EXHIBIT 13.1
SELECTED FINANCIAL DATA
The following table sets forth selected financial data for the Company. The
selected historical statements of operations data for each of the years ended
December 31, 2003, 2002, 2001, 2000 and 1999 and the selected historical balance
sheet data for the periods then ended have been derived from the Company's
audited Consolidated Financial Statements for the years ended December 31, 2003,
2002, 2001, 2000 and 1999. As discussed in Note 2 to the Consolidated Financial
Statements, the Company adopted Emerging Issues Task Force ("EITF") No. 01-14,
"Income Statement Characterization of Reimbursements Received for Out-of-Pocket
Expenses Incurred" on January 1, 2002, which requires the presentation of
reimbursed out-of-pocket expenses on a gross basis as revenues and expenses. In
accordance with the adoption of EITF 01-14, reimbursements from customers, which
primarily represent freight and postage fees, are presented on a gross basis for
each of the years ended December 31, 2003, 2002, 2001, 2000 and 1999.
RESULTS FOR YEAR ENDED DECEMBER 31: 2003 2002 2001 2000 1999
-------- -------- --------- --------- ---------
(IN 000'S, EXCEPT PER SHARE AMOUNTS)
Revenues $74,740 $82,420 $121,859 $202,975 $258,267
Cost of revenues 35,157 46,444 68,153 161,972 206,739
Special (credits) charges -- (293) -- 16,462 --
-------- -------- --------- --------- ---------
Gross profit 39,583 36,269 53,706 24,541 51,528
-------- -------- --------- --------- ---------
OPERATING EXPENSES:
Selling, general and administrative 36,444 37,332 43,329 38,209 30,460
Special (credits) charges (30) 404 -- 17,801 --
Depreciation and amortization 5,622 5,336 4,864 4,168 3,414
-------- -------- --------- --------- ---------
TOTAL OPERATING EXPENSES 42,036 43,072 48,193 60,178 33,874
-------- -------- --------- --------- ---------
Operating (loss) income (2,453) (6,803) 5,513 (35,637) 17,654
-------- -------- --------- --------- ---------
Interest expense (income), net 741 318 (532) 80 1,370
Other expense (income) 15 (124) (20) 141 60
-------- -------- --------- --------- ---------
TOTAL OTHER EXPENSE (INCOME) 756 194 (552) 221 1,430
-------- -------- --------- --------- ---------
(Loss) income before income taxes
and minority interest (3,209) (6,997) 6,065 (35,858) 16,224
Income tax (provision) benefit (8,772) 2,578 (2,573) 14,084 (6,389)
-------- -------- --------- --------- ---------
Net (loss) income before minority interest (11,981) (4,419) 3,492 (21,774) 9,835
Minority interest, net of income taxes -- -- (893) (199) --
-------- -------- --------- --------- ---------
NET (LOSS) INCOME $(11,981) $(4,419) $4,385 $(21,575) $9,835
======== ======== ========= ========= =========
Net (loss) income per share-basic $(1.04) $(0.38) $0.39 $(1.92) $0.99
Net (loss) income per share-diluted $(1.04) $(0.38) $0.38 $(1.92) $0.98
COMMON STOCK INFORMATION:
Average number of common shares outstanding-basic 11,542 11,516 11,318 11,212 9,911
Book value per common share(1) $4.31 $5.20 $5.59 $5.23 $7.99
YEAR-END FINANCIAL POSITION:
Current assets $29,721 $41,619 $58,093 $76,150 $94,810
Current liabilities 20,117 20,143 35,717 34,175 24,930
Property and equipment, net 14,750 18,915 14,500 13,717 8,922
Total assets 70,962 95,499 99,393 97,145 104,218
Long-term obligations 1,083 15,497 393 166 75
Total liabilities 21,200 35,640 36,110 34,341 25,005
Total shareholders' equity $49,762 $59,859 $63,283 $58,635 $79,213
(1) Book value per common share is calculated by dividing total shareholders'
equity at year end by the basic average number of common shares outstanding.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion may contain certain forward-looking statements that are
subject to conditions that are beyond the control of the Company. Actual results
may differ materially from those expressed or implied by such forward-looking
statements. Factors that could cause actual results to differ include, but are
not limited to, the Company's reliance on a small number of major clients; risks
associated with the terms and pricing of our contracts; reliance on the
telecommunications and direct marketing industries and the effect on the Company
of the downturns, consolidation and changes in those industries in the past two
years; risks associated with the fluctuations in volumes from our clients; risks
associated with upgrading, customizing, migrating or supporting existing
technology; risks associated with competition; and other factors discussed in
more detail under "Business-Certain Factors Affecting Forward-Looking
Statements" in our Annual Report on Form 10-K.
OVERVIEW
Innotrac Corporation ("Innotrac" or the "Company"), founded in 1984 and
headquartered in Atlanta, Georgia, is a full-service fulfillment and logistics
provider serving enterprise clients and world-class brands. The Company employs
sophisticated order processing and warehouse management technology and operates
seven fulfillment centers and two call centers in five cities spanning all time
zones across the continental United States.
We receive most of our clients' orders either through inbound call center
services, electronic data interchange ("EDI") or the Internet. On a same-day
basis, depending on product availability, the Company picks, packs, verifies and
ships the item, tracks inventory levels through an automated, integrated
perpetual inventory system, warehouses data and handles customer support
inquiries.
Our core service offering includes the following:
- Fulfillment Services:
- sophisticated warehouse management technology
- automated shipping solutions
- real-time inventory tracking and order status
- purchasing and inventory management
- channel development
- zone skipping for shipment cost reduction
- product sourcing and procurement
- packaging solutions
- back-order management
- returns management
- Customer Support Services:
- inbound call center services
- technical support and order status
- returns and refunds processing
- call centers integrated into fulfillment platform
- cross-sell/up-sell services
- collaborative chat
- intuitive e-mail response
2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Today, the Company is primarily focused on five diverse lines of business, or
industry verticals. This is a result of a significant effort made by the Company
to diversify both its industry and client base over the last three years. Prior
to 2000, the Company was primarily focused on the telecommunications industry,
with over 90% of its revenues being derived through this vertical. While a large
portion of the Company's revenues are still derived from this industry group,
the chart below is indicative of the diversification efforts achieved in recent
years.
BUSINESS MIX
Business Line/Vertical 2003 2002
- ---------------------- ---- ----
Telecommunications products 23.0% 26.5%
Modems 19.4 19.3
Retail/Catalog 27.4 20.2
Direct Marketing 18.0 27.0
B2B 12.2 7.0
----- -----
100.0% 100.0%
===== =====
The Company continues to be a major provider of fulfillment and customer support
services to the telecommunications industry. In spite of a significant
contraction and consolidation in this industry in the past several years, the
Company continues to provide customer support services and fulfillment of
telephones, Caller ID equipment, Digital Subscriber Line ("DSL") and Cable
Modems and other telecommunications products to companies such as BellSouth
Corporation ("BellSouth"), Qwest Communications International, Inc. ("Qwest")
and Comcast Corporation ("Comcast") and their customers. Inventory for our
telecommunications and DSL clients is held on a consignment basis, with the
exception of certain BellSouth inventory, for which we are contractually
indemnified, and includes items such as telephones, Caller ID equipment,
wireless pagers, DSL and cable modems and ancillary equipment. We anticipate
that the percentage of our revenues attributable to telecommunications and DSL
clients will remain fairly constant during 2004. Based on client forecasts, we
are anticipating a decrease of approximately $1.6 million in our wireless pager
business as our one client in this area has decided to exit, offset by an
increase in our DSL and cable modem business which is still in a strong growth
mode. The telephone and Caller ID equipment business is mature, yet steady.
The Company also provides a variety of these services for a significant number
of retail, catalog and direct marketing clients which include such companies as
The Coca-Cola Company, Ann Taylor Retail, Inc., Smith & Hawken, Ltd., Tactica
International, Inc. (a subsidiary of Helen of Troy), Porsche Cars North America,
Inc., Nordstrom.com LLC, Wilsons Leather Direct, Inc., Martha Stewart Living
Omnimedia, Inc., and Thane International. We take orders for our retail, catalog
and direct marketing clients via the internet, through a customer service
representative at our Pueblo and Reno call centers or through direct electronic
transmission from our clients. The orders are processed through one of our order
management systems and then transmitted to one of our seven fulfillment centers
located across the country and are shipped to the end consumer or retail store
location, as applicable, typically within 24 hours of when the order is
received. Inventory for our retail, catalog and direct marketing clients is held
on a consignment basis, with minor exceptions, and includes items such as shoes,
dresses, accessories, books and outdoor furniture. Our revenues are sensitive to
the number of orders and customer service calls received. Our client contracts
do not guarantee volumes. We anticipate that the percentage of our revenues
attributable to our retail and catalog clients will increase during 2004 due to
the anticipated additions of new channels, product lines and divisions for
existing clients, along with internal growth and a strengthening of the overall
economy. This would also be consistent with actual sales volumes
3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
experienced in the second half of 2003, which represented an increase of over
$1.1 million from the first half of 2003. Revenues attributable to our direct
marketing clients may decrease further in 2004 due to their lack of new "hit"
products and an anticipated decrease in advertising to attract consumers. The
direct marketing vertical was weak throughout all of 2003. Further, it has been
announced that one of our major direct marketing clients is for sale. The impact
of a change in ownership of this client cannot be estimated at this time, but
could materially impact our future results of operations if our services for
this client were reduced or discontinued.
The Company also provides these services for business-to-business ("B2B")
clients including Books Are Fun, Ltd. (a subsidiary of Reader's Digest), NAPA
and The Walt Disney Company. This is a small, but growing area of our business.
ACQUISITIONS
In order to reduce our industry and client concentration and to expand our
national presence, in December 2000, we acquired Universal Distribution Services
("UDS"). Our UDS division provides integrated order processing, order
management, fulfillment and customer relationship management services. UDS's
customer base comprises traditional direct marketing companies including Thane
International and Tactica International, Inc. It is located in a 275,000
square-foot facility in Reno, Nevada. During 2001, we expanded UDS's business by
taking advantage of our East Coast capabilities. Under the terms of Innotrac's
merger agreement with UDS, the former shareholders of UDS could receive, as part
of the consideration paid for their shares, annual contingent payments based on
the operating income generated by our UDS division over a three-year period that
commenced December 1, 2000. For the first year of the earnout period, UDS's
stockholders received approximately $13.7 million in cash and 310,000 shares of
our common stock pursuant to this arrangement. No earnout amounts were earned in
the second and third years.
In July 2001, to further our strategy to diversify our industry and client
concentration, we acquired iFulfillment, Inc. ("iFulfillment"). Our iFulfillment
subsidiary specializes in fully integrated, automated, order fulfillment
services for multi-channel retailers and catalogers including such clients as
Nordstrom.com LLC, Wilsons Leather Direct, Inc. and Martha Stewart Living
Omnimedia, Inc. It is located in a 354,000 square- foot leased facility in
Bolingbrook, Illinois. Due to the addition of a sizable new client in September
2002, we leased an additional 150,204 square feet in a nearby facility, which
was expanded by 54,103 square feet in April 2003. This new facility has
expansion space of an additional 51,254 square feet that we have an option to
lease in the future. There are no immediate plans to exercise that option.
