties that could cause actual results and events to differ materially from our forward-looking statements in the section entitled “Risk Factors” (refer to Part I Item 1A).  We undertake no obligation to update or revise publicly any forward-looking statement after the date of this report, whether as a result of new information, future events or otherwise.

ITEM 1.                BUSINESS

Overview

ITEX, The Membership Trading CommunitySM, is a leading marketplace for cashless business transactions across North America (“the Marketplace”).  We service our member businesses through our independent licensed brokers and franchise network, (individually, “broker” and together, the “Broker Network”) in the United States and Canada, as well as through certain corporate-owned offices.  Our business services and payment systems enable member businesses (our “members”) to trade products and services without exchanging cash.  These products and services are instead exchanged for ITEX dollars which can only be redeemed in the Marketplace (“ITEX dollars”).  We administer the Marketplace and act as a third-party record-keeper for our members’ transactions.  We generate revenue by charging members percentage-based transaction fees, association fees, and other fees assessed in United States dollars and Canadian dollars where applicable (collectively and as reported on our financial statements, “USD” or “Cash”).

We maintain our executive offices at 3326 160th Avenue SE, Suite 100, Bellevue, Washington 98008-6418.  Our telephone number is 425-463-4000.  We routinely post important information on our website under the Investor Relations tab. Our website address is www.itex.com.  There we also make available, free of charge, our SEC reports including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports, as soon as reasonably practicable after we file such material electronically with, or furnish it to, the SEC.  These reports are also available from the SEC website at www.sec.gov.  The information found on our website is not part of this or any other report we file with or furnish to the SEC.

Marketplace Transactions

The Marketplace provides a forum for our members to purchase from and sell their products and services to other members using “ITEX dollars” instead of USD.  An ITEX dollar is an accounting unit used to record the value of transactions as determined by the members in the Marketplace.  ITEX dollars are not intended to constitute legal tender, securities, or commodities and have no readily determinable correlation to USD.  ITEX dollars may only be used in the manner and for the purpose set forth in our Member Agreement and the rules of the Marketplace.  As described below, we issue, on a case by case basis, ITEX dollar credit lines to certain members.  Members with positive ITEX dollar account balances or those within their ITEX dollar credit line may use available ITEX dollars to purchase products or services from other members and may sell their products or services to other members.  Those members with negative ITEX dollar account balances are obligated to sell their products or services to other Marketplace members in order to offset their negative account balance.

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We assist members in marketing their products and services through our Broker Network, newsletters, e-mail, on our website at www.itex.com and through other promotional means.  Transactions are generally conducted by members directly but can be facilitated by our brokers.

Businesses use our Marketplace to attract new customers, increase sales and market share, and to utilize unproductive assets, surplus inventory, or excess capacity.  The Marketplace is especially useful to businesses where the variable costs of products or services are low, such as hospitality, media, and service related businesses.  For example, a hotel that has not filled its rooms by the end of the day has lost potential revenue but still has nearly the same overhead associated with owning and maintaining its facility.  Selling these unused rooms for ITEX dollars is beneficial for both the traveler (buyer) and the hotel (seller).  The traveler receives a hotel room without spending USD and the hotel fills an empty room, with the ability to use the ITEX dollars earned to purchase other products or services in the Marketplace.

In order to facilitate transactions, we may grant ITEX dollar credit lines to certain members.  When considering an ITEX dollar credit line, we assess the financial stability of the member and the demand by others for the member’s product or service.  Members without a line of credit may only use their ITEX dollars received from selling their product or service to purchase other products or services in the Marketplace.

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

Broker Network

Brokers are independent contractors with respect to the Company.  Combined, our corporate staff, brokers and their staff, and outside contractors total more than 400 individuals supporting the Marketplace.  Because we depend on a high rate of repeat business, the quality of broker interactions with members is an important element of our business strategy.  We develop strong, cooperative relationships with our Broker Network by providing training, marketing materials and programs, internet and computer-related support, incentive programs, and investments in customer relationship management technology.

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

Our franchise agreements and independent licensed broker contracts generally provide for a five-year term unless terminated for reasons defined in the agreement.  These agreements provide for subsequent five-year renewal terms as long as the franchisee or broker is not in breach of the agreement and are in compliance with our performance requirements, policies, and procedures then in place.

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Since 2003, we have offered the sale of ITEX franchises to qualified individuals.  In addition, we have sought to renew individual broker contracts under our most current franchise agreement which we periodically amend as current events and circumstances deem necessary.  Through our franchisees, we distribute our services by licensing our business ideas and concepts while retaining legal ownership of those concepts and ideas, including our name, logos, trademarks and member relationships.  Our franchise agreement grants a limited license and right to use and operate a recognizable ITEX outlet to the franchisee by utilizing our business system, technology and proprietary marks.  The franchise agreement allows us to oversee the obligations and responsibilities of the franchisee.  Under federal and state franchise and business opportunity laws, franchisees are entitled to additional protections including the provision that many of the substantive aspects of the business relationship (e.g., termination, transfer, cancellation, and non-renewal) will be governed by state law.  Refer to “Government Regulation” for more information.

Sources of Revenue

For each calendar year, we divide our operations into 13 four-week billing and commission cycles always ending on a Thursday (“operating cycle”).  For financial statement purposes, our fiscal year is from August 1 to July 31 (“year”, “2011” for August 1, 2010 to July 31, 2011, “2010” for August 1, 2009 to July 31, 2010).  We report our results as of the last day of each calendar month (“accounting cycle”).

Our main sources of revenue are transaction and association fees.  We charge both the buyer and the seller a transaction fee based on the ITEX dollar value of that Marketplace transaction.  We also charge members of the Marketplace an association fee every operating cycle in accordance with our members’ individual agreements.  Additionally, we may charge various auxiliary fees to members, such as annual membership dues, late fees, insufficient fund fees and other fees.  The fees we charge members are in USD and partially in ITEX dollars.  We bill members for all fees at the end of each operating cycle.  We track all financial activity in our internally developed database.  Members have the option of paying USD fees automatically by credit card, by electronic funds transfer or by check.  In the years ended July 31, 2011 and 2010, members made approximately 92% and 91%, respectively, of their payments through electronic funds transfer or by credit cards using our Preferred Member Autopay System (“Autopay System”).  If paying through our Autopay System, generally, the USD transaction fee is 6.0% of the ITEX dollar amount of the member’s purchases and sales during the operating cycle.  If paying by check, generally, the USD transaction fee is 7.5% of the ITEX dollar amount of that member’s purchases and sales during the operating cycle.  Additionally, regardless of a member’s transaction activity, each operating cycle we charge most members an association fee of $20 USD ($260 USD annually) and $10 ITEX dollars ($130 ITEX dollars annually).  Transaction and association fees composed 92% of our total revenue in both 2011 and 2010.

We prepare our financial statements on an accrual basis in accordance with United States Generally Accepted Accounting Principles (GAAP).  Refer to Note 1 ― “Summary of Significant Accounting Policies” included in the “Notes to Consolidated Financial Statements”, Item 8 – Financial Statements for a description of our accounting policies.  As discussed in our critical accounting policies, we recognize at fair value of the goods or services received when those goods or services have readily determinable fair values. We recognize ITEX dollars as required by the IRS for income tax reporting purposes.  We account for ITEX dollar transactions and USD fee assessments in statements to members and brokers.  The majority of the ITEX dollars we earn are distributed back to the Broker Network as revenue share and sales incentives.  Additionally, we use ITEX dollars we earn to fund the ITEX co-op advertising program utilized by both members and brokers.  We utilize less than 5% of ITEX dollars earned for certain ITEX operating expenses.

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Business Strategy

Our goal is to expand our market share of the cashless transaction industry, principally in North America.  We believe we can successfully increase the number of members participating in our Marketplace and our revenues if we provide members:

o A system that enables members to execute and track transactions in the Marketplace.  We have internally developed an industry exclusive, comprehensive, customer relationship management and payment processing software called Trade Exchange Account Manager “TEAM.”  This web based software solution provides members, brokers and our management team with enhanced information systems and marketing tools.  We continue to upgrade and enhance our multi-channel payment system that provides efficient internet access to ITEX members and our Broker Network.

o A community where members can meet and safely transact with other members.  Our website has a casual, community approach conveying to Marketplace members the variety of businesses that comprise the Marketplace and the benefits that come with their participation.  Our Broker Network and corporate staff monitor Marketplace transactions to ensure a fair and equitable environment for our members.  Members may sell in the Marketplace only those products and services they have the legal right to sell, pursuant to our Trading Rules.  We encourage members to use caution, common sense and practice safe transactions when using the Marketplace.

o More regions in which to trade by increasing the size and effectiveness of our Broker Network.  To attract new franchisees and increase the trade regions covered by the Marketplace, we have a franchise portion of our website, www.itex.com.  We identified target markets, provided added detail about our company and business model, and allowed potential franchisees to calculate sample financial forecasts.

o Excellent customer service by the Broker Network and our corporate office.  We provide training and support for new and existing brokers and refine our franchisee and broker operating manuals and related support materials on a continual basis.  Additionally, we hold a convention and several regional meetings annually where we discuss and openly share solutions for current issues and proactively plan for future enhancements and benefits to our Marketplace.

o Develop a web based Software as a Service (Web Services) model.  This model is targeted at mid to large sized businesses to enable them in creating reward communities or expand their existing relationship within their customer base, using the ITEX proprietary exchange platform.

Members

The Marketplace has approximately 25,000 members in the United States and Canada.  The majority of members are businesses with fewer than 10 employees.  Members may choose to participate in the Marketplace for a number of reasons including to:

· Attract new customers

· Increase sales and market share

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· Add new channels of distribution

· Utilize unproductive assets, surplus inventory or excess capacity

Members earn ITEX dollars which they have the opportunity to spend on products and services offered by other ITEX members.  The following is a representative example of a transaction:

A dentist earns ITEX dollars by providing dental work to three new customers, the owner of a vacation resort, a restaurant owner and a lawyer, all members of the Marketplace. These other members originally acquired ITEX dollars by providing products or services for other Marketplace members.

The dentist decides to remodel her office.  Through the Marketplace, she hires a contractor who agrees to perform the remodeling work for $1,500 ITEX dollars. Upon completion of the job, the dentist authorizes the deduction of $1,500 ITEX dollars from her ITEX account, payable to the contractor’s ITEX account.

Sales, Marketing and Transactions

Sales

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

Marketing

Our marketing strategy is to promote our Membership Trading Community brand and attract new members to the Marketplace while instructing them how to effectively use the Marketplace to grow their business.  Our marketing efforts include a program of support and education for our members and brokers in addition to continual upgrades and features of our website, www.itex.com.  New tools for brokers to customize and use in their sales efforts include pre-designed advertisements, brochures and sales presentations to give ITEX a consistent look and message.  To promote the Marketplace, we market products and services of existing members through our website, directories, newsletters, e-mail, and other means.  In addition, we utilize national and web-based advertising campaigns.

Transactions

Our brokers focus on generating transaction volume and maximizing the ITEX dollar amount per transaction.  Brokers facilitate transactions between members by identifying their needs and making them aware of products and services available in the Marketplace that could fulfill those needs.  Brokers actively market products and services available to and from the members they service on our website and pursue potential member businesses to offer more transactional opportunities by introducing them to the Marketplace.  Members can also log onto our website and initiate product or service listings on the Marketplace or search for products or services to purchase. Reoccurring transactions often develop between Marketplace members, generating transaction fees with less interaction by brokers.