In August 2002 we leased a 396,000 square-foot fulfillment center near
Cincinnati, in Hebron, Kentucky. This facility is used exclusively to provide
fulfillment services for Smith & Hawken, which is the Company's single largest
retail client, under the terms specified in a contract with Smith & Hawken,
which is for a term of six years. Capital expenditures associated with this
facility were approximately $4.6 million and were funded through our bank line
of credit.
With our national footprint virtually complete, we are committed to deeper
penetration within our existing business lines and continued diversification of
our client base. Our long-term goal is to have our business mix spread evenly
across a high number of clients in diverse industries. We will continue to seek
new clients and may open additional facilities in other geographic locations to
service these needs.
During 2002, the Company incurred significant start-up and associated technology
costs for new client implementations. We added Martha Stewart Living Omnimedia
and Smith & Hawken to our Reno system. As part of the migration of those two new
clients onto the system we added the requisite functionality and customization.
The customized nature of the system required significant resources to properly
scale the system to meet our client's needs and resulted in a considerable
increase in IT costs in 2002. Approximately $2.6 million of these costs were
eliminated in 2003.
4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth summary operating data, expressed as a percentage
of revenues, for the years ended December 31, 2003, 2002 and 2001. Operating
results for any period are not necessarily indicative of results for any future
period.
The financial information provided below has been rounded in order to simplify
its presentation. However, the percentages below are calculated using the
detailed information contained in the Consolidated Financial Statements and
notes thereto.
YEAR ENDED DECEMBER 31,
2003 2002 2001
----- ----- -----
Revenues, net 100.0% 100.0% 100.0%
Cost of revenues 47.0 56.4 55.9
Special charges (credits), net -- (0.4) --
----- ----- -----
Gross profit 53.0 44.0 44.1
Selling, general and administrative 48.8 45.3 35.6
Special charges, net -- 0.5 --
Depreciation and amortization 7.5 6.5 4.0
----- ----- -----
Operating (loss) income (3.3) (8.3) 4.5
Other expense (income) 1.0 0.2 (0.5)
----- ----- -----
(Loss) income before taxes and minority interest (4.3) (8.5) 5.0
Income tax (provision) benefit (11.7) 3.1 (2.1)
----- ----- -----
Net (loss) income before minority interest (16.0) (5.4) 2.9
Minority interest, net of income taxes -- -- (0.7)
----- ----- -----
Net (loss) income (16.0)% (5.4)% 3.6%
===== ===== =====
SPECIAL CHARGES
The Company recorded special charges of $34.3 million during the year ended
December 31, 2000. At December 31, 2003 and 2002, the Company had approximately
$0 and $277,000, respectively, in remaining accruals related to the special
charges recorded during the year ended December 31, 2000. Cash payments relating
to the special charge accruals for the years ended December 31, 2003 and 2002
were approximately $277,000 and $716,000, respectively.
The Company recognized approximately $3.0 million of special credits during the
year ended December 31, 2002, related to gains realized on sales of inventory
items which were previously written off as special charges in previous periods,
cash collected for accounts receivable that were written off as special charges
in previous periods, redeployment of leased computer hardware for which the
leases were fully accrued for as special charges in previous periods, and client
contract amendments which resulted in reduced liabilities. These amounts were
recorded as a reduction in the special charge line items in the Consolidated
Statements of Operations.
5
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
During 2002, the Company also recognized an additional $3.1 million in special
charges. Approximately $2.4 million of these charges were related to capitalized
hardware and software costs for systems purchased specifically for a potential
new client which were subsequently not utilized as originally planned. The loss
of the potential customer indicated that the carrying value of the asset group
was potentially not recoverable, and therefore, an impairment test under the
provisions of SFAS No. 144 was performed. As the fair market value of the asset
group was not readily determinable, a discounted, probability weighted cash flow
model was utilized as a basis to determine fair value. As a result of the cash
flow analysis, a $2.4 million impairment charge was recorded. Of the remaining
charges, approximately $500,000 related to the write-down to net realizable
value of specified fixed assets obtained as part of the December 2000
acquisition of UDS which were being utilized for one specific customer who
ceased conducting business with UDS. The balance of approximately $200,000 was
related to severance costs for positions which were eliminated.
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
Revenues. The Company's net revenues decreased 9.3% to $74.7 million for the
year ended December 31, 2003 from $82.4 million for the year ended December 31,
2002. The decrease in revenues is primarily due to a $3.6 million reduction in
business with Warranty Corporation of America ("WACA"), which lost one of its
significant clients in the fourth quarter of 2002, a significant $10.5 million
decrease in revenues from our two primary direct marketing clients, Thane and
Tactica, and a decision by BellSouth to exit their wireless pager business,
which resulted in a decrease of revenues of approximately $1.4 million. The
reduction in the WACA business began in the fourth quarter of 2002 and as of
December 31, 2003, we are no longer providing any services for WACA.
Additionally, the direct marketing industry remains soft. However, we have
recently received new programs from our direct marketing clients for 2004 and
added one new significant direct marketing client towards the end of 2003. The
BellSouth wireless program will be in a support mode only during 2004 which will
result in a further reduction in revenues to Innotrac of approximately $1.6
million. This decline in revenues was offset by growth in our retail and B2B
businesses with Smith & Hawken and Books Are Fun with revenues increasing by
approximately $8.3 million in 2003. We believe that we will see additional
growth from each of these clients in 2004 based on new programs, channels and
initiatives that we are already assisting with.
Cost of Revenues. The Company's cost of revenues decreased 24.3% to $35.2
million for the year ended December 31, 2003 compared to $46.4 million for the
year ended December 31, 2002. Cost of revenues decreased primarily due to a
30.8% decrease in freight costs associated with lower volumes, a lower revenue
base as discussed above and more efficient operations. The year ended December
31, 2002 also included some inefficiencies associated with startup operations
for Smith & Hawken, Books Are Fun, Martha Stewart and Ann Taylor. All of these
accounts commenced operations with Innotrac during 2002.
Special Credits. There were no special charges or credits during 2003. During
the year ended December 31, 2002, the Company recognized approximately $293,000
related to gains realized on sales of inventory items previously written down as
part of the 2000 special charge.
Gross Profit. For the year ended December 31, 2003, the Company's gross profit
increased to $39.6 million, or 53.0% of revenues, compared to $36.3 million, or
44.0% of revenues, for the year ended December 31, 2002. The increase in gross
profit was due primarily to a reduction in freight costs, improved operating
efficiencies in the call centers and fulfillment centers and elimination of
significant new client startup costs.
Selling, General and Administrative Expenses. S,G&A expenses for the year ended
December 31, 2003 decreased 2.4% to $36.4 million or 48.8% of revenues compared
to $37.3 million or 45.3% of revenues for the year ended December 31, 2002. The
decrease in expenses in 2003 was mainly attributable to a reduction in
information technology personnel and the conversion of information technology
consultants to employees at lower rates, which resulted in a $2.6 million
reduction. This was offset by higher facility costs of $2.2 million
6
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
associated with full year rents in Hebron and Romeoville and an increase of
approximately $700,000 in our accounts receivable reserve. Start-up expenses
associated with new client implementations were also included in the 2002
results. The increase in S,G&A expense as a percentage of revenues was primarily
due to a reduced revenue base.
Special (Credits)/Charges. During 2003, the Company recorded a special credit of
$30,000 associated with the settlement of a severance claim at an amount lower
then previously reserved for in 2002. During 2002, the Company recorded special
charges of $3.1 million primarily related to the impairment of capitalized
hardware and software costs for systems not being utilized as originally
planned. This was offset by the reversal of a portion of the 2000 special
charges totaling approximately $2.7 million related to accounts receivable
reserves that were no longer required, the redeployment of leased computer
hardware which were previously fully reserved for as special charges, and client
contract amendments which resulted in decreased future obligations to the
Company.
Income Taxes. During 2003, a valuation allowance has been recognized for the
full amount of the deferred tax asset as losses in recent years create
uncertainty about the realization of the tax benefits in future years. The
valuation allowance of approximately $9.9 million resulted in an overall tax
provision of approximately $8.8 million.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Revenues. The Company's revenues decreased 32.4% to $82.4 million for the year
ended December 31, 2002 from $121.9 million for the year ended December 31,
2001. The decrease in revenues is primarily due to the loss of the SBC contract
which ended on November 30, 2001 and represented approximately $15.3 million of
revenues during the year ended December 31, 2001; completion of the transition
from an inventory ownership to a fee-for-service model; and a 50.1% or $13.6
million decrease in freight revenues due to clients utilizing their own direct
billed freight accounts. This decline in revenues was partially offset by the
re-initiation of fulfillment services of customer premise equipment ("CPE")
during the third quarter of 2001 and the expansion of services to include
wireless pager equipment with BellSouth during the fourth quarter of 2001.
Additionally, the revenue decline was also partially offset by the commencement
of the Martha Stewart contract in the first quarter of 2002 and the Smith and
Hawken, Ann Taylor and Books Are Fun contracts in the third quarter of 2002.
Cost of Revenues. The Company's cost of revenues decreased 31.9% to $46.4
million for the year ended December 31, 2002 compared to $68.2 million for the
year ended December 31, 2001. $13.6 million of this decrease was attributable to
a reduction in pass-through freight costs. A reduction in call center direct
costs from the loss of the SBC contract in December 2001 and the subsequent
closure of the Atlanta call center in January 2002 also contributed to the
decrease in cost of revenues during 2002 as compared to 2001. This decline in
cost of revenues was partially offset by expenses incurred in the second half of
2002 relating to additional fulfillment labor required to handle the start-up of
several new fulfillment clients as outlined above.
Special Credits. The Company recognized approximately $293,000 of special
credits in 2002 related to gains realized on sales of inventory items previously
written down as part of the 2000 special charge. There were no special charges
or special credits in 2001.
Gross Profit. For the year ended December 31, 2002, the Company's gross profit
decreased to $36.3 million, or 44.0% of revenues, compared to $53.7 million, or
44.1% of revenues, for the year ended December 31, 2001. The decrease in gross
profit was due primarily to the revenue decrease discussed above.
Selling, General and Administrative Expenses. S,G&A expenses for the year ended
December 31, 2002 decreased 13.8% to $37.3 million or 45.3% of revenues compared
to $43.3 million or 35.6% of revenues for
7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
the year ended December 31, 2001. The decrease in expenses in 2002 was mainly
attributable to charges recorded during the first quarter of 2001, primarily for
(i) the impairment of software development costs and severance costs related to
Return.com and (ii) a significant decrease in bad debt expense in 2002. The
decline in S,G&A costs was partially offset by increased information technology
and start-up expenses associated with new client implementations during 2002.