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Systems and Technologies

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

· Account Information Manager (“AIM”) Online - provides our brokers and corporate staff with customer relationship management features including notes, transaction histories, calendaring and scheduling capabilities as well as Marketplace management features.

· Trade Flash - an online classified ad section where members can list products and services they are offering for ITEX dollars as well as locate products and services they are seeking to purchase with ITEX dollars.

· Member Directory - a categorized listing of ITEX members that allows members to advertise their business.

· Reporting – brokers, corporate management and accounting personnel are provided with a number of reports allowing for a comprehensive analysis of various aspects of the Marketplace.

We take a number of measures to ensure the security of our hardware and software systems and member information.  We continue to enhance our systems for data management and protection, intrusion detection and prevention, upgrade our network architecture, and to expand our disaster recovery processing capacity.  Our technologies are co-hosted in Washington and Idaho and we perform full back-ups daily.  We continue to improve the speed and reliability of our information systems and transaction tools for all of TEAM’s users by continually updating hardware and enhancing our software with new, internally developed programs and functionalities.

Industry Overview

Our industry was developed approximately 50 years ago when various trade exchanges (“Exchanges”) established a non USD-based index of valuation for credits and debits called “trade dollars.”  For us, the index of valuation is the ITEX dollar and our trade exchange is our Marketplace, consisting of approximately 25,000 members served by our 90 locations.  In 2011 we conducted an informal market analysis to determine the size of our industry, contacting hundreds of Exchanges across the United States. Based on our information, we believe there are approximately 300 exchange locations managing approximately 90,000 members.

Competition

We view our two primary competitors to be local Exchanges and internet distribution channels.  We believe that we are the Exchange leader in the United States and Canada based on reported USD revenues, participating member businesses and regions served.  Based on available industry information, we believe the next largest Exchange is International Monetary Systems, Ltd.

Internet distribution channel competitors include eBay, Travelocity, Priceline, Amazon and Overstock.  Similar to our Marketplace, these companies provide distribution channels to move excess or surplus inventory.  The greater the number of avenues to move excess inventory, the more competitive it is to attract businesses to trade their inventory in our Marketplace.  We also compete with these companies through price, ease of use and brand name awareness.

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We compete primarily on a service basis, the number of products and services available in the Marketplace and the liquidity of ITEX dollars.  We expect to encounter competition in our efforts to expand our Marketplace.  In addition to existing Exchanges, new, smaller competitors can launch new Exchanges at a relatively low cost since technological and financial barriers to entry are relatively low.  However, we believe participation from a significant number of members is necessary to offer a quality Exchange.  We also know there is a steep learning curve to manage an Exchange as well as a potentially significant investment in software. Each member of our senior management team has a minimum of 20 years of industry experience and our two technology software engineers have each been with ITEX for more than 10 years. Ultimately, we believe these elements create a difficult barrier to entry for new competitors and may require significant ramp-up times to make a competitive Exchange successful.  Regardless, our competitors could include companies with longer operating histories, greater market presence and name recognition, larger customer bases and greater financial, technical and marketing resources than we have.  Such companies could be strong competitors if they decided to develop a focused business effort in our industry.

In general, customer demands for wider availability of products and services, on-demand customer service, better computer servicing technology and the acceptance of the internet as a medium for communication and business have resulted in a more competitive industry.  We believe that in order to capture greater market share, local Exchanges will need to expand into larger regional or national organizations that possess the ability to offer a wider selection of products and services, service a more diverse and dispersed member clientele and have greater access to growth capital and management expertise.

We believe we will remain in a good competitive position as long as we continue to maintain the quality of our services and our relationships with our Broker Network and our member base.  Our ability to compete successfully will depend on our ability to continually enhance and improve our existing products and services, to adapt products and services to the needs of our brokers, members and potential members, to successfully develop and market new products and services, and to continually improve our operating efficiencies.  However, we cannot assure you that we will be able to compete successfully, that competitors will not develop competing technologies, products or strategic alliances and affiliations that make our brand, products and services less marketable or less useful or desirable.  Furthermore, we may not be able to successfully enhance our products and services or develop new products or services to meet our members’ needs.  Increased competition, price, legal challenges or other circumstances, could result in erosion of our market share and may require price reductions and increased spending on marketing and product development to remain competitive.

Government Regulation

Along with our brokers, we are subject to various federal, state and local laws, regulations and administrative practices affecting our businesses.  These include the requirement to obtain business licenses, withhold taxes, remit matching contributions for our employees’ social security accounts, and other such legal requirements, regulations and administrative practices required of businesses in general.  We are a third party record-keeper under the Tax Equity and Fiscal Responsibility Act (“TEFRA”) and we are required to account for and report annually to the IRS the total ITEX dollar sales transactions of each member in our Marketplace.

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It is the legal responsibility of our brokers to pay and withhold all applicable federal and state income taxes (including estimated taxes), Social Security, Medicare and all applicable federal and state self-employment taxes, and in general to comply with all applicable federal, state, and local laws, statutes, codes, rules, regulations and standards, including but not limited to the Americans with Disabilities Act.  Except for our corporate owned offices, our brokers are independent contractors, and we do not own, control or operate the businesses comprising our Broker Network.  However, a number of federal and state laws and regulations are implicated by virtue of our relationship with our Broker Network.  For example, state regulators may seek to hold us responsible for unrecognized tax liabilities or the actions of, or failures to act by, our brokers or their employees.  See Item 1A ─ Risk Factors ─ We may be held responsible by members, third parties, regulators or courts for the actions of, or failures to act by, our Brokers or their employees, which exposes us to possible adverse judgments,  other liabilities and negative publicity. Furthermore, although we have prohibited the listing of illegal goods and services in the Marketplace and implemented other protective measures, we may be unable to prevent our members from selling unlawful or stolen goods or unlawful services, or selling goods or services in an unlawful manner.  It is possible that government regulators and law enforcement officials could allege that our services aid and abet certain violations of certain laws.  See Item 1A ─ Risk Factors ─ Use of our services for illegal purposes could damage our reputation and harm our business.

We store personal and financial information for members of the Marketplace and in connection with our subscription-based client service offerings.  Federal and state law requires us to safeguard our members’ and clients’ personal and financial information, including credit card information. See Item 1A ─ Risk Factors ─ Failure to comply with laws and regulations that protect our members’ personal and financial information could result in liability and harm our reputation.  In addition, under federal (Federal Trade Commission Act) and state franchise and business opportunity laws, franchisees are entitled to certain protections including mandatory disclosures and the provision that many of the substantive aspects of the business relationship (i.e., termination, transfer, cancellation, and non-renewal) will be governed by state law.  An adverse finding in one or more of these business relationship aspects could govern the enforceability of our agreements or permit the recovery of damages and penalties which could have a material adverse effect on our financial condition.

With respect to our online technologies, there are currently relatively few laws or regulations directly applicable to access to, or commerce on, the internet other than those relating to data security.  However, it is possible that a number of additional laws and regulations may be adopted with respect to the internet, covering issues such as taxes, user privacy, information security, pricing and characteristics and quality of products and services.  We cannot predict the impact, if any, that future internet-related regulation or regulatory changes might have on our business.

Proprietary Rights

We rely on a combination of copyright and trademark laws, trade secrets, software security measures, franchise and license agreements and nondisclosure agreements to protect our proprietary technology and software products.  We have registered service marks for the word mark ITEX®, as well as “ITEX” used in connection with our logo design.  We intend to file additional service mark word and design applications for ITEX.  We seek to police the use of our marks and to oppose any infringement.  We have registered the internet domain name “ITEX.com” and other related domain names.

We cannot be certain that others will not develop substantially equivalent or superseding proprietary technology or be certain that equivalent products or services will not be marketed in competition with our products thereby substantially reducing the value of our proprietary rights.  Furthermore, there can be no assurance that any confidentiality agreements between us and our employees or any license agreements with our brokers will provide meaningful protection of our proprietary information in the event of any unauthorized use or disclosure of such proprietary information.

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Employees

As of July 31, 2011, we had 30 full-time, part-time, contract or temporary employees – 20 in our corporate headquarters and 10 in our corporate owned offices.  From time to time, we utilize independent consultants or contractors for technology support, marketing, sales and support, and accounting or administrative functions.  Our employees are not represented by any collective bargaining unit and we have never experienced a work stoppage.  We believe relations with our employees are good.

ITEM 1A.             RISK FACTORS

This Annual Report on Form 10-K contains statements that are forward-looking such as estimates, projections, statements relating to our business plans, objectives and expected operating results.  These statements are based on current expectations and assumptions that are subject to risks and uncertainties.  All statements that express expectations and projections with respect to future matters may be affected by changes in our strategic direction, as well as developments beyond our control.  We cannot assure you that our expectations will necessarily come to pass.  Actual results could differ materially because of issues and uncertainties such as those listed below, in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, Part II Item 7 and elsewhere in this report.  These factors, among others, may adversely impact and impair our business and should be considered in evaluating our financial outlook.

Our revenue growth and success is tied to the operations of our independent Broker Network, and as a result the loss of our brokers or the financial performance of our brokers can negatively impact our business

We service our member businesses primarily through our independent licensed broker and franchise network (individually, “broker”,together, the “Broker Network”) as well as through certain corporate-owned offices, and our financial success primarily depends on our brokers and the manner in which they operate and develop their offices.  We depend on the ability of our brokers to enroll new members, train them in the use of the Marketplace, grow our transactional volume by facilitating business among members, manage member relationships, provide members with information about ITEX products and services, and assure the payment of our fees.  Brokers are independently owned and operated and have a contractual relationship with ITEX, typically for a renewable five-year term.  Our inability to renew a significant portion of these agreements on terms satisfactory to our brokers and us could have a material adverse effect on our business, financial condition and results of operations.  Further, our brokers may not be successful in increasing the level of revenues generated compared to prior years, or even sustaining their own business activities, which depends on many factors, including the success of their marketing activities, control of expense levels, the employment and management of personnel, and being able to secure adequate financing to operate their businesses.  There can be no assurance that our brokers will be successful in adding members or increasing the volume of transactions through the Marketplace, or that if they do not renew their agreements or terminate operations we will be able to attract new brokers at rates sufficient to maintain a stable or growing revenue base.  If our brokers are unsuccessful in generating revenue, enrolling new members to equalize the attrition of members leaving the Marketplace, or if a significant number of brokers become financially distressed and terminate operations, our revenues could be reduced and our business operating results and financial condition may be materially adversely affected.

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

In 2011 our revenue decreased by approximately 3% compared to 2010.  Although we seek to increase revenues through organic growth and the development of new revenue streams, we cannot assure you that our revenues will increase in future quarters or future years.  We may be unable to add revenue through acquisitions, either because of the absence of acquisition candidates, lack of financing, or unacceptable terms.  Other than extrapolating from historical data based on the size of the Marketplace, it is difficult for us to project the level of our revenues accurately.  We have approximately 28% recurring revenues.  We do not have an order backlog, and approximately 64% of our net revenues each quarter come from transactions during that quarter.  Our operating results in one or more future quarters may fall below the expectations of investors.