The increase in S,G&A expense as a percentage of revenues was primarily due to
the reduction in revenues discussed above.
Special Charges. The Company recorded special charges of $3.1 million during
2002 primarily related to the impairment of capitalized hardware and software
costs for systems not being utilized as originally planned. This was offset by
the reversal of a portion of the 2000 special charges totaling approximately
$2.7 million related to accounts receivable reserves that were no longer
required, the redeployment of leased computer hardware which were previously
fully reserved for as special charges, and client contract amendments which
resulted in decreased future obligations to the Company. There were no special
charges in 2001.
Income Taxes. The Company's effective tax rate for the years ended December 31,
2002 and 2001 was a benefit of 36.8% and a provision of 42.4%, respectively. The
decrease in the absolute rate was principally due to the impact of certain items
not deductible for tax purposes in the prior period.
LIQUIDITY AND CAPITAL RESOURCES
The Company funds its operations and capital expenditures primarily through cash
flow from operations and borrowings under a credit facility with a bank. The
Company had cash and cash equivalents of approximately $2.2 million at December
31, 2003 as compared to $961,000 at December 31, 2002. Additionally, the Company
had reduced its borrowings under its revolving credit facility (discussed below)
to $11.8 million outstanding at December 31, 2003 as compared to $14.4 million
at December 31, 2002. The Company generated positive cash flow from operations
and free cash flow during 2003. We anticipate positive cash flows from
operations again in 2004. One of the primary contributors to generating cash in
2004 will be a further reduction in our wireless pager inventory of
approximately $5.5 million. This should also result in a further reduction in
borrowings under our revolving credit facility. Capital expenditures were a
modest $1.2 million in 2003 versus capital expenditures of $12.8 million in
2002. We anticipate capital expenditures of approximately $2.0 million in 2004.
This estimate is subject to various contingencies, including the possible need
to incur additional capital expenditures related to new clients or significant
new initiatives by existing clients.
The Company currently has a revolving credit agreement with a bank for
borrowings up to $40.0 million. We intend to reduce the size of this facility
from $40.0 million to $25.0 million as the Company does not anticipate a need
for the larger amount. We also anticipate that outstanding amounts under the
revolving credit facility should decrease in 2004 as our wireless pager
inventory is sold and related accounts receivables collected.
The provisions of the revolving credit agreement require that the Company
maintain a lockbox arrangement with the lender, and allows the lender to declare
any outstanding borrowing amounts to be immediately due and payable as a result
of noncompliance with any of the covenants. Accordingly, in the event of
noncompliance, these amounts could be accelerated. Furthermore, borrowings under
the revolving credit agreement are subject to borrowing base limitations.
In May 2002, the Company extended its credit facility until June 2005. The
Company and its subsidiary have granted a security interest in all of their
assets and the subsidiary has provided a guarantee to the lender as collateral
under this revolving credit agreement. The revolving credit agreement contains
various restrictive financial and change of ownership control covenants.
Noncompliance with any of the covenants allows the lender to declare any
outstanding borrowing amounts to be immediately due and payable. The credit
facility
8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
limits borrowings under the agreement to a specified percentage of eligible
accounts receivable and inventory, as defined, which totaled $18.5 million at
December 31, 2003. The financial covenants required the Company to maintain a
fixed charge coverage ratio of 1.75 to 1.00 by December 31, 2003. At December
31, 2003, the Company was not in compliance with this fixed charge ratio.
However, the Company received a waiver from the bank and that covenant was
amended and reduced to a lower ratio of 1.30 to 1.00 for the balance of the
term. The Company's fixed charge ratio at December 31, 2003 was 1.40 to 1.00.
Additionally, the revolving credit agreement contains a minimum tangible net
worth requirement of $34 million. Tangible net worth is computed as
shareholders' equity less goodwill, other intangible assets and certain deferred
costs. Included in the bank's definition of tangible net worth is the carrying
amount of the deferred tax asset. Accordingly, as a valuation allowance was
recorded at December 31, 2003 for the entire deferred asset balance of $9.9
million, the Company was no longer in compliance with the tangible net worth
requirement of $34 million. However, the Company received a waiver from the bank
and that covenant was amended and reduced to $24 million for the balance of the
term. Compliance with the minimum tangible net worth covenant and other
financial covenants is determined on a quarterly basis.
Interest on borrowings is payable monthly at rates equal to the prime rate, or
at the Company's option, LIBOR plus up to 225 basis points. On November 13,
2003, the Company fixed $6.0 million of its $11.8 million of borrowings at a
90-day LIBOR rate of 2.68%. During the years ended December 31, 2003, 2002 and
2001 the Company incurred interest expense related to the line of credit of
approximately $704,000, $266,100 and $0, respectively, resulting in a weighted
average interest rate of 3.80%, 3.75% and 0%, respectively. At December 31,
2003, the Company had $6.7 million available under the revolving credit
agreement.
During the year ended December 31, 2003, the Company generated $3.8 million in
cash flow from operating activities compared to $3.9 million in cash flow from
operating activities in the same period in 2002. The slight decrease in cash
from operating activities was primarily the result of a decrease of $7.8 million
in accounts payable associated with a large inventory purchase made in December
2002 and paid in January 2003, increase in trade accounts receivable of $2.6
million and a reduction in accrued expenses of $3.8 million primarily
attributable to a reduction in outstanding credits due customers, the settlement
of various legal claims and a reduction in accrued severance. These items were
offset by a decrease in inventories of $13.2 million, primarily wireless pagers.
During the year ended December 31, 2003, net cash used in investing activities
was $1.4 million as compared to $25.9 million in 2002. The 2002 amounts included
a $13.7 million earn-out payment made in February 2002 and $12.8 million in
capital expenditures, primarily in conjunction with the Company's new facility
in Hebron, Kentucky and capitalized technology costs. Capital expenditures in
2003 were $1.2 million. All of these expenditures were funded through existing
cash on hand, cash flow from operations and borrowings under the Company's
credit facility.
During the year ended December 31, 2003, the net cash used in financing
activities was $1.2 million compared to $13.6 million provided by financing
activities in the same period in 2002. The primary difference between years is
attributable to borrowings of $14.4 million under the credit facility in 2002
versus a reduction in outstanding borrowings of $2.6 million in 2003.
Additionally, during 2003, the Company generated cash of $1.6 million through
the exercise of previously granted employee stock options. We anticipate
approximately $5.5 million in further reductions will take place by the end of
2004 and that additional employee stock options will be exercised resulting in
cash payments to the Company.
The Company estimates that its cash and financing needs through 2004 will be met
by cash flows from operations and its credit facility. The Company has generated
positive cash flows from operations in each of the last three years and
anticipates doing so again in 2004. The Company may need to raise additional
funds in order to take advantage of unanticipated opportunities, such as
acquisitions of complementary businesses or
9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
the opening of new facilities. There can be no assurance that the Company will
be able to raise any such capital on terms acceptable to the Company or at all.
The Company's primary long-term contractual commitments consist of capital and
operating leases. As of December 31, 2003, the Company did not have any off
balance sheet arrangements that have or are reasonably likely to have a current
or future effect on the financial condition, changes in financial condition,
revenues or expenses, results of operations, liquidity, capital expenditures or
capital resources. In addition, the Company had none of the following as of
December 31, 2003: guarantees of other entities' obligations, structured finance
arrangements, synthetic leases, repurchase obligations or similar commercial or
financing commitments. Additionally, the Company does not trade in commodity
contracts.
The following table sets forth the Company's contractual commitments by period.
There are no additional purchase obligations or other long-term liabilities
other than those reflected below. For additional information, see Note 7 to the
Consolidated Financial Statements (in 000's).
Payments Due by Period
------------------------------------------------------------------
Total Less than 1 year 1-3 years 4-5 years After 5 years
------- ---------------- --------- --------- -------------
Capital leases $ 151 $ 95 $ 56 $ -- $ --
Operating leases 27,844 7,779 13,514 6,551 --
Line of credit (1) 11,802 -- 11,802 -- --
(1) The provisions of the revolving line of credit agreement require that the
Company maintain a lockbox arrangement with the lender and allows the lender to
declare any outstanding borrowing amounts to be immediately due and payable as a
result of noncompliance with any of the covenants. Accordingly, in the event of
noncompliance, these amounts could be accelerated.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
Management believes the Company's exposure to market risks is immaterial.
Innotrac holds no market risk- sensitive instruments for trading purposes. At
present, the Company does not employ any derivative financial instruments, other
financial instruments or derivative commodity instruments to hedge any market
risks and does not currently plan to employ them in the future. To the extent
that the Company has borrowings outstanding under its credit facility, the
Company will have market risk relating to the amount of borrowings due to
variable interest rates under the credit facility. The Company believes its
exposure is immaterial due to the short-term nature of these borrowings.
Additionally, all of the Company's lease obligations are fixed in nature as
noted in Note 7 to the Consolidated Financial Statements, and the Company has no
long-term purchase commitments.
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are those policies that can have a significant
impact on the presentation of our financial position and results of operations
and demand the most significant use of subjective estimates and management
judgment. Because of the uncertainty inherent in such estimates, actual results
may differ from these estimates. Specific risks inherent in our application of
these critical policies are described below. For all of these policies, we
caution that future events rarely develop exactly as forecasted, and the best
estimates routinely require adjustment. These policies often require difficult
judgments on complex matters that are often subject to multiple sources of
authoritative guidance. Additional information concerning our accounting
policies can be found in Note 2 to our Consolidated Financial Statements. The
policies that we believe are most critical to an investor's understanding of our
financial results and condition and require complex management judgment are
discussed below:
10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Goodwill and Other Acquired Intangibles. Goodwill represents the cost of an
acquired enterprise in excess of the fair market value of the net tangible and
identifiable intangible assets acquired. Goodwill and other acquired intangibles
related to business combinations prior to July 1, 2001 were being amortized over
5-20 years on a straight-line basis, which represented management's estimation
of the related benefit to be derived from the acquired business. The Company
adopted SFAS No. 142, "Goodwill and Other Intangible Assets, "effective January
1, 2002, which changed the accounting for goodwill and other indefinite life
intangibles from an amortization method to an impairment only approach. Under
SFAS No. 142, goodwill impairment is deemed to exist if the net book value of a
reporting unit exceeds its estimated fair value.
Innotrac's goodwill carrying amount as of December 31, 2003 was $25.2 million.
This asset relates to the goodwill associated with the Company's acquisition of
Universal Distribution Services ("UDS") in December 2000 (including the earnout
payment made to the former UDS shareholders in February 2002), and the
acquisition of iFulfillment, Inc. in July 2001. In accordance with SFAS No. 142,
the Company contracted with an independent third party valuation firm to perform
a valuation in the first quarter of 2004. The third party valuation supported
that the fair value of the reporting unit at January 1, 2004 exceeds the
carrying amount of the net assets, including goodwill, and thus no impairment
currently exists. Management has reviewed and concurs with the major assumptions
used in the third party's valuation at January 1, 2004. The Company will perform
this impairment test annually as of January 1 or sooner if circumstances
indicate.