We cannot assure you that we can continue to be operated profitably, which depend on many factors, including the success of our development and expansion efforts, the control of expense levels and the success of our business activities.  We are currently subject to increased expense levels as a result of responding to proxy contests, litigation and other actions by dissident shareholders.  We invest in marketing, broker and member support, technology and further development of our operating infrastructure. Some of this investment may entail long-term commitments. As a result, we may be unable to adjust our spending rapidly enough to compensate for any unexpected revenue shortfall, which may harm our profitability.  Market information for the barter industry is difficult to ascertain.  Despite our efforts to expand our revenues, we may not be successful.  We experience a certain amount of attrition from members leaving the Marketplace.  If new member enrollments do not continue or are insufficient to offset attrition, we will increasingly need to focus on keeping existing members active and increasing their activity level in order to maintain or grow our business.  We cannot assure you that this strategy would be successful to offset declining revenues or profits.

Our brokers could take actions that could harm our business, our reputation and adversely affect the ITEX Marketplace

Our agreements with our brokers require that they understand and comply with all laws and regulations applicable to their businesses, and operate in compliance with our Marketplace Rules.  Brokers are independently owned and operated and are not our employees, partners, or affiliates.  We set forth operational standards and guidelines; however, we have limited control over how our broker businesses are run.  Our brokers have individual business strategies and objectives, and may not operate their offices in a manner consistent with our philosophy and standards.  We cannot assure that our brokers will avoid actions that adversely affect the reputation of ITEX or the Marketplace.  Improper activity stemming from one broker can generate negative publicity which could adversely affect our entire Broker Network and the Marketplace.  Our image and reputation and the image and reputation of other brokers may suffer materially, and system-wide sales could significantly decline if our brokers do not operate their businesses according to our standards.  While we ultimately can take action to terminate brokers and franchisees that do not comply with the standards contained in our agreements, and even though we may implement compliance and monitoring functions, we may not be able to identify problems and take action quickly enough and, as a result, our image and reputation may suffer, causing our revenues or profitability to decline.  Further, the success and growth of our Broker Network depends on our maintaining a satisfactory working relationship with our existing brokers and attracting new brokers to our network.  Lawsuits and other disputes with our brokers could discourage our brokers from expanding their business or lead to negative publicity, which could discourage new brokers from entering our network or existing brokers from renewing their agreements, and could have a material adverse effect on our business, financial condition and results of operations.

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We could be negatively affected as a result of a proxy fight and related litigation.

In July 2010, a dissident shareholder group declared its intention to change the management structure of ITEX.  It nominated a full opposition slate of individuals for election to replace our Board of Directors at the 2010 Annual Meeting of Shareholders, while stating it was preparing its own executive team to replace existing ITEX management.  The dissident group was unsuccessful in 2010, and according to a Schedule 13D filed on August 23, 2011, most of the members of the 2010 dissident shareholder group have disbanded.    However, remaining group members representing 5.1% of our voting common stock filed preliminary proxy materials with the SEC on September 28, 2011 announcing their intention to elect two of their nominees to replace a majority of the Board of Directors.  In addition, a member of the group has filed a shareholder derivative lawsuit against the Company’s Board of Directors (See Note 11 ― “Legal Proceedings” included in the “Notes to Consolidated Financial Statements.”)   A proxy contest and related litigation could negatively affect us because:

· Responding to proxy contests, litigation and other actions by dissident shareholders can be costly and time-consuming, disrupting our operations and diverting the attention of management and our employees;

· Perceived uncertainties as to our future direction may divert the attention of, damage morale and create instability among members of our Broker Network as well as our management and employees, and adversely impact our existing and potential strategic and operational relationships and opportunities;

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

· If individuals are elected to our Board of Directors with a specific agenda, it may adversely affect our ability to effectively and timely implement our current business plan which could have a material adverse effect on our results of operations and financial condition;

· If certain corporate governance proposals are implemented that are not scaled to the size of our company or do not provide a benefit commensurate with their cost, our profitability as well as the value creation capabilities of our organization may be adversely affected;

· Increases in legal fees, administrative and associated costs incurred in connection with responding to a proxy contest and related litigation are substantial; and

· A proxy contest, or the threat of one, could cause our stock price to experience periods of volatility or stagnation.

We may be held responsible by members, third parties, regulators or courts for the actions of, or failures to act by, our brokers or their employees, which exposes us to possible adverse judgments, other liabilities and negative publicity

From time to time we are subject to claims for the conduct of our brokers in situations where a broker has caused injury to a member as a result of a transaction in the Marketplace.  Third parties, regulators or courts may seek to hold us responsible for the actions or failures to act by our brokers or their employees.  Failure to comply with laws and regulations by our brokers, or litigation involving potential liability for broker activities could be costly and time consuming for us, divert management attention, result in increased costs of doing business, lead to adverse judgments, expose us to possible fines and negative publicity, or otherwise harm our business.

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Failure to deal effectively with member disputes could result in costly litigation, damage our reputation and harm our business

ITEX faces risks with respect to transactional disputes between members of the Marketplace.   From time to time we receive complaints from members who may not have received the products or services that they had purchased, concerning the quality of the products or services, or who believe they have been defrauded by other members or ITEX brokers. We also receive complaints from sellers because a buyer has changed his or her mind and decided not to honor the contract to purchase the item.  While ITEX does, in some cases, as part of its transaction dispute resolution process reverse transactions, reduce or eliminate credit lines, suspend accounts, or take other measures with members who fail to fulfill their payment or delivery obligations to other members, the determination as to whether a transaction is reversed or how to resolve a specific dispute is made by ITEX in its sole discretion.  Measures we may take to resolve transactional disputes or combat risks of fraud have the potential to damage relations with our members or brokers or decrease transactional activity in the Marketplace by restricting the activities of certain members. Furthermore, negative publicity and member sentiment generated as a result of member complaints or fraudulent or deceptive conduct by members of our Marketplace could damage our reputation, or reduce our ability to attract new members or retain our current members.

We occasionally receive communications from members requesting reimbursement or threatening or commencing legal action against us if no reimbursement is made.  In addition, because we service our member businesses through our Broker Network, we are subject to claims and could potentially be found liable for the conduct of our brokers in a situation where that broker has caused injury to a member.  Litigation involving disputes between members and liability for broker actions could be costly and time consuming for us, divert management attention, result in increased costs of doing business, lead to adverse judgments, or otherwise harm our business. In addition, affected members may complain to regulatory agencies that could take action against us, including imposing fines or seeking injunctions.

Use of our services for illegal purposes could damage our reputation and harm our business

Our members, typically small businesses, actively market products and services through the Marketplace and our website.  The law relating to the liability of providers of online services for the activities of users or members of their service is often the subject of litigation.  We may be unable to prevent our members from selling unlawful or stolen goods or unlawful services, or selling goods or services in an unlawful manner, and we could be subject to allegations of civil or criminal liability for unlawful activities carried out by users through our services.  It is possible that third parties, including government regulators and law enforcement officials, could allege that our services aid and abet certain violations of certain laws, for example, laws regarding the sale of counterfeit items, the fencing of stolen goods, selective distribution channel laws, and the sale of items outside of the U.S. that are regulated by U.S. export controls.

Although we have prohibited the listing of illegal goods and services and implemented other protective measures, we may be required to spend substantial resources to take additional protective measures or discontinue certain service offerings, any of which could harm our business.  Any costs incurred as a result of potential liability relating to the alleged or actual sale of unlawful goods or services could harm our business. In addition, negative media publicity relating to the listing or sale of unlawful goods and stolen goods using our services could damage our reputation, diminish the value of our brand names, and make members reluctant to use our services.

ITEX’s trade dollar currency is also susceptible to potentially illegal or improper uses.  Recent changes in law have increased the penalties for intermediaries providing payment services for certain illegal activities.  Despite measures taken by ITEX as administrator and as a third-party record-keeper to detect and lessen the risk of this kind of conduct, illegal activities could still be funded using ITEX dollars. Any resulting claims or liabilities could harm our business.

 

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Our business is subject to online security risks, including security breaches and identity theft

We host confidential information as part of our client relationship management and transactional processing platform.  Our security measures may not detect or prevent security breaches that could harm our business.  Currently, a significant number of our members authorize us to bill their credit card accounts directly for fees charged by us.  We take a number of measures to ensure the security of our hardware and software systems and member and client information.  Advances in computer capabilities, new discoveries in the field of cryptography or other developments may result in the technology used by us to protect transaction data being breached or compromised.  Other large Internet companies have been the subject of sophisticated and highly targeted attacks on portions of their sites.  In addition, any party who is able to illicitly obtain a members’ password could access the members’ transaction data.  An increasing number of websites have reported breaches of their security.  Any compromise of our security could harm our reputation and, therefore, our business, and could result in a violation of applicable privacy and other laws.  In addition, a party that is able to circumvent our security measures could misappropriate proprietary information, cause interruption in our operations, damage our computers or those of our users, or otherwise damage our reputation and business. Under credit card rules and our contracts with our card processors, if there is a breach of credit card information that we store, we could be liable to the credit card issuing banks for their cost of issuing new cards and related expenses.  In addition, if we fail to follow credit card industry security standards, even if there is no compromise of customer information, we could incur significant fines or lose our ability to give customers the option of using credit cards to pay their fees.  If we were unable to accept credit cards, our business would be seriously damaged.

We continue to enhance our systems for data management and protection, and intrusion detection and prevention. However, our servers may be vulnerable to computer viruses, physical or electronic break-ins, and similar disruptions.  We may need to expend significant resources to protect against security breaches or to address problems caused by breaches.  Security breaches, including any breach by us or by parties with which we have commercial relationships that result in the unauthorized release of our members’ personal information, could damage our reputation and expose us to a risk of loss or litigation and possible liability.  Our insurance policies carry coverage limits which may not be adequate to reimburse us for losses caused by security breaches.

Unplanned system interruptions or system failures could harm our business and reputation

Any interruption in the availability of our transactional processing services due to hardware and operating system failures will reduce our revenues and profits.  Our revenue depends on members using our processing services.  Any unscheduled interruption in our services results in an immediate, and possibly substantial, loss of revenues.  Frequent or persistent interruptions in our services could cause current or potential members to believe that our systems are unreliable, leading them to switch to our competitors or to avoid our websites or services, and could permanently harm our reputation.  Furthermore, any system failures could result in damage to our members’, clients’ or brokers’ businesses. These persons could seek compensation from us for their losses. Even if unsuccessful, this type of claim likely would be time-consuming and costly for us to address.

 

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Although our systems have been designed around industry-standard architectures to reduce downtime in the event of outages or catastrophic occurrences, they remain vulnerable to damage or interruption from earthquakes, floods, fires, power loss, telecommunication failures, terrorist attacks, computer viruses, computer denial-of-service attacks, and similar events or disruptions.  Some of our systems are not fully redundant, and our disaster recovery planning may not be sufficient for all eventualities. Our systems are also subject to break-ins, sabotage, and intentional acts of vandalism.  Despite any precautions we may take, the occurrence of a natural disaster, a decision by any of our third-party hosting providers to close a facility we use without adequate notice for financial or other reasons, or other unanticipated problems at our hosting facilities could cause system interruptions, delays, and loss of critical data, and result in lengthy interruptions in our services.  Our business interruption insurance may not be sufficient to compensate us for losses that may result from interruptions in our service as a result of system failures.

Failure to comply with laws and regulations that protect our members’ personal and financial information could result in liability and harm our reputation

We store personal and financial information for members of the Marketplace.  Privacy concerns relating to the disclosure and safeguarding of personal and financial information have drawn increased attention from federal and state governments.  Federal and state law requires us to safeguard our members’ and clients’ financial information, including credit card information.  Although we have established security procedures to protect against identity theft and the theft of this personal and financial information, breaches of our privacy may occur. To the extent the measures we have implemented are breached or if there is an inappropriate disclosure of confidential or personal information or data, we may become subject to litigation or administrative sanctions, which could result in significant fines, penalties or damages and harm to our brand and reputation.  Even if we were not held liable, a security breach or inappropriate disclosure of confidential or personal information or data could harm our reputation.  In addition, we may be required to invest additional resources to protect us against damages caused by these actual or perceived disruptions or security breaches in the future.  Changes in these federal and state regulatory requirements could result in more stringent requirements and could result in a need to change our business practices.  Establishing systems and processes to achieve compliance with these new requirements may increase our costs and could have a material adverse effect on our business, financial condition and results of operations.

We have claims and lawsuits against us that may result in adverse outcomes

From time to time we are subject to a variety of claims and lawsuits. (See Note 11 ― “Legal Proceedings” included in the “Notes to Consolidated Financial Statements.”)Adverse outcomes in one or more of these claims may result in significant monetary damages that could adversely affect our ability to conduct our business. Although management currently believes resolving all of these matters, individually or in the aggregate, will not have a material adverse impact on our financial statements, the litigation and other claims are subject to inherent uncertainties and management’s view of these matters may change in the future. A material adverse impact on our financial statements also could occur for the period in which the effect of an unfavorable final outcome becomes probable and reasonably estimable.

If we lose the services of our chief executive officer, our business could suffer

Our performance depends substantially on the continued services of our Chief Executive Officer, Steven White.  Mr. White also currently fills the executive positions of Interim Chief Financial Officer and Chief Accounting Officer.  Our board places heavy reliance on Mr. White’s experience and management skills.  We have not entered into a formal employment agreement with Mr. White, other than an agreement to receive a payment in connection with a “change of control,” as defined in the agreement.    We do not carry key man life insurance to insure the business in the event of Mr. White’s death.  If we were to lose the services of Mr. White, we could face substantial difficulty in hiring a qualified successor or successors, and could experience a loss in performance while any successor obtains the necessary training and experience.  Corporate staff and our franchisees and brokers could lose confidence in the direction and stability of the Company and choose to pursue other opportunities. In addition, in connection with a management transition we may need to attract, train, retain and motivate additional financial, technical, managerial, marketing or support personnel.  We face the risk that if we are unable to attract and integrate new personnel, or retain and motivate existing personnel, our business, financial condition and results of operations will be adversely affected.

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Alliances, mergers and acquisitions could result in operating difficulties, dilution and other harmful consequences

We have acquired seven trade exchange membership lists since 2005 and integrated them into the ITEX system.  We expect to continue to evaluate and consider other potential strategic transactions, including business combinations, acquisitions and dispositions of businesses, technologies, services, products and other assets and strategic investments.  At any given time we may be engaged in discussions or negotiations with respect to one or more of these types of transactions.  Any of these transactions could be material to our financial condition and results of operations.  The process of integrating an acquired company, business or technology may create unforeseen operating difficulties and expenditures and is risky.  The areas where we may face difficulties include:

• Diversion of management time, as well as a shift of focus from operating the businesses to challenges related to integration and administration;

• Challenges associated with integrating employees from the acquired company into the acquiring organization.  These may include declining employee morale and retention issues resulting from changes in, or acceleration of, compensation, or changes in management, reporting relationships, future prospects, or the direction of the business;

• The need to integrate each company’s accounting, management, information, human resource and other administrative systems to permit effective management, and the lack of control if such integration is delayed or not implemented;

• The need to implement controls, procedures and policies appropriate for a public company at companies that prior to acquisition had lacked such controls, procedures and policies;

• The need to transition operations, members, and customers onto our existing platforms; and

• Liability for activities of the acquired company before the acquisition, including violations of laws, rules and regulations, commercial disputes, tax liabilities and other known and unknown liabilities.

The expected benefit of any of these strategic relationships may not materialize and the cost of these efforts may negatively impact our financial results.  Future alliances, mergers or acquisitions or dispositions could result in potentially dilutive issuances of our equity securities, the expenditure of our cash or the incurrence of debt, contingent liabilities or amortization expenses, or write-offs of goodwill, any of which could adversely affect our results of operations and dilute the economic and voting rights of our stockholders.  Future acquisitions may require us to obtain additional equity or debt financing, which may not be available on favorable terms or at all.

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We may need additional financing; current funds may be insufficient to finance our plans for growth or our operations

Although we believe that our financial condition is stable and that our cash balances and operating cash flows provide adequate resources to fund our ongoing operating requirements, we have limited funds and may have contractual obligations in the future.  Our existing working capital may not be sufficient to allow us to execute our business plan as fast as we would like or may not be sufficient to take full advantage of all available strategic opportunities.  We believe our current core operations reflect a scalable business strategy, which will allow our business model to be executed with limited outside financing.  However, we also may expand our operations, enter into a strategic transaction, or acquire competitors or other business to business enterprises.  We have a line of credit with our primary banking institution, which will provide additional reserve capacity for general corporate and working capital purposes, and if necessary, enable us to make certain expenditures related to the growth and expansion of our business model.  However, if adequate capital were not available or were not available on acceptable terms at a time when we needed it, our ability to execute our business plans, develop or enhance our services, make acquisitions or respond to competitive pressures would be significantly impaired.  Further, we cannot be certain that we will be able to implement various financing alternatives or otherwise obtain required working capital if needed or desired.

We are dependent on the value of foreign currency.

We transact business in Canadian dollars as well as U.S. dollars.  Revenues denominated in Canadian dollars comprised 7.8% and 7.0% in the years ended July 31, 2011 and 2010, respectively.  While foreign currency exchange fluctuations are not believed to materially adversely affect our operations at this time, changes in the relation of the Canadian dollar to the U.S. dollar could continue to affect our revenues, cost of sales, operating margins and result in exchange losses.

If we fail to maintain an effective system of internal controls, we may not be able to detect fraud or report our financial results accurately, which could result in a loss of investor confidence in our financial reports and have an adverse effect on our stock price

Effective internal controls are necessary for us to provide reliable financial reports and to detect and prevent fraud.  We periodically assess our system of internal controls to review their effectiveness and identify potential areas of improvement.  These assessments may conclude that enhancements, modifications or changes to our system of internal controls are necessary.  Performing assessments of internal controls, implementing necessary changes, and maintaining an effective internal controls process is expensive and requires considerable management attention.  Internal control systems are designed in part upon assumptions about the likelihood of future events, and all such systems, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met.  We face the risk that the design of our controls and procedures may prove to be inadequate or that our controls and procedures may be circumvented, thereby causing delays in detection of errors or inaccuracies in data and information.  It is possible that any lapses in the effective operations of controls and procedures could materially affect earnings, that we could suffer losses, that we could be subject to costly litigation, that investors could lose confidence in our reported financial information and our reputation, and that our operating results could be harmed, which could have a negative effect on the trading price of our common stock.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we must certify the effectiveness of our internal controls over financial reporting annually.  If we are unable to assert that our internal control over financial reporting is effective for a particular year we could lose investor confidence in the accuracy and completeness of our financial reports.  That could adversely affect our competitive position in our business, and the market price for our common stock.

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Our Brokers may default on their loans

From time to time we finance the operational and expansion activities of our brokers.  We loan brokers funds for general operational purposes, to acquire the management rights to select member accounts, and for other reasons. These loans are repaid from regular deductions from broker commissions.    We have increased the amount of our loans to brokers from $605 in 2010 to $909 in 2011. We anticipate broker loans will increase in fiscal 2012, as we finance the sale and divestment of two of our corporate-owned stores. In the event one or more brokers default on their loans, it may adversely affect our financial condition.

ITEM 1B.             UNRESOLVED STAFF COMMENTS

None

ITEM 2.                PROPERTIES

Our corporate and administrative headquarters offices are located in Bellevue, Washington.  We lease properties in the following locations that are utilized by our senior management, sales and marketing, finance, general and administrative personnel:

	Area leased		Monthly
Location	(sq. feet)		rent		Lease expiration
Bellevue, Washington		7,035	$	13,192	April 30, 2015
Oakbrook Terrace, Illinois (1)		5,086		9,324	November 30, 2011
Milwaukie, Oregon (2)		768		425	October 31, 2012

(1) We entered into this lease as part of a 2008 acquisition (refer to “Overview” included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, Part II Item 7.)

(2) We entered into this lease as part of a 2011 acquisition (refer to “Overview” included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, Part II Item 7.)

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

ITEM 3.                LEGAL PROCEEDINGS

For information regarding legal proceedings, refer toNote 11 ― “Legal Proceedings” included in the “Notes to Consolidated Financial Statements”, Item 8 – Financial Statements.

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PART II

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

Market Information

Our common stock trades on the OTC Bulletin Board under the symbol “ITEX.OB” The range of high and low bid prices for our common stock for each quarter during the two most recent years is as follows:

Fiscal Year Ended July 31,	2011				2010
	High		Low *		High		Low *
First Quarter	$	4.76	$	-	$	3.75	$	1.25
Second Quarter	$	4.80	$	3.50	$	4.15	$	2.25
Third Quarter	$	4.70	$	-	$	4.55	$	1.90
Fourth Quarter	$	4.31	$	-	$	4.75	$	-

* Low bid prices are not calculated unless a minimum of two market participants have posted both bid and ask prices.

This table reflects the range of high and low bid prices for our common stock during the indicated periods, as published by the OTC Bulletin Board.  The quotations merely reflect the prices at which transactions were proposed and do not necessarily represent actual transactions.  Prices do not include retail markup, markdown or commissions.

There were 640 holders of record of our common stock as of July 31, 2011.  Most shares of our common stock are held by brokers and other institutions on behalf of shareholders.

During the fourth quarter of 2010, the board of directors declared and paid our first cash dividend in the amount of 2.5 cents per share.  In the second quarter of 2011, the board increased the quarterly dividend to 4 cents per share. In subsequent quarters, we have continued to pay dividends of 4 cents per share, or 16 cents per share annually.

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Purchases of Equity Securities by the Issuer and Affiliated Purchasers

The following table provides information about our purchases or any affiliated purchaser during the three-months ended July 31, 2011 of equity securities that are registered by us pursuant to Section 12 of the Exchange Act.

	(a)		(b)		(c)		(d)
Period	Total Number of Shares Purchased		Average Price Paid  per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs (1)
5/01/11 - 5/31/11		-		-		-		-
6/01/11 – 6/30/11		1,510	$	4.15		-		-
7/01/11 - 7/31/11		280	$	4.05		-	$	1,561,050

(1) Amounts shown in this column reflect amounts remaining under the $2.0 million stock repurchase program, authorized by the Board of Directors and announced on March 9, 2010.  The program authorizes the repurchase of shares in open market purchases or privately negotiated transactions, has no expiration date and may be modified or discontinued by the Board of Directors at any time.

ITEM 7.                MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

OVERVIEW

ITEX, The Membership Trading CommunitySM, is a leading exchange for cashless business transactions across North America (the “Marketplace”).  We service our member businesses through our independent licensed brokers and franchise network (individually, “broker” and together, the “Broker Network”) in the United States and Canada.  Our business services and payment systems enable approximately 25 thousand member businesses (our “members”) to trade products and services without exchanging cash.  These products and services are instead exchanged for ITEX dollars which can only be redeemed in the Marketplace (“ITEX dollars”).  We administer the Marketplace and act as a third-party record-keeper for our members’ transactions.  We generate revenue by charging members percentage-based transaction fees, association fees, and other fees assessed in United States dollars and Canadian dollars where applicable (collectively and as reported on our financial statements, “USD” or “Cash”).