Deferred Tax Asset. Innotrac utilizes the liability method of accounting for
income taxes. Under the liability method, deferred taxes are determined based on
the difference between the financial and tax basis of assets and liabilities
using enacted tax rates in effect in the years in which the differences are
expected to reverse. A valuation allowance is recorded against deferred tax
assets if the Company considers it is more likely than not that deferred tax
assets will not be realized. Innotrac's net deferred tax asset as of December
31, 2003 is $9.9 million. This deferred tax asset was generated primarily by
net operating loss carryforwards created primarily by the special charge of
$34.3 million recorded in 2000 and the net losses generated in 2002 and 2003.
Innotrac has a tax net operating loss carryforward of $31.5 million at December
31, 2003 that expires between 2020 and 2023. Innotrac's ability to generate the
expected amounts of taxable income from future operations is dependent upon
general economic conditions, collection of existing outstanding accounts
receivable, competitive pressures on sales and margins and other factors beyond
management's control. Due to these factors, combined with losses in recent years
creates uncertainty about the ultimate realization of the gross deferred tax
asset in future years. Therefore a full valuation allowance of approximately
$9.9 million has been recorded in 2003. Income taxes associated with future
earnings will be offset by a reduction in the valuation allowance. When, and
if, the Company can return to consistent profitability and management determines
that it will be able to utilize the deferred tax assets prior to their
expiration, then the valuation allowance can be reduced or eliminated.
Accounting Estimates. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosures of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
The Company makes estimates each reporting period associated with its reserve
for uncollectible accounts. These estimates are based on the aging of the
receivables. One direct marketing client, with a substantial past due balance at
December 31, 2003, entered into a payment arrangement with Innotrac in February
2004 that would eliminate the past due amounts during the first half of 2004.
Payments of approximately $1 million towards this past due amount were received
in February and March, 2004. In spite of these arrangements and subsequent
payments, and due primarily to the financial condition, payment history and
aging of the receivables of this client, the Company still determined it prudent
to establish a specific reserve of $1.1 million
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
for this account at December 31, 2003. Management will continue to assess the
level of reserve needed against this account quarterly.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No.
146, "Accounting for Costs Associated with Exit or Disposal Activities." This
Statement requires recording costs associated with exit or disposal activities
at their fair values when a liability has been incurred. Under previous
guidance, certain exit costs were accrued upon management's commitment to an
exit plan, which is generally before an actual liability has been incurred. The
Company adopted SFAS No. 146 on January 1, 2003. Adoption of SFAS No. 146 did
not have a material impact on the Company's consolidated financial position,
results of operations or cash flows.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure-an amendment to FASB Statement No. 123,"
which is effective for fiscal years beginning after December 15, 2002. SFAS No.
148 amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. SFAS No. 148 also
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The Company accounts for stock-based compensation
under Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock
Issued to Employees." The Company intends to continue to account for stock-based
employee compensation under APB No. 25. Note 2 to the Consolidated Financial
Statements includes the additional disclosure requirements of SFAS No. 148 as
required by entities which continue to account for stock-based employee
compensation under APB No. 25.
In November 2002, the FASB issued Interpretation ("FIN") No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN No. 45 requires footnote disclosure
of the guarantees or indemnification agreements a company issues. With certain
exceptions, these agreements will also require a company to prospectively
recognize an initial liability for the fair value, or market value, of the
obligations it assumes under the guarantee. The initial recognition and initial
measurement provisions of this Interpretation are applicable on a prospective
basis to guarantees issued or modified after December 31, 2002. The Company
adopted FIN No. 45 on January 1, 2003. Adoption of FIN No. 45 did not have a
material impact on the Company's consolidated financial position, results of
operations or cash flows.
12
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of Innotrac Corporation:
We have audited the accompanying consolidated balance sheets of Innotrac
Corporation and its subsidiaries as of December 31, 2003 and 2002, and the
related consolidated statements of operations, shareholders' equity and cash
flows for the years then ended. Our audits also included the 2003 and 2002
financial statement schedule listed in the Index at Item 15 as Schedule II.
These financial statements and financial statement schedule are the
responsibility of the Corporation's management. Our responsibility is to express
an opinion on the 2003 and 2002 financial statements and financial statement
schedule based on our audits. The financial statements and financial statement
schedule as of December 31, 2001 and for the year then ended, before the
reclassifications and inclusion of disclosure discussed in Notes 2 and 16 to the
financial statements, were audited by other auditors who have ceased operations.
Those auditors expressed an unqualified opinion on those financial statements
and stated that such 2001 financial statement schedule, when considered in
relation to the 2001 basic financial statements taken as a whole, presented
fairly, in all material respects, the information set forth therein, in their
report dated February 8, 2002.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the 2003 and 2002 consolidated financial statements present
fairly, in all material respects, the financial position of Innotrac Corporation
and its subsidiaries as of December 31, 2003 and 2002, and the results of their
operations and their cash flows for the years then ended, in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, the 2003 and 2002 financial statement schedule, when considered
in relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects the information set forth therein.
As discussed in Note 2 to the financial statements, in 2002 the Corporation
changed its method of accounting for goodwill and other intangible assets to
conform to Statement of Financial Accounting Standards No. 142 (SFAS No. 142).
As discussed above, the financial statements of Innotrac Corporation and its
subsidiaries as of December 31, 2001 and for the year then ended, were audited
by other auditors who have ceased operations. These consolidated financial
statements have been revised as follows:
(a) As described in Note 2 under the heading "Revenue Recognition," the
Corporation adopted EITF Issue No. 01-14, "Income Statement
Characterization of Reimbursements Received for Out-of-Pocket
Expenses Incurred," on January 1, 2002. We audited the
reclassification described in Note 2 that was applied to conform the
2001 financial statements to the comparative presentation required
by EITF Issue No. 01-14. Our audit procedures with respect to the
reclassifications of out-of-pocket freight and postage expenses
included (i) comparing the amounts shown for out-of-pocket expenses
in the Corporation's consolidated statements of operations to the
Corporation's underlying records obtained from management, and (ii)
on a test basis, comparing the underlying records obtained from
management to independent supporting documentation, and (iii)
testing the mathematical accuracy of the underlying analysis;
13
(b) As described in Note 2 under the heading "Goodwill and Other
Intangible Assets," transitional disclosures required by SFAS No.
142, which was adopted by the Corporation as of January 1, 2002,
have been added. Our audit procedures with respect to the
disclosures in Note 2 discussed above with respect to 2001 included
(i) comparing the previously reported net income to the previously
issued financial statements and the adjustment to reported net
income representing amortization expense (including any related tax
effects) recognized in that period to the Corporation's underlying
analysis obtained from management, and (ii) testing the mathematical
accuracy of the reconciliation of adjusted net income to reported
net income, and the related earnings-per-share amount;
(c) As described in Note 16, certain note disclosures have been added.
Our audit procedures with respect to the note disclosures described
in Note 16 included comparing added disclosure amounts to the
Corporation's underlying records obtained from management.
In our opinion, the reclassifications and disclosures for 2001 described
in Notes 2 and 16 are appropriate. However, we were not engaged to audit,
review, or apply any procedures to the 2001 financial statements of the
Corporation other than with respect to such reclassification and
disclosures and, accordingly, we do not express an opinion or any other
form of assurance on the 2001 financial statements taken as a whole.
DELOITTE & TOUCHE LLP
Atlanta, Georgia
March 30, 2004
14
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
PURSUANT TO SECURITIES AND EXCHANGE COMMISSION RULE 2-02 OF REGULATION S-X, THE
FOLLOWING REPORT IS A COPY OF A REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP,
WHICH HAS CEASED OPERATIONS, AND HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP.
ARTHUR ANDERSEN LLP REPORTED ON SUCH FINANCIAL STATEMENTS PRIOR TO THE
RECLASSIFICATIONS AND REVISIONS DISCUSSED IN NOTE 2 AND NOTE 16 OF THE NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS.
To Innotrac Corporation:
We have audited the accompanying consolidated balance sheets of INNOTRAC
CORPORATION (a Georgia corporation) AND SUBSIDIARIES as of December 31, 2001 and
2000 and the related consolidated statements of operations, shareholders' equity
and cash flows for each of the three years in the period ended December 31,
2001. 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 auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Innotrac
Corporation and its subsidiaries as of December 31, 2001 and 2000 and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2001 in conformity with accounting standards
generally accepted in the United States.
ARTHUR ANDERSEN LLP
Atlanta, Georgia
February 8, 2002
15
INNOTRAC CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN 000'S)
DECEMBER 31,
ASSETS 2003 2002
-------- --------
CURRENT ASSETS:
Cash and cash equivalents $ 2,228 $ 961
Accounts receivable, net of allowance of $1,696 (2003)
and $959 (2002) 15,682 14,203
Inventories, net 10,896 24,098
Prepaid expenses and other 915 2,357
Deferred income taxes, net -- 552
-------- --------
TOTAL CURRENT ASSETS 29,721 42,171
-------- --------
PROPERTY AND EQUIPMENT:
Rental equipment 895 1,372
Computer, machinery and equipment 27,320 26,315
Furniture, fixtures and leasehold improvements 4,682 4,585
-------- --------
32,897 32,272
Less accumulated depreciation and amortization (18,147) (13,357)
-------- --------
14,750 18,915
-------- --------
Goodwill, net 25,169 24,988
Deferred income taxes, net -- 7,940
Other assets, net 1,322 1,485
-------- --------
TOTAL ASSETS $ 70,962 $ 95,499
======== ========
DECEMBER 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 2003 2002
-------- --------
CURRENT LIABILITIES:
Accounts payable $ 5,738 $ 13,517
Line of credit 11,802 --
Accrued salaries and commissions 443 1,570
Accrued expenses and other 2,134 5,056
-------- --------
TOTAL CURRENT LIABILITIES 20,117 20,143
-------- --------
NONCURRENT LIABILITIES:
Line of credit -- 14,372
Other noncurrent liabilities 1,083 1,125
-------- --------
TOTAL NONCURRENT LIABILITIES 1,083 15,497
-------- --------
Commitments and contingencies (see Note 7) -- --
SHAREHOLDERS' EQUITY:
Preferred stock: 10,000,000 shares authorized,
$0.10 par value, no shares outstanding -- --
Common stock: 50,000,000 shares authorized, $0.10 par value,
11,715,280 (2003) and 11,674,595 (2002) shares issued,
11,715,280 (2003) and 11,417,780 (2002) shares outstanding 1,171 1,167
Additional paid-in capital 63,791 62,614
Accumulated deficit (15,200) (3,219)
Treasury stock: 0 (2003) and 256,815 (2002) shares -- (703)
-------- --------
TOTAL SHAREHOLDERS' EQUITY 49,762 59,859
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 70,962 $ 95,499
======== ========
The accompanying notes are an integral part of these consolidated balance
sheets.