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For each calendar year, we divide our operations into 13 four-week billing and commission cycles always ending on a Thursday (“operating cycle”).  For financial statement purposes, our fiscal year is from August 1 to July 31 (“year”, “2011” for August 1, 2010 to July 31, 2011, “2010” for August 1, 2009 to July 31, 2010).  Our fourth quarter is the three-month period from May 1, 2011 to July 31, 2011 (“fourth quarter”).  We report our results as of the last day of each calendar month (“accounting cycle”). The timing of billing and collection activities after the end of the billing cycle does not correspond with the end of the accounting period, therefore this timing difference results in the fluctuations of the balances of cash, accounts receivable, commissions payable and accrued commissions on the consolidated balance sheet and consolidated statement of cash flows.

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

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

· Comparative Results.  For the year ended 2011, as compared to 2010, our revenue decreased by $501, or 3%, from $16,925 to $16,424, and our income from operations decreased by $571, or 34%, from $1,674 to $1,103.

· Revenue Sources.  Our decrease in revenues for 2011 was primarily due to a reduction in transaction revenue of $488, or 4% from $10,873 to $10,385.   Revenue from our core business was down 5% for the year ended July 31, 2011 when compared to the corresponding 2010 period.  Our primary customers are small businesses with less than ten employees.  We believe this segment of the business community is more vulnerable than larger companies in a difficult economic environment, with strained or insufficient cash flow being a major impediment to growth.  In addition, we believe part of this decline can be attributed to the distraction and uncertainty within our broker network created as a result of the proxy contest.

Revenues from media and web services represented approximately 5% of our total revenues, declining from $873 in 2010 to $800 in 2011.  Our principal contract generating web services revenue was terminated during 2011.  It is not anticipated that web services revenue will be generated during 2012.

· Corporate-owned Offices.  The ITEX system is approximately 96% broker managed and 4% corporate operated.  As a general operating philosophy, we depend on the ability of our brokers to enroll new members, train them in the use of the Marketplace, grow our transactional volume by facilitating business among members, manage member relationships, provide members with information about ITEX products and services, and assure the payment of our dues and fees.  Our broker model requires less capital investment and lower operating expenses than if we operated all of the offices in our network directly.  From time to time, we complement our Broker Network with a few corporate-owned locations, acquired either as a result of business acquisitions or as a result of ensuring the orderly transition of broker locations.  Part of our strategy when we acquire exchange members, is to incubate the asset with corporate staff, flush out non-performing members, synchronize fee plans, and then distribute members to existing franchisees or spin off members to new franchises.  The result is a wider member base, managed by new franchisees, and a member list asset that continues to be owned by ITEX.

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During 2010, we reflected a gain of $99 due to the sale of a San Francisco corporate-owned office, absorbed a loss of $3 from the disposition of fixed assets and a loss of $255 from a default on a note receivable by a broker acquired as a result of a previous office sale.  In January 2010, we exercised our step-in rights and are currently managing this location as a corporate-owned office.  We expect to sell the management rights to this office during 2012, which will generate a gain to be reflected in a subsequent reporting period.

· Revenue Trends and Growth.  As discussed above, we experienced a downturn in revenue this year and do not anticipate that web services revenue will be generated during 2012.  Although we seek to increase revenues through organic growth and the development of new revenue sources, the primary driver of revenue growth in recent years has been through our business acquisitions.  These acquisitions are intermittent and cannot be relied upon as a future source of revenue growth, because of the absence of acquisition candidates, lack of financing, or unacceptable terms.  We have approximately 28% recurring revenues from association fees.  Approximately two-thirds of our net revenues each quarter come from transactions during that quarter.  We believe the expansion of our membership base will increase our recurring revenues. We continue to seek to increase our revenue by:

· enhancing our internet applications and web services;

· marketing the benefits of participation in the Marketplace;

· adding new brokers.

In fiscal 2010 and 2011, our national advertising campaign emphasized the benefits of participation in the ITEX Marketplace.  We were able to utilize advertising credits obtained in a business acquisition in 2008 for the ad placements.

Adding new brokers is an important component of our overall growth plan, and we are increasing our broker recruiting efforts.  One recruitment program which has achieved some success is our Broker Mentor program, in which existing brokers recruit prospective brokers and provide ongoing training to the prospective broker until certain performance thresholds are met.  Upon meeting the performance thresholds, the prospective broker is offered a franchise for a reduced fee of $5 from our standard broker fee of $20.  The mentoring broker receives a 5% commission override on the cash collected per cycle by the new broker.  We added seven new brokers in 2011 as a result of this and other initiatives.

· Supporting Members, Brokers and Employees.  We continually enhance our internet applications and web services to make our online services more user friendly to our employees, brokers and members, and to create confidence in the ITEX Marketplace.  We are in the process of upgrading our payment processing and team software with .NET technologies.  In June 2010 we launched a new interface for www.itex.com  with more tools and better search functionality for our members and brokers.  During 2010, we expanded our production and co-location facilities. In addition, we provided new workstations and monitors to our staff to interface with our internet applications with the goal of making the Marketplace more efficient.

We seek to support our Broker Network in various ways to add to its productivity and efficiency, including encouraging the use of current technology products and services.  In the summer of 2010, we provided new desktop computers, software and monitors to brokers that met established eligibility requirements, as well as to our corporate and corporate-owned offices, replacing models that were several years old.  In the summer of 2010 we purchased approximately 180 computer systems upon the launch of Office 2010, using Dell desktops and notebooks as the standard models, with software that included Microsoft Windows 7.

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In addition, we seek to provide stability amongst our stakeholders to enhance the value creation capabilities of the organization.  Since 2007, ITEX has been subject to both an unsolicited tender offer and an election contest in 2010 which dissident shareholders attempted to take control of the Board of Directors. Although largely disbanded, part of last year’s dissident shareholder group has announced their intention to elect two of their nominees to replace a majority of the Board of Directors.  In management’s view, the proxy contest in 2010 created disruption, uncertainty and damaged morale within the organization and the Broker Network.  During the quarter ended April 30, 2011, we acted to shore up morale and commitment among the Broker Network and our staff.  First, the Board of Directors of the Company authorized restricted stock awards to employees under long-term service-based vesting periods.  See Financial Statements, Note 10 – Share-Based Payments.  These served as retention bonuses to protect our employee assets by reducing turnover costs and helping make ITEX a more compelling place to stay and work, even in uncertain and turbulent times. Next, we acted to incentivize members of our Broker Network by providing them with an avenue to make a financial investment in the Company, aligning their interests with stockholders and further increasing their personal stake in our long term success.  See Financial Statements, Note 11 – Share-Based Payments.  These actions are being challenged by a stockholder who has filed a shareholder derivative lawsuit against the Company’s Board of Directors (See Note 11 ― “Legal Proceedings” included in the “Notes to Consolidated Financial Statements.”)

· Geographical expansion. We have acquired seven trade exchange membership lists since 2005 and integrated them into the ITEX system.The acquisitions have contributed to our member counts and revenue and allowed us to expand the breadth of our network by opening offices in several geographic areas in which the ITEX presence was previously weak or nonexistent. In addition we removed competitors from our industry, strengthening our brand.   Part of our strategy when we acquire an exchange’s members is to distribute members to existing franchisees or spin off to new franchisees. We continue to evaluate and consider other potential strategic transactions, if and when such opportunities arise.

· Financial Position.  Our financial condition and balance sheet remained strong at July 31, 2011, with cash of $5,386 compared to $5,169 at the same period in 2010.  Our net cash flows provided by operating activities were $1,684 for the year ended July 31, 2011, compared to $2,536 for the corresponding period the previous year.  The decrease is primarily due to a reduction of $571 in operating income, a decrease of $160 in accrued expenses and a reduction of $184 in deferred revenue.  We seek to maintain an ample liquidity cushion, while returning some cash to our stockholders.  We initiated a $2,000 stock repurchase plan during the 2010 year which is still in effect.  During 2011 we repurchased $421 of our stock.

In May 2010, the board initiated a quarterly cash dividend program. Since the inception of the program through July 31, 2011 we have distributed $632 in cash dividends.

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

Condensed Results

	Year Ended July 31,
	2011		2010
Revenue	$	16,424	$	16,925
Cost of marketplace revenue	$	10,159	$	10,777
Operating expenses		5,162		4,474
Income from operations		1,103		1,674
Other income/(expense)		149		(117	)
Income before income taxes		1,252		1,557
Income tax expense		551		611
Net income	$	701	$	946
Net income per common share:
Basic	$	0.19	$	0.26
Diluted	$	0.19	$	0.26
Average common and equivalent share:
Basic		3,604		3,572
Diluted		3,648		3,577

Year ended July 31, 2011 and 2010.  Marketplace and other revenue for the year ended July 31, 2011, decreased $501 or 3% to $16,424 from $16,925 during the prior year.  This decrease was primarily due a $488 decrease in our transaction revenue. We believe part of the decline in transaction revenue is due to the distraction and uncertainty within our Broker Network created as a result of the proxy contest.

Association revenue decreased $25 or 1% to $4,716 from $4,741. The association revenue decrease was due to a one-time promotional plan offering discounted association fees for referring members to the Marketplace. Transaction revenue decreased $488 or 4% to $10,385 from $10,873. The transaction revenue decrease was due to lower transaction volume in the Marketplace in 2011 when compared to 2010.

Income before income taxes for the year ended July 31, 2011 was $1,252, a decrease of $305 or 20% from income before income taxes in 2010 of $1,557.  We attribute this decrease primarily to the $593 increase in SG&A, of which legal fees increased $535 or 177% to $838 for the year ended July 31, 2011 from $303 in the prior period.

Earnings per share decreased by $0.07 to $0.19 per share for the year ended July 31, 2011, from $0.26 per share for the year ended July 31, 2010.

Web Services

Our primary source of web services revenue since the 3rd quarter of fiscal 2009 had been derived from subscription fees, transactional, support and consulting fees.  On February 28, 2011, the web services agreement was terminated by our main web services customer.

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The web services agreements generated approximately 5% of our total revenues for the year ended July 31, 2011.  As a result of the early termination by our client, we recognized as revenue during the 3rd quarter of 2011 $216, which was the remaining amount of deferred web services revenue that existed on our balance sheet. As of July 31, 2011 we have no deferred revenue derived from web services reflected on our balance sheet.

Selected Quarterly Financial Results

Year ended July 31, 2011	First Quarter		Second Quarter		Third Quarter			Fourth Quarter		Total
Revenue	$	4,112	$	4,417	$	3,960		$	3,935	$	16,424
Income from operations	$	292	$	235	$	388		$	188	$	1,103
Net cash flows from operating activities	$	354	$	437	$	(245	)	$	1,138	$	1,684
Total stockholders' equity	$	14,993	$	15,012	$	14,724		$	14,758	$	14,758

Year ended July 31, 2010	First Quarter		Second Quarter		Third Quarter		Fourth Quarter		Total
Revenue	$	3,924	$	4,537	$	4,158	$	4,306	$	16,925
Income from operations	$	340	$	526	$	421	$	387	$	1,674
Net cash flows from operating activities	$	433	$	462	$	548	$	1,093	$	2,536
Total stockholders' equity	$	14,271	$	14,460	$	14,722	$	14,869	$	14,869

Revenue, Costs and Expenses

The following table summarizes our selected consolidated financial information for the years ended July 31, 2011 and 2010, with amounts expressed as a percentage of total revenues:

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	Years Ended July 31,
	2011					2010
	Amount		Percent of Revenue			Amount			Percent of Revenue
Revenue:
Marketplace revenue and other revenue	$	16,424		100	%	$	16,925			100	%
Costs and expenses:
Cost of Marketplace revenue		10,159		62	%		10,777			64	%
Salaries, wages and employee benefits		2,001		12	%		1,850			11	%
Selling, general and administrative		2,573		16	%		1,980			12	%
Depreciation and amortization		588		4	%		644			4	%
		15,321		94	%		15,251			91	%
Income from operations		1,103		6	%		1,674			10	%
Other income, net		149		1	%		(117	)		-1	%
Income before income taxes		1,252		7	%		1,557			9	%
Income tax expense (benefit)		551		3	%		611			4	%
Net income	$	701		4	%	$	946			5	%

Revenue

Revenue consists of Marketplace transaction fees, association fees and other revenue net of revenue adjustments for both broker offices and corporate-owned offices.  Revenue also includes a nominal amount of ITEX dollars (non-cash).  The following are the components of revenue that are included in the consolidated statements of income:

	Year Ended July 31,
	2011		Percent change from 2010			2010
Broker offices:
Association fees	$	4,406		-2	%	$	4,485
Transaction fees		9,737		-5	%		10,278
Other revenue		1,078		-6	%		1,149
Corporate owned offices:
Association fees		310		21	%		256
Transaction fees		648		9	%		595
Other revenue		21		-9	%		23
Revenue	$	16,200		-3	%	$	16,786
ITEX dollar revenue	$	224		61	%	$	139
Total revenue	$	16,424		-3	%	$	16,925

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Year ended July 31, 2011 and 2010.  Revenue decreased by $501 or 3% for the year ended 2011 compared to 2010.  This decrease was primarily due to a $488 decrease in our 2011 transaction fees from $10,873 to $10,385, or 4%. We believe part of this decline in transaction revenue is due to the distraction and uncertainty within our Broker Network created as a result of the proxy contest.  Association fees decreased 1% from $4,741 to $4,716, primarily as a result of a one-time promotional plan during 2011 offering discounted association fees for referring members into the Marketplace.

Corporate-owned offices association fee, transaction fee and other revenue increased $104 or 12%, as we added one net additional corporate-owned office during 2011. Our intention is to manage all corporate-owned offices internally with the intention of selling at a later date.

The decrease in other revenue is primarily related to our web services revenue initiatives which began in February 2009.  The revenue generated from platform subscription, support and consulting fees resulting from these arrangements amounted to $699 and $715 for the years ended July 31, 2011 and 2010, respectively. In 2011, the web services agreements were terminated by the client. We do not expect any revenue from web services in the near future. We have taken steps to reduce our expenses that were associated with the web services revenue so that we expect that the operating income impact will be reduced in future periods. In addition, Media Services revenue declined by $57 from $158 in 2010 to $101 in 2011.

ITEX Dollar Revenue

As described in notes to our consolidated financial statements, we receive ITEX dollars from members’ transaction and association fees, and, to a lesser extent, from other member fees.  ITEX dollars earned from members are later used by us as a method of payment in revenue sharing and incentive arrangements with our Broker Network, including co-op advertising, as well as for certain general corporate expenses. ITEX dollars are only usable in our Marketplace.

We take extensive measures to maintain the integrity of our role in the Marketplace economy, and to protect against the misuse or misappropriation of ITEX dollars.  For example:

· All ITEX dollar purchases for corporate purposes are approved by senior management.

· We do not sell or purchase ITEX dollars for USD.

Occasionally we spend ITEX dollars in the Marketplace for our corporate needs. As discussed in Note 1 to our consolidated financial statements, we record ITEX dollar revenue in the amounts ultimately equal to expenses we incurred and paid for in ITEX dollars, resulting in an overall net effect of $0 on the operating and net income lines. We recorded $224 and $139 as ITEX dollar revenue for the years ended July 31, 2011 and 2010, respectively.

During 2011, the company purchased two assets for $6 that were capitalized and will be depreciated over 5 years, therefore the revenue and expense related to ITEX dollar activities will not match during the depreciable period.  In the year of asset acquisition 2011, we will reflect $6 in net income and in the future depreciable years, we will reflect a loss of $1. At the end of the five-year depreciable period the net effect will be $0 on net income.

The corresponding ITEX dollar expenses in the year ending July 31, 2011 were for equipment, printing, outside services and miscellaneous expenses.  We plan to continue to utilize ITEX dollars for our corporate purposes in future periods.

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Cost of Marketplace revenue

Cost of Marketplace revenue consists of commissions paid to brokers, salaries and employee benefits of our corporate owned offices, payment of processing fees and other expenses directly correlated to Marketplace revenue.  The following are the main components of cost of Marketplace revenue that are included in the consolidated statements of income:

	Year Ended July 31,
	2011			Percent change from 2010			2010
Association fee commissions	$	1,591			-5	%	$	1,672
Transaction fee commissions		7,282			-5	%		7,705
Corporate owned office salaries, wages, employee benefits, and independent contractor expenses		899			8	%		835
Other Marketplace expenses		324			-29	%		459
Media costs - Ad Credits		63			-41	%		106
	$	10,159			-6	%	$	10,777
Costs of Marketplace revenue as a percentage of total revenue		62	%					64	%

Year ended July 31, 2011 and 2010.  Costs of Marketplace revenue for the year ended 2011, as compared to the year ended 2010, decreased by $618, or 6%. The overall decrease in costs of revenue for association and transaction fee commissions of 5% was comparable to the 4% decline for transaction revenue over the same period.  Costs of Marketplace revenue as a percentage of total revenue declined by 2% from 64% to 62% for the year ended 2011. Costs of Marketplace revenue as a percentage of total revenue decreased slightly for period ended July 31, 2011 because of the decrease in other Marketplace expenses. During 2010, we expensed $129 for a broker computer equipment and software upgrade program.

Transaction fee commissions decreased by $423, or 5% for the year ended 2011, as compared to 2010.  Transaction fee commissions will generally increase or decrease at a similar percentage as the increase or decrease in transaction revenue, which was the case for 2011.

Association fee commissions decreased by $81, or 5% for the year ended 2011 as compared to 2010. The decrease in commissions paid was greater than the corresponding 1% decrease in association revenue for the same period due to an increase in non-commissioned corporate-owned store association revenue and a shift in the Brokers commission plans.

Corporate-owned office costs consist of compensation and operating expenses associated with the operation of the offices.  Our corporate-owned office costs increased by $64 or 8% for the year ended 2011, as compared to the year ended 2010. The net increase in expense is primarily due to the hiring of additional employees to staff the corporate offices.

Other Marketplace expenses consist of miscellaneous Marketplace related expenses such as credit card processing fees and other commissions not associated with association or transaction revenue.  Other Marketplace expenses decreased by $135, or 29% for the year ended 2011 as compared to 2010. The primary decrease is due to $129 of expense that occurred during the prior 2010 year for computer equipment and software upgrades that were awarded to brokers. This cost was not incurred in 2011.

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Media costs – Ad credits consist of the cost of media ad credits utilized that have been sold to ITEX members. Media costs – Ad credits decreased by $43, or 41% for the year ended 2011 as compared to 2010. The primary decrease is due to decreased utilization of the ad credits for ITEX members accounts during 2011.

The following shows the commissions and corporate-owned office costs separately as a percent of their related revenue:

	Year Ended July 31,
	2011		% of Related Revenue			2010		% of Related Revenue
Association fee commissions	$	1,591		36	%	$	1,672		37	%
Transaction fee commissions	$	7,282		75	%	$	7,705		75	%
Corporate owned office salaries, wages, employee benefits, and independent contractor expenses	$	899		92	%	$	835		95	%

Corporate-owned office salaries, wages and employee benefits decreased from 95% of corporate- owned store revenue in the period ending July 31, 2010, to 92% for the period ending July 31, 2011.  The decrease in percentage of related revenue is primarily due to an increase in corporate-owned store revenue. The costs increased on a dollar basis year over year as we added one additional corporate-owned store and added headcount in 2011 in order to manage the web services related revenue, which is reflected in the corporate-owned store expense.

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Corporate Salaries, Wages and Employee Benefits

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

	Year Ended July 31,
	2011			Percent change from 2010			2010
Corporate salaries, wages and employee benefits	$	2,001			8	%	$	1,850
Percentage of revenue		12	%					11	%

Year ended July 31, 2011 and 2010.  Corporate salaries, wages and employee benefits expenses increased by $151or 8% for the year ended 2011, as compared to the year ended 2010. The increase in compensation-related costs for the year is primarily due to an increase of $87 in stock-based compensation along with an increase of $96 in salaries, vacation, bonuses and the reclassification of a contractor to an employee. These increases were offset somewhat by decreases of $21 in 401(k) matching expenses as the 401(k) matching program was discontinued in 2010.

Selling, General and Administrative Expenses

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

	Year Ended July 31,
	2011			Percent change from 2010			2010
Selling, general and administrative expenses	$	2,573			30	%	$	1,980
Percentage of revenue		16	%					12	%

Year ended July 31, 2011 and 2010.SG&A expenses increased by $593 or 30% for the year ended 2011 as compared to the year ended 2010. The increase is due primarily to a $535 increase in legal fees during 2011. In addition supplies and other office expenses was $67 more primarily due to $85 more in ITEX dollars being utilized for SG&A purposes in 2011 as compared to 2010. Some of the increase for 2011 was offset by a $38 decrease in bad debt expense and $31 more of SG&A was transferred to Costs of Marketplace revenue in 2011.

Depreciation and Amortization

Depreciation and amortization expenses include depreciation on our fixed assets and amortization of our intangible assets.  Comparative results are as follows:

	Year Ended July 31,
	2011			Percent change from 2010			2010
Depreciation and amortization	$	588			-9	%	$	644
Percentage of revenue		4	%					4	%

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Year ended July 31, 2011 and 2010.  Depreciation and amortization decreased by $56, or 9% for the year ended 2011 as compared to the year ended 2010. The primary reason for the decrease is that there were no material additions of property and equipment or amortizable intangible assets in 2011 which resulted in a decreased amount of depreciation and amortization as assets are moving towards being fully depreciated.

Other Income (expense)

Other income (expense) includes interest received on notes receivable and promissory notes and gains and losses on sale of assets.  The interest income is derived primarily from our notes receivable for corporate office sales:

	Year Ended July 31,
	2011			Percent change from 2010			2010
Interest income	$	50			19	%	$	42
Gain on sale of assets	$	99			3	%	$	96
Seattle note receivable default	$	-					$	(255	)
Other income / (expense)	$	149			100	%	$	(117	)
Other income/(expense), as a percentage of revenue		1	%					-1	%

Year ended July 31, 2011 and 2010.  Other income (expense) increased by $266 for the year ended 2011 as compared to the year ended 2010. Other income (expense) for the year ended 2011 includes a $35 gain on sale of advertising credits, reflects a gain of $66 from the sale of  membership lists and a loss of $2 from the disposition of fixed assets. Other income (expense) for the year ended 2010 includes a gain on a sale of $99 due to the sale of the San Francisco corporate-owned office. Also included in 2010 are a loss of $3 on the disposition of fixed assets and a $255 loss representing the principal amount due on a note originating from the November 2003 sale of the Seattle corporate-owned office to a broker. The original amount of the note was $450. In 2010, we exercised our step-in rights and are currently managing the Seattle office as a corporate-owned office.   The note balance was declared to be in default resulting in the recognition of the $255 loss.