16
INNOTRAC CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN 000'S, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
--------------------------------
2003 2002 2001
-------- -------- --------
Revenues, net $ 74,740 $ 82,420 $121,859
Cost of revenues 35,157 46,444 68,153
Special (credits), net -- (293) --
-------- -------- --------
TOTAL COST OF REVENUES 35,157 46,151 68,153
-------- -------- --------
GROSS PROFIT 39,583 36,269 53,706
-------- -------- --------
OPERATING EXPENSES:
Selling, general and administrative 36,444 37,332 43,329
Special (credits) charges, net (30) 404 --
Depreciation and amortization 5,622 5,336 4,864
-------- -------- --------
Total operating expenses 42,036 43,072 48,193
-------- -------- --------
OPERATING (LOSS) INCOME (2,453) (6,803) 5,513
-------- -------- --------
OTHER EXPENSE (INCOME):
Interest expense (income), net 741 318 (532)
Other 15 (124) (20)
-------- -------- --------
TOTAL OTHER EXPENSE (INCOME) 756 194 (552)
-------- -------- --------
(LOSS) INCOME BEFORE INCOME
TAXES AND MINORITY INTEREST (3,209) (6,997) 6,065
INCOME TAX (PROVISION) BENEFIT (8,772) 2,578 (2,573)
-------- -------- --------
NET (LOSS) INCOME BEFORE MINORITY INTEREST (11,981) (4,419) 3,492
MINORITY INTEREST, NET OF INCOME TAXES -- -- (893)
-------- -------- --------
NET (LOSS) INCOME $(11,981) $ (4,419) $ 4,385
======== ======== ========
EARNINGS PER SHARE:
Basic $ (1.04) $ (0.38) $ 0.39
======== ======== ========
Diluted $ (1.04) $ (0.38) $ 0.38
======== ======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 11,542 11,516 11,318
======== ======== ========
Diluted 11,542 11,516 11,690
======== ======== ========
The accompanying notes are an integral part of these consolidated statements.
17
INNOTRAC CORPORATION
CONSOLIDATED STATEMENTS OF
SHAREHOLDERS' EQUITY
(IN 000'S)
Retained Accumulated
Common Stock Earnings Other
--------------- Paid-in (Accumulated Comprehensive Treasury
Shares Amount Capital Deficit) Income Stock Total
------ ------ ------- ------------- ------------- -------- --------
BALANCE AT DECEMBER 31, 2000 11,365 $1,136 $60,889 $ (3,184) $ -- $(206) $58,635
Restricted stock grant, net -- -- 134 -- -- -- 134
Purchase of treasury stock -- -- -- -- -- (49) (49)
Comprehensive income:
Net income -- -- -- 4,385 -- -- 4,385
Unrealized gain on available-for-
sale securities -- -- -- -- 178 -- 178
------ ------ ------- -------- ----- ----- -------
BALANCE AT DECEMBER 31, 2001 11,365 $1,136 $61,023 $1,201 $ 178 $(255) $63,283
Issuance of common stock 310 31 1,519 -- -- -- 1,550
Restricted stock grant, net -- -- 72 -- -- -- 72
Purchase of treasury stock -- -- -- -- -- (448) (448)
Comprehensive income:
Net loss -- -- -- (4,419) -- -- (4,419)
Reclassification adjustment
for realized gain included in
Consolidated Statement of
Operations -- -- -- -- (178) -- (178)
------ ------ ------- -------- ----- ----- -------
BALANCE AT DECEMBER 31, 2002 11,675 $1,167 $62,614 $(3,219) $ -- $(703) $59,859
Issuance of common stock 40 4 264 -- -- -- 268
Restricted stock grant, net -- -- 328 -- -- -- 328
Issuance of treasury stock -- -- 304 -- -- 703 1,007
Tax benefit for stock options
exercised -- -- 281 -- -- -- 281
Net loss -- -- -- (11,981) -- -- (11,981)
------ ------ ------- -------- ----- ----- -------
BALANCE AT DECEMBER 31, 2003 11,715 $1,171 $63,791 $(15,200) $ -- $ -- $49,762
====== ====== ======= ======== ===== ===== =======
The accompanying notes are an integral part of these consolidated statements.
18
INNOTRAC CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN 000'S)
YEAR ENDED DECEMBER 31,
--------------------------------
2003 2002 2001
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $(11,981) $ (4,419) $ 4,385
Adjustments to reconcile net (loss) income to net
cash provided by operating activities:
Depreciation and amortization 5,622 5,336 4,864
Impairment and/or loss on disposal of fixed assets 22 3,638 3,385
Deferred income taxes 8,492 (5,317) 3,389
Minority interest in subsidiary -- -- (893)
Amortization of deferred compensation 72 72 134
Changes in working capital, net of effect of businesses acquired:
(Increase) decrease in accounts receivable (1,479) (541) 17,659
Decrease (increase) in inventories 13,202 3,165 (12,208)
Decrease (increase) in prepaid expenses and other assets 1,338 1,248 (180)
(Decrease) increase in accounts payable (7,780) 4,936 (13,562)
(Decrease) in accrued expenses and other (3,714) (4,248) (2,491)
-------- -------- --------
Net cash provided by operating activities 3,794 3,870 4,482
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,182) (12,830) (6,914)
Acquisition of businesses, net of cash acquired (181) (13,502) (5,859)
Sale (purchase) of available-for-sale securities -- 436 (436)
-------- -------- --------
Net cash (used in) investing activities (1,363) (25,896) (13,209)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (repayments) borrowings under line of credit (2,570) 14,372 --
Repayment of capital lease and other obligations (119) (250) (145)
Exercise of employee stock options 1,556 -- --
Purchase of treasury stock -- (448) (49)
Loan fees paid (31) (100) --
-------- -------- --------
Net cash (used in) provided by financing activities (1,164) 13,574 (194)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 1,267 (8,452) (8,921)
Cash and cash equivalents, beginning of period 961 9,413 18,334
-------- -------- --------
Cash and cash equivalents, end of period $ 2,228 $ 961 $ 9,413
======== ======== ========
Supplemental cash flow disclosures:
Cash paid for interest $ 794 $ 355 $ 110
======== ======== ========
Cash income tax refunds received, net of taxes paid $ (1,565) $ (18) $ (80)
======== ======== ========
The accompanying notes are an integral part of these consolidated statements.
19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
Innotrac Corporation ("Innotrac" or the "Company") and its wholly-owned
subsidiary, iFulfillment, Inc., a Georgia corporation, provide order processing,
order fulfillment and call center services. The Company offers inventory
management, inbound call center, pick/pack/ship services, order tracking,
transaction processing and returns handling from its leased facilities in
Atlanta, Georgia, Pueblo, Colorado, Reno, Nevada, Bolingbrook, Illinois and
Hebron, Kentucky. The Company's facilities represent over 1.6 million square
feet of warehouse space and 520 dedicated call center seats.
2. SIGNIFICANT ACCOUNTING POLICIES
Basis of Financial Statement Presentation. The consolidated financial statements
include the accounts of the Company and its subsidiary. The financial statements
have been prepared on the accrual basis of accounting in conformity with
accounting principles generally accepted in the United States of America. All
significant intercompany transactions and balances have been eliminated in
consolidation.
Accounting Estimates. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosures of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Concentration of Revenues. Revenues earned under the Company's contracts with
its telecommunication clients to provide fulfillment of telecommunications
equipment and related order processing and call center support services,
including DSL modems and wireless pagers, accounted for approximately 42%, 46%
and 60% of total revenues for the years ended December 31, 2003, 2002 and 2001,
respectively. Revenues generated from the fulfillment of DSL and cable modem
equipment accounted for 19%, 19%, and 18% of the aforementioned totals.
The following table sets forth the percentage of total revenues derived from
each of the Company's largest clients for the years ended December 31, 2003,
2002 and 2001. Except for the major clients noted in the following table, no
other single customer provided more than 10% of consolidated revenues during
these years.
YEAR ENDED DECEMBER 31,
2003 2002 2001
---- ---- ----
BELLSOUTH - TELECOM EQUIPMENT 18.5% 18.7% 12.2%
- DSL EQUIPMENT 13.0 9.7 10.8
SMITH & HAWKEN 13.2 5.6 --
TACTICA 10.2 16.8 9.9
THANE INTERNATIONAL 3.9 8.7 15.3
SBC COMMUNICATIONS -- -- 12.6
20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Cash and Cash Equivalents. The Company considers all short-term, highly liquid
investments with an original maturity of three months or less to be cash
equivalents.
Short-Term Investments. Current available-for-sale marketable securities are
carried at their estimated fair value based on current market quotes. Any
unrealized gains or losses are reported in shareholders' equity as a component
of other accumulated comprehensive income (loss). At December 31, 2003 and 2002,
the Company had no available-for-sale securities.
Fair Value of Financial Instruments. The carrying value of the Company's
revolving credit facility approximates fair value given that interest rates
under the facility are based on prevailing market rates.
Inventories. Inventories, consisting primarily of telephones and interactive
wireless pagers are stated at the lower of cost or market, with cost determined
by the first-in, first-out method. Substantially all inventory at December 31,
2003 and 2002 is for the account of one client who has indemnified the Company
from substantially all risk associated with such inventory.
Property and Equipment. Property and equipment are stated at cost. Depreciation
is determined using straight-line methods over the following estimated useful
lives:
Rental equipment 3 years
Computers and software 3-5 years
Machinery and equipment 5-7 years
Furniture and fixtures 7 years
Leasehold improvements are amortized using the straight-line method over the
shorter of the service lives of the improvements or the remaining term of the
lease. Maintenance and repairs are expensed as incurred.
Goodwill and Other Acquired Intangibles. Goodwill represents the cost of an
acquired enterprise in excess of the fair market value of the net tangible and
identifiable intangible assets acquired. Goodwill and other acquired intangibles
related to business combinations prior to July 1, 2001 were being amortized over
5 to 20 years on a straight-line basis, which represented management's
estimation of the related benefit to be derived from the acquired business.
However, goodwill and other acquired intangibles from business combinations
occurring after June 30, 2001 are accounted for under the transition provisions
for business combinations of Statement of Financial Accounting Standards
("SFAS") No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other
Intangible Assets" which includes the iFulfillment acquisition. The Company
adopted SFAS No. 142 effective January 1, 2002, which changed the accounting for
goodwill and other indefinite life intangibles from an amortization method to an
impairment only approach. The Company tests goodwill annually for impairment at
January 1 or sooner if circumstances indicate.
Under SFAS No. 142, goodwill impairment is deemed to exist if the net book value
of a reporting unit exceeds its estimated fair value. Upon completion of its
analysis for impairment as of January 1, 2004 in accordance with SFAS No. 142,
no impairment was determined to exist at that time. Innotrac's goodwill carrying
amount as of December 31, 2003 was $25.2 million. This asset relates to the
goodwill associated with the Company's acquisition of Universal Distribution
Services ("UDS") in December 2000, including the earnout payment made to the
former UDS shareholders in February 2002, and the acquisition of iFulfillment,
Inc. in July 2001.
21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In accordance with the adoption of SFAS No. 142, no amortization of goodwill was
recorded in 2003 or 2002. During the year ended December 31, 2001 amortization
expense associated with goodwill was approximately $239,800. The Company's
pro-forma consolidated net income and earnings per share for the year ended
December 31, 2001, excluding goodwill amortization, would have been net income
of $4.5 million ($0.40 per share basic and $0.39 diluted).
The Company has intangible assets that continue to be subject to amortization
under the provisions of SFAS No. 142. The intangible assets consist of acquired
customer contracts, which are included in other assets in the Company's
Consolidated Balance Sheets and which are amortized over a period of 1 to 5
years on a straight-line basis. At December 31, 2003 and 2002, the Company had
intangible assets, consisting primarily of customer contracts, of approximately
$387,000 and $589,000, net of accumulated amortization of approximately $873,000
and $671,000, respectively. Amortization expense of these intangible assets
amounted to approximately $202,000, $369,000 and $258,000 during the years ended
December 31, 2003, 2002 and 2001, respectively.
Impairment of Long-Lived Assets. The Company reviews long-lived assets and
certain intangible assets for impairment when events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable.
Impairment would be measured based on a projected cash flow model. If the
projected undiscounted cash flows for the asset are not in excess of the
carrying value of the related asset, the impairment would be determined based
upon the excess of the carrying value of the asset over the projected
discounted cash flows for the asset.
Deferred Tax Asset. Innotrac utilizes the liability method of accounting for
income taxes. Under the liability method, deferred taxes are determined based on
the difference between the financial and tax basis of assets and liabilities
using enacted tax rates in effect in the years in which the differences are
expected to reverse. A valuation allowance is recorded against deferred tax
assets if the Company considers it is more likely than not that deferred tax
assets will not be realized. A valuation allowance has been recorded against
deferred tax assets at December 31, 2003 (see Note 8).
Revenue Recognition. Innotrac derives its revenue primarily from two sources:
(1) fulfillment operations and (2) the delivery of business services. Innotrac's
fulfillment services operations record revenue at the conclusion of the material
selection, packaging and shipping process. Innotrac's call center services
business recognizes revenue according to written pricing agreements based on
number of calls, minutes or hourly rate basis. All other revenues are recognized
as services are rendered. As required by the consensus reached in Emerging Issue
Task Force ("EITF") Issue No. 99-19, revenues have been recorded net of the cost
of the equipment for all fee-for-service clients.
During 2001, the Emerging Issues Task Force ("EITF") issued EITF No. 01-14,
"Income Statement Characterization of Reimbursements Received for Out-of-Pocket
Expenses Incurred," which was adopted by the Company as of January 1, 2002. EITF
No 01-14 states that reimbursements received from customers for out-of-pocket
expenses incurred on their behalf should be characterized as revenue in the
Company's statement of operations. Prior to the adoption of this standard, the
Company netted reimbursements from customers, primarily for freight and postage
fees, against the related expenses within revenues. With the adoption of this
standard, the Company has reclassified reimbursements from customers for these
expenses as cost of revenues, and has conformed this presentation for all
periods presented. The adoption of EITF 01-14 increased the revenues, net and
cost of revenues line items within the Consolidated Statements of Operations
from amounts previously reported in 2001 by $27.1 million.
Stock-Based Compensation Plans. The Company accounts for its stock-based
compensation plans under Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" ("APB 25").
22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Since the exercise price for all options granted under those plans was equal to
the market value of the underlying common stock on the date of grant, no
compensation cost is recognized in the accompanying consolidated statements of
operations. Had compensation cost for stock options been determined under a fair
value based method, in accordance with Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation," as amended by
Statement of Financial Accounting Standards No. 148, the Company's net (loss)
income and net (loss) income per share would have been the following pro forma
amounts (in 000's, except per share data):
YEAR ENDED DECEMBER 31,
--------------------------------
2003 2002 2001
-------- -------- --------
Net (loss) income $(11,981) $(4,419) $4,385
Pro forma net (loss) income $(12,699) $(5,074) $3,350
Diluted net (loss) income per share $(1.04) $(0.38) $0.38
Pro forma net (loss) income per share $(1.10) $(0.44) $0.29
Under the fair value based method, compensation cost, net of tax is $718,000,
$655,000 and $1,035,000 for the years ended December 31, 2003, 2002 and 2001,
respectively.
The Company has computed for pro forma disclosure purposes the value of all
options granted using the Black-Scholes option-pricing model as prescribed by
SFAS No. 123 using the following weighted average assumptions:
2003 2002 2001
--------- --------- ---------
Risk-free interest rate 4.27% 4.05% 5.45%
Expected dividend yield 0% 0% 0%
Expected lives 2.6 Years 3.1 Years 2.7 Years
Expected volatility 80.4% 86.6% 84.3%
Minority Interests. Minority interest arises from Mail Boxes Etc.'s ("MBE") 40%
(14% prior to December 29, 2000) ownership of Return.com Online, LLC
("Return.com"), a subsidiary of the Company. In March 2001, United Parcel
Service, Inc. ("UPS") announced a definitive agreement to purchase MBE. As a
result of this agreement, the Company reacquired MBE's 40% ownership interest in
Return.com in April 2001. A note receivable of $3.4 million due from MBE, at
that time, was forgiven by the Company in exchange for MBE's ownership interest
in Return.com, resulting in 100% ownership by the Company.
23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
As a result of the Company's controlling ownership interest in Return.com, the
Company consolidated the results of operations and financial position of
Return.com in the accompanying 2001 consolidated financial statements. During
the year ended December 31, 2001, the Company wrote off its $2.8 million
investment in Return.com against an impairment reserve the Company recorded in
the first quarter of 2001. At December 31, 2001, Return.com was no longer in
operation.
Earnings Per Share. Basic earnings per share is computed by dividing net income
by the weighted average number of common shares outstanding. In the computation
of diluted earnings per share, the weighted average number of common shares
outstanding is adjusted for the effect of all potential common stock equivalent
shares.
Recent Accounting Pronouncements. In June 2002, the FASB issued SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities." This
Statement requires recording costs associated with exit or disposal activities
at their fair values when a liability has been incurred. Under previous
guidance, certain exit costs were accrued upon management's commitment to an
exit plan, which is generally before an actual liability has been incurred. The
Company adopted SFAS No. 146 on January 1, 2003. Adoption of SFAS No. 146 did
not have a material impact on the Company's consolidated financial position,
results of operations or cash flows.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure-an amendment to FASB Statement No. 123,"
which is effective for fiscal years beginning after December 15, 2002. SFAS No.
148 amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. SFAS No. 148 also
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The Company accounts for stock-based compensation
under Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock
Issued to Employees." The Company intends to continue to account for stock-based
employee compensation under APB No. 25. Note 2 (above) includes the additional
disclosure requirements of SFAS No. 148 as required by entities which continue
to account for stock-based employee compensation under APB No. 25.
In November 2002, the FASB issued Interpretation ("FIN") No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN No. 45 requires footnote disclosure
of the guarantees or indemnification agreements a company issues. With certain
exceptions, these agreements will also require a company to prospectively
recognize an initial liability for the fair value, or market value, of the
obligations it assumes under the guarantee. The initial recognition and initial
measurement provisions of this Interpretation are applicable on a prospective
basis to guarantees issued or modified after December 31, 2002. The Company
adopted FIN No. 45 on January 1, 2003. Adoption of FIN No. 45 did not have a
material impact on the Company's consolidated financial position, results of
operations, or cash flows.
24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. ACQUISITIONS
In July 2001, the Company acquired the assets and assumed specified liabilities
of iFulfillment, Inc. ("iFulfillment") for approximately $5.8 million.
iFulfillment specializes in fully integrated, automated order fulfillment
services for multi-channel retailers and catalogers. The transaction was
accounted for under the purchase method of accounting and, accordingly, the
operating results of iFulfillment have been included since the date of
acquisition in the Company's consolidated results of operations. The Company has
accounted for this transaction in accordance with the provisions of SFAS No. 141
and SFAS No. 142. In 2003, net purchase price adjustments of $181,000 were
recorded which increased the amount of recorded goodwill for the iFulfillment
acquisition. The following table summarizes the assets purchased and liabilities
assumed as well as the allocation of the purchase price to various intangibles
and goodwill (in 000's):
Current assets $ 207
Current liabilities (2,050)
Property 1,417
Other liabilities (632)
Customer contract 250
Goodwill 6,621
-------
Purchase price $ 5,813
=======
In December 2000, the Company acquired UDS for approximately $4.3 million in
total consideration which was accounted for under the purchase method of
accounting. Operating results for UDS have been included in the Company's
results since December 2000. At December 31, 2001, the Company recorded an
accrual for approximately $15.3 million for payment to the sellers of UDS under
the terms of an earn-out provision contained in the merger agreement. The
earn-out accrual was recorded as additional goodwill. In February 2002, the
payment was made consisting of $13.7 million of cash and 310,000 shares of the
Company's common stock valued at $1.6 million. No additional earn-out amounts
were due or payable at December 31, 2003 or 2002. Goodwill related to UDS at
December 31, 2003 amounted to $18.5 million, net of accumulated amortization of
$0.3 million. Pro forma results have not been presented as these acquisitions
were not considered material.
4. SPECIAL CHARGES AND SPECIAL CREDITS
During 2000, the Company substantially completed its migration towards a
fee-for-service business model, which eliminates inventory ownership risk and
also elected to discontinue its front-end web site development, maintenance and
hosting services to its e-commerce clients. As a result of these significant
changes in the Company's business, a special pre-tax charge of $34.3 million was
recognized. The special charges of $34.3 million for the year ended December 31,
2000 included the following: $24.4 million for inventory, accounts receivable
and other items primarily related to the Company's shift to a fee-for-service
business model; $6.2 million for the impairment of long-lived assets primarily
due to the abandonment of specified software development projects; and $3.7
million in costs to exit the e-commerce business related to web development,
maintenance and hosting services. At December 31, 2003 and 2002, the Company had
approximately $0 and $277,000, respectively, in accruals related to the special
charges recorded during the year ended December 31, 2000. Cash payments relating
to the special charge accruals for the years ended December 31, 2003 and 2002
were approximately $277,000 and $716,000, respectively.
25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company recognized approximately $3.0 million of special credits during the
year ended December 31, 2002, related to gains realized on sales of inventory
items which were written off as special charges in previous periods, cash
collected for accounts receivable that were written off as special charges in
previous periods, redeployment of leased computer hardware for which the leases
were fully accrued for as special charges in previous periods, and client
contract amendments which resulted in reduced liabilities. These amounts were
recorded as a reduction in the special charge line item in the consolidated
statements of operations.