Interest income is derived primarily from our notes receivable for corporate office sales. The notes receivable are repaid in installments. The installment payments for the various notes receivable end between 2012 and 2018.

Recoverability of Deferred Tax Assets

Deferred tax assets on our balance sheet primarily include federal and state net operating loss carry forwards (collectively “NOLs”) which are expected to result in future tax benefits.  Realization of these NOLs assumes that we will be able to generate sufficient future taxable income to realize these assets.  Deferred tax assets also include temporary differences between the financial reporting basis and the income tax basis of our assets and liabilities at enacted tax rates expected to be in effect when such assets or liabilities are realized or settled.  In 2011 and 2010, respectively, we utilized $1,282 and $1,940 of our available NOLs.  As of July 31, 2011, we have approximately $12,913 of NOLs available to offset future taxable income.

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We periodically assess the realizability of our available NOLs to determine whether we believe we will generate enough future taxable income to utilize substantially all of the available NOLs.  As part of our evaluation process for the year ended July 31, 2011, we determined that based on our estimates of future taxable income, we will not be able to utilize a portion of the state of California NOL.  We determined that there is no allowance required on our Federal NOL. As of July 31, 2011 and 2010, we have a $152 and $0 valuation allowance on state of California NOLs for the period ended July 31, 2011 and 2010, respectively.

FINANCIAL CONDITION (in thousands)

Our total assets were $17,021 and $17,638 at July 31, 2011 and 2010, respectively, representing a decrease of $617 or 3%.  This decrease resulted primarily due to utilization of $558 of deferred tax asset and continued amortization of our intangible assets of $487 during the year.  Our cash totaled $5,386 and $5,169 as of July 31, 2011 and 2010, respectively, representing an increase of $217, or 4%.  Our cash flow activity is described in more detail below (see “Liquidity and Capital Resources”).

Accounts receivable balances, net of allowances of $354 and $349, were $805 and $859 as of July 31, 2011 and 2010 respectively, representing a decrease of $54 or 6%, primarily due to timing of our cycle close in comparable years.

	July 31, 2011		% of Gross Accounts Receivable			July 31, 2010		% of Gross Accounts Receivable
Gross accounts receivable	$	1,159		100	%	$	1,208		100	%
Less: allowance		354		31	%		349		29	%
Net accounts receivable	$	805		69	%	$	859		71	%

Our total current liabilities were $2,255 and $2,579 at July 31, 2011 and 2010, respectively, representing a decrease of $324 or 13%.  The decrease is due to a decreases of $86 in deferred revenue, accrued expenses of $160 and a $34 reduction in advance payments for the year.

Our stockholders’ equity decreased by $111 or 1% to $14,758 at July 31, 2011, compared to $14,869 at July 31, 2010 primarily due to $541 in dividends paid and $421 of stock repurchases during 2011.  This decrease was offset by net income of $701 during 2011.

LIQUIDITY AND CAPITAL RESOURCES (in thousands)

Our principal sources of liquidity are our cash provided by operating activities and cash on hand.  Net cash provided by operating activities was $1,684 and $2,536 for the years ended July 31, 2011 and 2010, respectively.   Our cash balance as of July 31, 2011 totaled $5,386.  Additionally, we have a revolving credit agreement for a $3,000 line of credit facility from our primary banking institution, U.S. Bank (“line of credit”), effective through November 30, 2011. We anticipate renewing the credit facility at the same level for another year. We have no outstanding balance on our line of credit as of July 31, 2011.

The following table presents a summary of our cash flows for the years ended 2011 and 2010 respectively (in thousands):

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	Year Ended July 31,
	2011			2010
Net cash provided by operating activities	$	1,684		$	2,536
Net cash provided by (used in) investing activities		(525	)		186
Net cash used in financing activities		(942	)		(110	)
Increase (decrease) in cash and cash equivalents	$	217		$	2,612

We have financed our operational needs over the last two years through cash flow generated from operations.  During 2011, we increased our cash position by $217 to $5,386. In 2011 we used a portion of operational cash flow provided by operating activities for routine operating expenses, membership list purchases, loans to brokers, stock buybacks and quarterly dividend payments to common stockholders.

Our working capital as of July 31, 2011, includes advertising credits, originally obtained in our business acquisition in August 2008, in the amount of $157, which represented unsold prepaid credits for future media print and broadcast placements. We initially recorded the total advertising credits at fair value based on the estimated future selling price less reasonable costs of disposal. As of July 31, 2011, the total carrying value of our advertising credits was $60. The future operating cash flows may be negatively affected and our original estimate of the net realizable value of the advertising credits will be decreased if we are not able to resell the advertising credits to our customers.

As part of our contemplated future expansion activities and our evaluation of strategic alternatives and opportunities, we may seek to acquire certain competitors or other business to business enterprises, or consider partnering or other collaboration agreements, or a merger or other strategic transaction.  We expect that our current working capital would be adequate for this purpose.  However, we may seek to finance a portion of the acquisition cost subject to the consent of any secured creditors.  We maintain a $3,000 line of credit facility from our primary banking institution, U.S. Bank.  The line of credit was established to provide additional reserve capacity for general corporate and working capital purposes and, if necessary, to enable us to make future expenditures related to the growth and expansion of our business model.  We believe that our financial condition is stable and that our cash balances, other liquid assets, and cash flows from operating activities provide adequate resources to fund ongoing operating requirements.

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

The following summarizes our cash flows by quarter for 2011 and 2010:

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Year ended July 31, 2011	First Quarter			Second Quarter			Third Quarter			Fourth Quarter			Total
Net cash provided by (used in) operating activities	$	354		$	437		$	(245	)	$	1,138		$	1,684
Net cash (used in) investing activities		(34	)		(81	)		(42	)		(368	)		(525	)
Net cash (used in) financing activities		(90	)		(143	)		(560	)		(149	)		(942	)
	$	230		$	213		$	(847	)	$	621		$	217

Year ended July 31, 2010	First Quarter		Second Quarter		Third Quarter			Fourth Quarter			Total
Net cash provided by (used in) operating activities	$	433	$	462	$	548		$	1,093		$	2,536
Net cash provided by (used in) investing activities		108		67		35			(24	)		186
Net cash used in financing activities		-		-		(17	)		(93	)		(110	)
	$	541	$	529	$	566		$	976		$	2,612

Operating Activities

For the year ended July 31, 2011, net cash provided by operating activities was $1,684 compared to $2,536 in the year ended July 31, 2010, a decrease of $852, or 34%.  The decrease is primarily due to a reduction of $245 in net income, a decrease of $160 in accrued expenses and a reduction of $86 in deferred revenue.

The difference between our net income and our net cash provided by operating activities was attributable to non-cash expenses included in net income, and changes in the operating assets and liabilities, as presented below (in thousands):

	Year ended July 31,
	2011			2010
Net income	$	701		$	946
Add: non-cash  expenses		1,141			1,372
Add: changes in operating assets and liabilities		(158	)		218
Net cash provided by operating activities	$	1,684		$	2,536

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

Changes in operating assets and liabilities primarily reflect changes in working capital components of the balance sheet apart from cash and cash equivalents. Net cash provided by operating activities also reflects changes in some non-current components of the balance sheet, such as long-term deferred rent and non-current prepaid expenses and deposits.

As discussed earlier in the overview section of our Management’s Discussion and Analysis of Financial Condition and Results of Operations, for each calendar year, we divide our operations into 13 four-week billing and commission cycles always ending on a Thursday, while we report our financial results as of the last day of each calendar month. The timing of billing and collection activities after the end of the billing cycle does not correspond with the end of the accounting period, therefore this timing difference results in the fluctuations of the balances of cash, accounts receivable, commissions payable and accrued commissions and therefore in periodic fluctuations in cash flows resulting from changes in operating assets and liabilities.

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The total cash we received exclusively from our Marketplace members, excluding corporate- owned office sales, media sales, and revenue from our subscription-based arrangement for client management platform, and net of credit card returns, electronic fund transfer returns, and return checks is as follows (in thousands):

	Year Ended July 31,
	2011		Percent of total			2010		Percent of total
Credit cards, net	$	9,770		66	%	$	9,820		64	%
Electronic fund transfers, net		3,789		26	%		4,074		27	%
Checks and cash, net		1,264		8	%		1,444		9	%
Cash received from Marketplace members, net	$	14,823		100	%	$	15,338		100	%

Investing Activities

For the year ended July 31, 2011, net cash used in investing activities was $525 compared with $186 provided by investing activities in the year ended July 31, 2010, a decrease in cash provided by in investing activities of $711, or 382%.  In the year ended July 31, 2011, the net cash used in investing activities was primarily driven by $472 in purchases of membership list and $168 of advances on loans. In the year ended July 31, 2010, the net cash provided by investing activities was primarily related to $195 in note receivable principal collections.

Financing Activities

Our net cash used in financing activities consists of contractual and discretionary debt repayments and discretionary repurchases of our common stock in order to provide more liquidity for our shareholders.  The following summarizes our financing activities:

Year ended July 31, 2011	First Quarter			Second Quarter			Third Quarter			Fourth Quarter			Total
Principal payments on Private placement	$	-		$	-		$	-		$	20		$	20
Cash dividend paid to common stockholders	$	(90	)	$	(143	)	$	(145	)	$	(163	)	$	(541	)
Discretionary repurchase of common stock		-			-			(415	)		(6	)		(421	)
	$	(90	)	$	(143	)	$	(560	)	$	(149	)	$	(942	)

Year ended July 31, 2010	First Quarter		Second Quarter		Third Quarter			Fourth Quarter			Total
Cash dividend paid to common stockholders	$	-	$	-	$	-		$	(91	)	$	(91	)
Discretionary repurchase of common stock		-		-		(17	)		(2	)		(19	)
	$	-	$	-	$	(17	)	$	(93	)	$	(110	)

We repurchased 94 and 5 shares of ITEX stock in 2011 and 2010, respectively.

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Commitments and Contingencies

We utilize leased facilities in the normal course of our business.  As of July 31, 2011, the future minimum commitments under these operating leases are as follows:

	Executive office		Corp owned office		Corp owned office		Total
Location:	Bellevue, WA		Chicago, IL		Milwaukie, OR
Expiration date:	April 30, 2015		November 30, 2011		October 31, 2012
Lease commitments  for the year ending July 31,
2012		159		28		5		192
2013		163		-		1		164
2014		166		-		-		166
2015		127		-		-		127
Total	$	615	$	28	$	6	$	649

The lease expense, inclusive of utilities included in our lease payments, for our executive office space and corporate-owned offices for the years ended July 31, 2011 and 2010 was $301 and $299, respectively.

We have not leased any equipment in 2011 or 2010.  We have purchase commitments for telecommunications and data communications.  As of July 31, 2011, the future minimum commitments under these purchase commitments are as follows:

	Telecommunications and data communications
Purchase commitments for  the year ending July 31,
2012	$	39
2013		12
Total	$	51

OTHER MATTERS

Critical Accounting Policies and Estimates

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

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

Revenue Recognition

We generate our revenue by charging members percentage-based transaction fees, association fees, and other fees assessed in United States dollars and Canadian dollars where applicable (collectively and as reported on our financial statements “USD” or “Cash”).  We recognize revenue when persuasive evidence of an arrangement exists, the transaction has occurred or a cycle period has ended, the charges are fixed and determinable and no major uncertainty exists with respect to collectability.