During 2002, the Company also recognized an additional $3.1 million in special
charges. Approximately $2.4 million of these charges were related to capitalized
hardware and software costs for systems purchased specifically for a potential
new client which were subsequently not utilized as originally planned. The loss
of the potential customer indicated that the carrying value of the asset group
was potentially not recoverable, and therefore, an impairment test under the
provisions of SFAS No. 144 was performed. As fair market value of the asset
group was not readily determinable, a discounted, probability weighted cash flow
model was utilized as a basis to determine fair value. As a result of the cash
flow analysis, a $2.4 million impairment charge was recorded. Of the remaining
charges, approximately $500,000 related to the write-down to net realizable
value of specified fixed assets obtained as part of the December 2000
acquisition of UDS which were being utilized for one specific customer who
ceased conducting business with UDS. The balance of approximately $200,000 was
related to severance costs for positions which were eliminated.
5. ACCOUNTS RECEIVABLE
Accounts receivable were composed of the following at December 31, 2003 and 2002
(in 000's):
2003 2002
-------- --------
Billed receivables $ 17,231 $ 13,606
Unbilled receivables 147 1,556
-------- --------
17,378 15,162
Less: Allowance for doubtful accounts (1,696) (959)
-------- --------
$ 15,682 $ 14,203
======== ========
6. FINANCING OBLIGATIONS
The Company currently has a revolving credit agreement with a bank for
borrowings up to $40.0 million (subject to borrowing base limitations). The
Company is currently negotiating to reduce the size of the facility to $25.0
million as the Company does not anticipate a need for the larger amount. The
credit facility expires in June 2005. The Company and its subsidiary have
granted a security interest in all of their assets and the subsidiary has
provided a guarantee to the lender as collateral under this revolving credit
agreement. The revolving credit agreement contains various restrictive financial
and change of ownership control covenants. Noncompliance with any of the
covenants allows the lender to declare any outstanding borrowing amounts to be
immediately due and payable. The credit facility limits borrowings to a
specified percentage of eligible accounts receivable and inventory, as defined,
which totaled $18.5 million at December 31, 2003. At December 31, 2003 the
Company had $6.7 million available under the revolving credit agreement.
The financial covenants required the Company to maintain a fixed charge ratio of
1.75 to 1.00 by December 31, 2003. The Company was not in compliance with this
covenant at December 31, 2003. However, the Company has received a waiver from
the bank and that covenant was amended and reduced to a lower ratio of 1.30 to
1.00 for the balance of the term. The Company's fixed charge ratio at December
31, 2003 was 1.40 to 1.00.
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Additionally, the revolving credit agreement contains a minimum tangible net
worth requirement of $34 million. Tangible net worth is computed as
shareholders' equity less goodwill, other intangible assets and certain deferred
costs. Included in the bank's definition of tangible net worth is the carrying
amount of the Company's deferred tax asset. Due to the fact that a valuation
allowance was recorded at December 31, 2003 for the entire deferred tax asset
balance of $9.9 million, the Company was no longer in compliance with the
tangible net worth requirement of $34 million. However, the Company received a
waiver from the bank and that covenant was amended and reduced to $24 million
for the balance of the term. Compliance with the minimum tangible net worth
covenant and other financial covenants is determined on a quarterly basis.
The revolving credit agreement is classified as a noncurrent liability in the
Consolidated Balance Sheets as of December 31, 2002. During the first quarter of
2003, the Company and the lender modified the terms of the revolving credit
agreement. The result of these negotiations, which 1) requires that the Company
maintain a lockbox arrangement with the lender, and 2) allows the lender to
declare any outstanding borrowing amounts to be immediately due and payable as a
result of noncompliance with any of the covenants resulted in the classification
of this revolving credit agreement being included in current liabilities at
December 31, 2003.
Interest on borrowings is payable monthly at rates equal to the prime rate, or
at the Company's option, LIBOR plus up to 225 basis points. On November 13,
2003, the Company fixed $6.0 million of its $11.8 million of borrowings at the
90-day LIBOR rate of 2.68%. During the years ended December 31, 2003, 2002 and
2001, the Company incurred interest expense related to the line of credit of
approximately $704,000, $266,100 and $0, respectively, resulting in a weighted
average interest rate of 3.80%, 3.75%, and 0%, respectively. The Company also
incurred unused revolving credit facility fees of approximately $50,000 and
$123,000 during the years ended December 31, 2003 and 2002, respectively.
7. COMMITMENTS AND CONTINGENCIES
Operating Leases. Innotrac leases office and warehouse space and equipment under
various operating leases. The primary office and warehouse operating leases
provide for escalating payments over the lease term. Innotrac recognizes rent
expense on a straight-line basis over the lease term. The Company also has
capital lease obligations that expire over the next two years primarily for
warehouse equipment and computer hardware.
Aggregate future minimum lease payments under noncancellable operating and
capital leases with original periods in excess of one year as of December 31,
2003 are as follows (in 000's):
CAPITAL OPERATING
LEASES LEASES
------- ---------
2004 ........................ $ 95 $ 7,779
2005 ........................ 56 6,734
2006 ........................ -- 6,780
2007 ........................ -- 5,602
2008 ........................ -- 949
------- ---------
Total minimum lease payments $ 151 $ 27,844
======= =========
Amount related to interest (10)
-------
Capital lease obligations 141
Current portion .......... (93)
-------
Long-term portion ........ $ 48
=======
Rent expense under all operating leases totaled approximately $8.1 million, $6.1
million and $4.2 million during the years ended December 31, 2003, 2002 and
2001, respectively.
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Legal Proceedings. The Company is subject to various legal proceedings and
claims that arise in the ordinary course of business. There are no material
pending legal proceedings to which the Company is a party.
Shareholder Rights Plan. In December of 1997, the Company's Board of Directors
approved a Shareholder Rights Plan (the "Rights Plan"). The Rights Plan provides
for the distribution of one Right for each outstanding share of the Company's
Common Stock held of record as of the close of business on January 1, 1998 or
that thereafter becomes outstanding prior to the earlier of the final expiration
date of the Rights or the first date upon which the Rights become exercisable.
Each Right entitles the registered holder to purchase from the Company one
one-hundredth of a share of Series A Participating Cumulative Preferred Stock,
par value $.10 per share, at a price of $60.00 (the "Purchase Price"), subject
to adjustment. The Rights are not exercisable until ten calendar days after a
person or group (an "Acquiring Person") buys, or announces a tender offer for,
15% or more of the Company's Common Stock. Such ownership level has been
increased to 40% for a particular shareholder that owned approximately 25.5% of
the shares outstanding on December 31, 2003. In the event the Rights become
exercisable, each Right will entitle the holder to receive that number of shares
of Common Stock having a market value equal to the Purchase Price. If, after any
person has become an Acquiring Person (other than through a tender offer
approved by qualifying members of the Board of Directors), the Company is
involved in a merger or other business combination where the Company is not the
surviving corporation, or the Company sells 50% or more of its assets, operating
income, or cash flow, then each Right will entitle the holder to purchase, for
the Purchase Price, that number of shares of common or other capital stock of
the acquiring entity which at the time of such transaction have a market value
of twice the Purchase Price. The Rights will expire on January 1, 2008, unless
extended, unless the Rights are earlier exchanged, or unless the Rights are
earlier redeemed by the Company in whole, but not in part, at a price of $0.001
per Right.
Employment Commitment. In June 1999, in conjunction with the opening of a new
call center facility, the Company entered into an Employment Commitment
Agreement with the City of Pueblo, Colorado, whereby the Company received cash
incentives of $968,000. These funds were accounted for as a reduction in the
basis of the assets acquired. In return for this consideration, the Company is
obligated to employ a minimum number of full-time employees at its Pueblo
facility, measured on a quarterly basis. This obligation, which became effective
June 2002, will continue through June 2009. During 2002 and 2003, the Company
had substantially met the minimum employee requirements of 359 full-time
employees, as measured on a quarterly basis. In the event that the number of
full-time employees fails to meet the minimum requirement, the Company will
incur a quarterly penalty of $96.30 for each employee less than the minimum
required amount.
8. INCOME TAXES
Details of the income tax benefit (provision) for the years ended December 31,
2003, 2002 and 2001 are as follows (in 000's):
2003 2002 2001
-------- -------- --------
Current $ (232) $ 3,312 $ 815
Deferred (8,540) (734) (3,388)
-------- -------- --------
$ (8,772) $ 2,578 $ (2,573)
======== ======== ========
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Deferred income taxes reflect the net effect of the temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The significant
components of the Company's deferred tax assets and liabilities as of December
31, 2003 and 2002 are as follows (in 000's):
2003 2002
-------- --------
Deferred tax assets:
Net operating loss carryforwards $ 11,541 $ 10,409
Allowance for doubtful accounts 604 364
Reserves 230 188
Other 451 47
-------- --------
Total deferred tax assets 12,826 11,008
Valuation allowance (9,882) --
-------- --------
Net deferred tax assets 2,944 11,008
Deferred tax liabilities:
Depreciation
(2,944) (2,516)
-------- --------
Net deferred taxes -- $ 8,492
Net deferred taxes:
Current deferred tax assets -- $ 552
Noncurrent deferred tax assets -- 7,940
-------- --------
$ -- $ 8,492
======== ========
Innotrac utilizes the liability method of accounting for income taxes. Under the
liability method, deferred taxes are determined based on the difference between
the financial and tax basis of assets and liabilities using enacted tax rates in
effect in the years in which the differences are expected to reverse. A
valuation allowance is recorded against deferred tax assets if the Company
considers it is more likely than not that deferred tax assets will not be
realized. Innotrac's gross deferred tax asset as of December 31, 2003 is
approximately $12.8 million. This deferred tax asset was generated primarily by
net operating loss carryforwards created primarily by the special charge of
$34.3 million recorded in 2000 and the net losses generated in 2002 and 2003.
Innotrac has a tax net operating loss carryforward of $31.5 million at December
31, 2003 that expires between 2020 and 2023.
Innotrac's ability to generate the expected amounts of taxable income from
future operations is dependent upon general economic conditions, collection of
existing outstanding accounts receivable, competitive pressures on sales and
margins and other factors beyond management's control. Due to these factors
combined with losses in recent years creates uncertainty about the ultimate
realization of the gross deferred tax asset in future years. Therefore a
valuation allowance of approximately $9.9 million has been recorded in 2003.
Income taxes associated with future earnings will be offset by a reduction in
the valuation allowance. When, and if, the Company can return to consistent
profitability and management determines that it will be able to utilize the
deferred tax assets prior to their expiration, then the valuation allowance can
be reduced or eliminated.
The difference between the provision for income taxes (benefit) and the amount
computed by applying the U.S. federal income tax rate for the years ended
December 31, 2003, 2002 and 2001 is as follows:
2003 2002 2001
-------- -------- --------
Statutory federal income tax (benefit) $ (1,091) $ (2,379) $ 2,062
State income taxes, net of federal effect (106) (280) 243
Items not deductible for tax purposes 109 77 261
Valuation allowance for deferred tax assets 9,882 -- --
Other (22) 4 7
-------- -------- --------
Income tax provision (benefit) $ 8,772 $ (2,578) $ 2,573
======== ======== ========
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. EARNINGS PER SHARE
The following table shows the shares used in computing diluted earnings per
share ("EPS") in accordance with Statement of Financial Accounting Standards No.