Our largest sources of revenue are transaction fees and association fees.  We charge members of the Marketplace an association fee every operating cycle in accordance with our members’ individual agreements.  We also charge both the buyer and the seller a transaction fee based on the ITEX dollar value of that Marketplace transaction.  Additionally, we may charge various auxiliary fees to members, such as annual membership dues, late fees, and insufficient fund fees.  The total fees we charge to members are in USD and partially in ITEX dollars (see below, “Accounting for ITEX Dollar Activity”).   We bill members for all fees at the end of each operating cycle.  We track all financial activity in our internally developed database.  Members have the option of paying USD fees automatically by credit card, by electronic funds transfer or by check.  In the years ended July 31, 2011 and 2010, members made approximately 92% and 91%, respectively, of their payments through electronic funds transfer or by credit cards using our Preferred Member Autopay System (“Autopay System”).  If paying through our Autopay System, generally, the USD transaction fee is 6% of the ITEX dollar amount of the member’s purchases and sales during the operating cycle.  If paying by check, generally, the USD transaction fee is 7.5% of the ITEX dollar amount of that member’s purchases and sales during the operating cycle.  Additionally, regardless of a member’s transaction activity, each operating cycle we charge most members an association fee of $20 USD ($260 USD annually) and $10 ITEX dollars ($130 ITEX dollars annually).  Transaction and association fees composed 92% of our total revenue in both 2011 and 2010.

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

Our Web services contracts include multiple deliverable components, in which we recognize revenue from the platform subscription fee on a straight-line basis over the contract term. The Company recognizes revenue from recurring transaction processing, support and consulting fees as delivery has occurred or services have been rendered.

As discussed below, we generally do not record revenues or expenses in our financial statements for ITEX dollars we receive from or expend to members or brokers, but we do record revenues and expenses for ITEX dollars we spend on various products or services where the value of those ITEX dollars is readily determinable (see below, “Accounting for ITEX Dollar Activity”).  Comparative results are as follows (in thousands):

36

 

ITEX Dollar Summary	Year Ended July 31,
	2011			2010
Fees received from the Marketplace	$	5,088		$	4,757
Expenditures to and for the Marketplace		(5,070	)		(4,753	)
Increase	$	18		$	4

Gross versus Net Revenue Recognition

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

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

The Media Revenue portion of our business, which is included in other fee revenue, is accounted for on a net revenue basis. We report as revenue the net portion remaining after the cost of media sales is deducted.

Accounting for ITEX Dollar Activities

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

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

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We expend ITEX dollars primarily on the following items:

· Co-op advertising with Marketplace members and brokers;

· Revenue sharing with brokers for transaction fees and association fees;

· Incentives to brokers for registering new members in the Marketplace.

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

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

Valuation of Notes Receivable

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

· Significant underperformance relative to expected historical or projected future operating results;

· Change in management of the franchisee or independent licensed broker responsible for the note.

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

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

38

Valuation Allowance on Deferred Tax Assets

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

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

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

In assessing the recoverability of deferred tax assets, we periodically assess whether it is more likely that some portion or all of the deferred tax assets will not be realized.  The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible.  We consider the scheduled reversal of deferred tax liabilities and projections for future taxable income over the periods in which the deferred tax assets are deductible.  As part of our evaluation process for the year ended July 31, 2011, we determined that based on our estimates of future taxable income, we will not be able to utilize a portion of the state of California NOL.  We have taken a $152 valuation allowance during the year ended July 31, 2011.  We determined that there is no allowance required on our Federal NOL. As of July 31, 2011 and 2010, we have a $152 and $0 valuation allowance on state of California NOLs for the period ended July 31, 2011 and 2010, respectively.

On July 31, 2011, we had NOLs of approximately $12,913 available to offset future taxable income.  When circumstances warrant, we re-assess the realizability of our available NOLs for future periods.  When this occurs, if we determine that the realizability of our NOLs has changed, we record the impact of that change as a component of our consolidated statements of income in that period.

The deferred tax assets recorded at July 31, 2011 represent our current estimate of all deferred tax benefits to be utilized in the current year and future periods beyond 2011.

Goodwill

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

39

Goodwill acquired in a purchase business combination is determined to have an indefinite useful life and is not amortized, but instead tested for impairment at least annually. A two-phase approach is used for testing goodwill for impairment. The first phase is a screen for potential impairment, while the second phase (if necessary) measures the amount of impairment, if any. Goodwill is written down and charged to operating results in any period in which the recorded value of goodwill exceeds its fair value. We analyzed goodwill as of July 31, 2011, and we did not identify any impairment.

Business Combinations

The Company accounts for business combinations using the purchase method of accounting. The total consideration paid in an acquisition is allocated to the fair value of the acquired company’s identifiable assets and liabilities. Any excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill. The consolidated financial statements reflect the results of operations of an acquired business from the completion date of an acquisition. The costs to acquire a business, including transaction costs, are allocated to the fair value of net assets acquired for any business combinations occurring prior to August 1, 2009. Subsequent to August 1, 2009, all costs to acquire a business are expensed.

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

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

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

Software for Internal Use

We have developed extensive software to manage and track the ITEX dollar activity in the Marketplace to calculate USD and ITEX dollar fees accordingly.  We account for qualifying costs incurred in the development of software for internal use in accordance with the financial guidance.  In accordance with this guidance, costs incurred in the planning and post-implementation stages are expensed as incurred, while costs relating to application development are capitalized.  Qualifying software development costs, including software in development meeting certain criteria, are included as an element of property and equipment in the consolidated balance sheets.

Share-based Payments

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

Recent Accounting Pronouncements

In January 2010, the Financial Accounting Strandards Board (“FASB”) issued provisions concerning improving disclosures about fair value measurements. This guidance  requires additional disclosure of transfers of assets and liabilities between Levels 1 and 2 of the fair value hierarchy and disclosure of activities, on a gross basis, including purchases, sales, issuances, and settlements in the reconciliation of the assets and liabilities measured under Level 3 of the fair value hierarchy. This standard also clarifies existing disclosures requirements on levels of disaggregation by adsset type and disclosures about inputs and valuation techniques. The Company will adopt this guidance as it becomes effective.

40

Effective September 2011, the FASB issued guidance for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Under the amendments in this Update, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. Under the amendments in this Update, an entity has the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the first step of the two-step goodwill impairment test. An entity may resume performing the qualitative assessment in any subsequent period. The Company will adopt this guidance in the period after December 15, 2011.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

Report of Independent Registered Public Accounting Firm	42
Consolidated Balance Sheets	43
Consolidated Statements of Income	44
Consolidated Statement of Stockholders’ Equity	45
Consolidated Statements of Cash Flows	46
Notes to Consolidated Financial Statements	47

41

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

ITEX Corporation

Bellevue, Washington

We have audited the accompanying consolidated balance sheets of ITEX Corporation as of July 31, 2011 and 2010, and the related consolidated statements of income, stockholders' equity and cash flows for the years then ended.  These consolidated financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of ITEX Corporation as of July 31, 2011 and 2010, and the consolidated results of their operations and their cash flows for each of the years then ended in conformity with accounting principles generally accepted in the United States of America.

/s/ Ehrhardt Keefe Steiner & Hottman PC

Ehrhardt Keefe Steiner & Hottman PC

Denver, Colorado

October 18, 2011

42

ITEX CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands)

	July 31, 2011			July 31, 2010
ASSETS
Current assets:
Cash	$	5,386		$	5,169
Accounts receivable, net of allowance of $354 and $349		805			859
Prepaid expenses		131			118
Loans and advances		10			55
Prepaid advertising credits		60			157
Deferred tax asset, net of allowance of $22 and $0		798			1,018
Notes receivable - corporate office sales		180			125
Other current assets		6			24
Total current assets		7,376			7,525
Property and equipment, net of accumulated depreciation of $468 and $380		89			169
Goodwill		3,266			3,282
Deferred tax asset, net of allowance of $130 and $0 and net of current portion		4,681			5,000
Intangible assets, net of accumulated amortization of $2,691 and $2,205		855			994
Notes receivable - corporate office sales, net of current portion		729			480
Other long-term assets		25			188
Total assets		17,021			17,638
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts and other expenses payable		76			124
Commissions payable to brokers		669			661
Accrued commissions to brokers		785			789
Accrued expenses		545			705
Deferred revenue		47			133
Advance payments		133			167
Total current liabilities		2,255			2,579
Long-term liabilities:
Other long-term liabilities		8			190
Total Liabilities		2,263			2,769
Commitments and contingencies
Stockholders’ equity:
Common stock, $0.01 par value; 9,000 shares authorized; 3,646 shares and 3,576 shares issued and outstanding, respectively		36			36
Additional paid-in capital		28,867			29,138
Accumulated deficit		(14,145	)		(14,305	)
Total stockholders' equity		14,758			14,869
Total liabilities and stockholders’ equity	$	17,021		$	17,638

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

43

ITEX CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(In thousands except per share amounts)

	Year ended July 31,
	2011		2010
Revenue:
Marketplace and other revenue	$	16,424	$	16,925
Costs and expenses:
Cost of Marketplace revenue		10,159		10,777
Corporate salaries, wages and employee benefits		2,001		1,850
Selling, general and administrative		2,573		1,980
Depreciation and amortization		588		644
		15,321		15,251
Income from operations		1,103		1,674
Other income/(expense):
Interest income		50		42
Other income (expense), net		99		(159	)
		149		(117	)
Income before income taxes		1,252		1,557
Income tax expense		551		611
Net income	$	701	$	946
Net income per common share:
Basic	$	0.19	$	0.26
Diluted	$	0.19	$	0.26
Weighted average shares outstanding:
Basic		3,604		3,572
Diluted		3,648		3,577

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

44

ITEX CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(In thousands)

										Stockholder
	Common Stock						Additional paid			Notes			Accumulated
	Shares			Amount			in capital			Receivable			deficit			Total
Balance, July 31, 2009		3,571		$	36		$	29,105		$	-		$	(15,160	)	$	13,981
Common Stock awards issued		10															0
Common Stock repurchased and retired		(5	)					(19	)								(19	)
Stock based compensation expense								52									52
Dividend payment														(91	)		(91	)
Net Income														946			946
Balance, July 31, 2010		3,576		$	36		$	29,138		$	-		$	(14,305	)	$	14,869
Stock based compensation expense		13						130									130
Common Stock repurchased and retired		(94	)		(1	)		(420	)								(421	)
Private placement - Brokers		151			1			604			(605	)					0
Payments on Broker notes receivables											20						20
Dividend payment														(541	)		(541	)
Net Income														701			701
Balance, July 31, 2011		3,646		$	36		$	29,452		$	(585	)	$	(14,145	)	$	14,758

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

45

ITEX CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

	Year ended July 31,
	2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	701		$	946
Items to reconcile to net cash provided by operating activities:
Depreciation and amortization		588			644
Loss on disposal of equipment		2			3
Share-based compensation		130			52
Increase (decrease) in allowance for uncollectible receivables		5			(2	)
Decrease in deferred income taxes		538			519
Gain on Sale - Media Credits		(34	)		-
Gain on Sale - Membership lists		(68	)		-