128 (in 000's):
2003 2002 2001
------ ------ ------
Diluted earnings per share:
Weighted average shares outstanding 11,542 11,516 11,318
Employee and director stock options -- -- 372
------ ------ ------
Weighted average shares assuming dilution 11,542 11,516 11,690
====== ====== ======
Options and warrants outstanding to purchase shares of the Company's common
stock aggregating 1.9 million, 2.2 million and 1.0 million were not included in
the computation of diluted EPS for the years ended December 31, 2003, 2002 and
2001, respectively, because their effect was anti-dilutive. This includes a
warrant with registration rights issued to Thane International in December 2000
to purchase 150,000 shares of Innotrac common stock at the exercise price of
$6.50, which vests 20% annually. Additionally, restricted stock of 65,447 shares
were also excluded because their effect was anti-dilutive and the shares were
not vested at December 31, 2003.
10. OTHER COMPREHENSIVE INCOME
SFAS No. 130, "Reporting Comprehensive Income," established standards for
reporting and display of comprehensive income and its components in financial
statements. For the years ended December 31, 2003, 2002 and 2001, the components
of the Company's comprehensive (loss) income are as follows (in 000's):
Year Ended
December 31,
--------------------------------
2003 2002 2001
-------- -------- --------
Other comprehensive income:
Net (loss) income $(11,981) $(4,419) $4,385
Unrealized gain -- -- 177
Reclassification adjustment for realized
gains included in consolidated statement of operations -- (76) --
-------- -------- --------
Comprehensive (loss) income $(11,981) $(4,495) $4,562
======== ======== ========
11. SHAREHOLDERS' EQUITY
In June 2000, the Company's Board of Directors authorized the repurchase, at the
direction of senior management, of up to $5.0 million of the Company's common
stock. The stock repurchase program was extended for an additional twelve months
by the Board of Directors in February 2002. During the years ended December 31,
2003, 2002 and 2001, the Company repurchased approximately 0, 205,400 and 6,400
shares at a total cost of $0, $448,000 and $49,000, respectively.
At December 31, 2003, all treasury shares previously repurchased had been
reissued for stock options exercised during 2003, and accordingly no treasury
stock balance remains.
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. EMPLOYEE RETIREMENT PLANS
Innotrac employees may participate in a 401(k) defined contribution plan. The
plan covers all employees who have at least six months of service and are 18
years of age or older. Participants may elect to defer up to 15% of compensation
up to a maximum amount determined annually pursuant to IRS regulations.
Innotrac's policy is to provide matching employer contributions equal to 15% of
contributions for less than five years of service, 25% of contributions for five
to nine years of service, and 35% of contributions for over nine years of
service. However, this match was suspended from January 1, 2002 through June 30,
2002, reinstituted from July 1, 2002 through December 31, 2002 and has been
temporarily suspended thereafter. Total matching contributions made to the plan
and charged to expense by Innotrac for the years ended December 31, 2003, 2002
and 2001 were approximately $0, $49,000 and $108,000, respectively.
The Company has an executive deferred compensation plan for certain employees,
as designated by the Company's Board of Directors. Participants may elect to
defer up to 30% of compensation. Innotrac's policy is to provide matching
employer contributions ranging from 20% to 100% of employee contributions based
on years of service. However, this match was suspended for both 2003 and 2002.
Matching contributions were $79,412 for the year ended December 31, 2001. The
Company invests these contributions in employee-directed marketable equity
securities which are recorded as trading securities at fair-market value on the
accompanying consolidated balance sheet (in other assets) and aggregated
$733,446 and $563,506 at December 31, 2003 and 2002, respectively. The monies
held by the plan are subject to general creditors of the Company in the event of
a Company bankruptcy filing.
13. STOCK BASED COMPENSATION
The Company has adopted two stock option plans: the 1997 and 2000 Stock Option
and Incentive Award Plans ("The Plans"). The Plans provide key employees,
officers, directors, contractors and consultants an opportunity to own shares of
common stock of the Company and to provide incentives for such persons to
promote the financial success of the Company. Awards under The Plans may be
structured in a variety of ways, including as "incentive stock options," as
defined in Section 422 of the Internal Revenue Code, as amended, non-qualified
stock options, restricted stock awards, and stock appreciation rights ("SARs").
Incentive stock options may be granted only to full-time employees (including
officers) of the Company and its subsidiary. Non-qualified options, restricted
stock awards, SARs, and other permitted forms of awards may be granted to any
person employed by or performing services for the Company, including directors,
contractors and consultants. The 1997 Stock Option Plan and 2000 Stock Option
Plan, as amended, provide for the issuance of options to purchase up to an
aggregate of 800,000 shares and 2,800,000 shares of common stock, respectively.
At December 31, 2003, there were 1,651,650 shares available to be issued under
The Plans.
Incentive stock options are also subject to certain limitations prescribed by
the Code, including the requirement that such options may not be granted to
employees who own more than 10% of the combined voting power of all classes of
voting stock of the Company, unless the option price is at least 110% of the
fair market value of the common stock subject to the option. The Board of
Directors of the Company (or a committee designated by the Board) otherwise
generally has discretion to set the terms and conditions of options and other
awards, including the term, exercise price and vesting conditions, if any; to
select the persons who receive such grants and awards; and to interpret and
administer The Plans.
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A summary of the options outstanding and exercisable by price range as of
December 31, 2003 is as follows (shares in 000's):
Options Outstanding Options Exercisable
------------------------------------ -----------------------------------
Weighted Average Weighted
Range of As of Remaining Weighted Average As of Average
Exercise Prices December 31, 2003 Contractual Life Exercise Price December 31, 2003 Exercise Price
- --------------- ----------------- ---------------- ---------------- ----------------- ---------------
$1.77 - $3.54 624 7.8 $3.31 120 $3.13
$3.54 - $5.31 279 7.8 4.35 85 4.48
$5.31 - $7.07 228 6.8 6.44 137 6.31
$7.07 - $8.84 242 6.6 7.30 153 7.23
$8.84 - $10.61 224 3.9 9.10 224 9.10
$10.61 - $12.38 20 4.4 12.00 20 12.00
$12.38 - $14.15 5 5.8 12.63 5 12.63
$15.92 - $17.68 20 5.2 16.87 20 16.87
----- --- ----- --- -----
1,642 6.9 $5.59 764 $7.07
===== === ===== === =====
A summary of activity in the Company's two stock option plans is as follows
(shares in 000's):
Weighted Average
Shares Price
------ ----------------
Outstanding at December 31, 2000 1,844 6.19
Granted 454 7.35
Forfeited (490) 7.07
----- -----
Outstanding at December 31, 2001 1,808 6.23
Granted 559 3.41
Forfeited (330) 5.96
----- -----
Outstanding at December 31, 2002 2,037 5.50
Granted 120 4.31
Exercised (306) 4.35
Forfeited (209) 5.79
----- -----
Outstanding at December 31, 2003 1,642 $5.59
===== =====
Options exercisable at December 31, 2003 764 $7.07
===== =====
14. RELATED PARTY TRANSACTIONS
The Company leases a single engine aircraft from a company wholly-owned by its
Chairman and Chief Executive Officer, pursuant to an agreement that provides for
Innotrac to pay for 86% of all expenses associated with this aircraft. This
allocation is determined annually based on actual business usage. The Company
paid approximately $133,656 during 2003. For the years ended December 31, 2002
and 2001, the Company paid $60,000 annually.
The Company paid approximately $82,500, $63,000 and $51,224 during 2003, 2002
and 2001, respectively, in fees to an accounting firm for tax and consulting
services. One of the directors of the Company is the Managing Partner and part
owner of that firm.
The Company paid approximately $863,000, $744,000 and $1,083,345 during 2003,
2002 and 2001, respectively, in fees to a print broker for services related to
the printing of marketing, client, inter-company and other materials. The broker
is owned by the brother of the Company's Chairman and Chief Executive Officer.
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In 2003, the Company and the IPOF Group (consisting of IPOF Fund, LP and its
general partner, David Dadante), which as of December 31, 2003 beneficially
owned approximately 3.0 million shares of Common Stock, entered into an amended
Agreement to permit the IPOF Group to acquire up to 40% of the Common Stock on
the terms set forth in that Agreement without becoming an "Acquiring Person"
under the Company's Rights Agreement with SunTrust Bank. The Agreement with the
IPOF Group contains various restrictions on the IPOF's Group right to vote and
take certain other shareholder actions. Among these restrictions, the IPOF Group
agreed to vote all shares in excess of 15% proportionately with vote(s) cast by
the other shareholders of the Company and not seek to place a representative on
the Company's Board or seek to remove any member of the Board. The IPOF Group
further acknowledged that it is an "affiliate," as defined under applicable
federal securities law.
The Company and its outside counsel have become aware of possible IPOF Group
violations of the short-swing profit rules under Section 16(b) of the Securities
and Exchange Act of 1934. Upon conclusion of the investigation of this matter,
the Company and IPOF Group, on March 3, 2004, entered into a negotiated
resolution of these potential violations.
15. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
(000's, except per share data) First Second Third Fourth(1)
-------- -------- -------- ---------
2003 Quarters:
Revenues, net $ 18,334 $ 17,631 $ 18,545 $ 20,230
Operating (loss) income (1,165) (472) (180) (636)
Net (loss) income (892) (393) (249) (10,447)
Net (loss) income per share-basic (0.08) (0.03) (0.02) (0.89)
Net (loss) income per share-diluted $ (0.08) $ (0.03) $ (0.02) $ (0.89)
2002 Quarters:
Revenues, net $ 21,048 $ 19,351 $ 20,064 $ 21,957
Operating income (loss) 1,584 588 (8,462) (513)
Net income 966 313 (5,308) (390)
Net income per share-basic 0.08 0.03 (0.46) (0.03)
Net income per share-diluted $ 0.08 $ 0.03 $ (0.46) $ (0.03)
- ----------------
(1) Results for the fourth quarter of 2003 include valuation allowances for the
deferred tax asset and for one specific account receivable. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Note 8 for further explanation.
16. ADDITIONAL PRIOR YEAR DISCLOSURES
In order to maintain consistency and comparability between periods presented,
certain revisions have been made to the accompanying consolidated financial
statement notes as of December 31, 2001 and for the year then ended. Such
additions to certain disclosures have been made to conform to the 2003 and 2002
financial statement presentation as follows:
Notes to Consolidated Financial Statements:
- -- Note 9, Earnings per Share: Options and restricted shares outstanding which
were anti-dilutive and not included in the computation of EPS for 2001 have been
disclosed.
- -- Note 12, Employee Retirement Plans: Matching contribution for the executive
deferred compensation plan for 2001 has been disclosed.
- -- Note 14, Related Party Transactions: Payments for an aircraft lease, for
accounting fees and for print services for 2001 have been disclosed.
33