SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2004
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES ACT OF 1934
For the transition period from ___to___
Commission file number 000-23740
INNOTRAC CORPORATION
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(Exact name of registrant as specified in its charter)
Georgia 58-1592285
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
6655 Sugarloaf Parkway Duluth, Georgia 30097
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (678) 584-4000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes (X) No ( )
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) Yes ( ) No (X).
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Outstanding at May 3, 2004
--------------------------
Common Stock at $.10 par value 11,852,693 Shares
INNOTRAC CORPORATION
INDEX
Page
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Part I. Financial Information
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets -
March 31, 2004 (Unaudited) and December 31, 2003 3
Condensed Consolidated Statements of Operations for the
Three Months Ended March 31, 2004 and 2003 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2004 and 2003 (Unaudited) 5
Notes to Condensed Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosure About Market Risks 18
Item 4. Controls and Procedures 18
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
1
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
The following condensed consolidated financial statements of Innotrac
Corporation, a Georgia corporation (the "Company"), have been prepared in
accordance with the instructions to Form 10-Q and, therefore, omit or condense
certain footnotes and other information normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America. In the opinion of management, all adjustments
are of a normal and recurring nature, except those specified otherwise, and
include those necessary for a fair presentation of the financial information for
the interim periods reported. Results of operations for the three months ended
March 31, 2004 are not necessarily indicative of the results for the entire year
ending December 31, 2004. These financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's 2003 Annual Report on Form 10-K.
2
INNOTRAC CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31, 2004 DECEMBER 31, 2003
-------------- -----------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents ........................................................... $ 1,368 $ 2,228
Accounts receivable (net of allowance for doubtful accounts of $2,221 at
March 31, 2004 and $1,696 at December 31, 2003) ................................. 16,357 15,682
Inventory ........................................................................... 6,292 10,896
Prepaid expenses and other .......................................................... 1,304 915
-------- --------
Total current assets ...................................................... 25,321 29,721
-------- --------
Property and equipment:
Rental equipment .................................................................... 863 895
Computer software and equipment ..................................................... 27,863 27,320
Furniture, fixtures and leasehold improvements....................................... 4,727 4,682
-------- --------
33,453 32,897
Less accumulated depreciation and amortization ...................................... (19,291) (18,147)
-------- --------
14,162 14,750
-------- --------
Goodwill ................................................................................. 25,169 25,169
Other assets, net ........................................................................ 1,290 1,322
-------- --------
Total assets .............................................................. $ 65,942 $ 70,962
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable .................................................................... $ 5,630 $ 5,738
Line of credit ...................................................................... 6,116 11,802
Accrued expenses and other .......................................................... 2,982 2,577
-------- --------
Total current liabilities ................................................. 14,728 20,117
-------- --------
Noncurrent liabilities:
Other noncurrent liabilities ........................................................ 1,071 1,083
-------- --------
Total noncurrent liabilities .............................................. 1,071 1,083
-------- --------
Commitments and contingencies (see Note 5)
Shareholders' equity:
Preferred stock: 10,000,000 shares authorized, $0.10 par value,
no shares issued or outstanding ............................................. -- --
Common stock: 50,000,000 shares authorized, $0.10 par value,
11,833,193 shares issued, 11,833,193 (2004) and 11,715,280 (2003)
shares outstanding .......................................................... 1,183 1,171
Additional paid-in capital .......................................................... 64,124 63,791
Accumulated deficit ................................................................. (15,164) (15,200)
-------- --------
Total shareholders' equity ................................................ 50,143 49,762
-------- --------
Total liabilities and shareholders' equity ................................ $ 65,942 $ 70,962
======== ========
See notes to condensed consolidated financial statements.
3
Financial Statements-Continued
INNOTRAC CORPORATION
CONDENSED UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED MARCH 31,
2004 2003
---------- ---------
Revenues, net .................................................. $ 19,994 $ 18,334
Cost of revenues ............................................... 8,938 8,659
-------- --------
Gross profit .................................. 11,056 9,675
-------- --------
Operating expenses:
Selling, general and administrative expenses .............. 9,484 9,371
Depreciation and amortization ............................. 1,252 1,469
-------- --------
Total operating expenses ............................ 10,736 10,840
-------- --------
Operating income (loss) ....................... 320 (1,165)
-------- --------
Other (income) expense:
Interest expense ......................................... 93 246
Other income ............................................. -- (6)
-------- --------
Total other expense ................................ 93 240
-------- --------
Income (loss) before income taxes .............................. 227 (1,405)
Income tax benefit ............................................. -- 513
-------- --------
Net income (loss) ............................. $ 227 $ (892)
======== ========
Earnings per share:
Basic ................................................... $ 0.02 $ (0.08)
======== ========
Diluted ................................................. $ 0.02 $ (0.08)
======== ========
Weighted average shares outstanding:
Basic ................................................... 11,634 11,422
======== ========
Diluted ................................................. 12,534 11,422
======== ========
See notes to condensed consolidated financial statements.
4
Financial Statements-Continued
INNOTRAC CORPORATION
CONDENSED UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003
(IN THOUSANDS)
THREE MONTHS ENDED MARCH 31,
2004 2003
-------- -------
Cash flows from operating activities:
Net income (loss) ................................................................... $ 227 $ (892)
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization ................................................... 1,252 1,469
Deferred income taxes ........................................................... - (513)
Amortization of deferred compensation ........................................... 33 18
Withholding taxes paid on shares issued to employees............................. (286) -
Changes in operating assets and liabilities:
Increase in accounts receivable ................................................. (674) (2,035)
Decrease in inventories ......................................................... 4,603 3,229
Increase in prepaid expenses and other assets ................................... (433) (10)
Decrease in accounts payable .................................................... (107) (5,961)
Increase (decrease) in accrued expenses and other ............................... 411 (1,221)
-------- -------
Net cash provided by (used in) operating activities ........................ 5,026 (5,916)
-------- -------
Cash flows from investing activities:
Capital expenditures ................................................................ (588) (397)
-------- -------
Net cash used in investing activities ...................................... (588) (397)
-------- -------
Cash flows from financing activities:
(Repayments) borrowings under line of credit ........................................ (5,687) 5,688
Repayment of capital lease and other obligations .................................... (19) (36)
Exercise of employee stock options .................................................. 408 47
-------- -------
Net cash (used in) provided by financing activities ....................... (5,298) 5,699
-------- -------
Net decrease in cash and cash equivalents ................................................ (860) (614)
Cash and cash equivalents, beginning of period ........................................... 2,228 961
-------- -------
Cash and cash equivalents, end of period ................................................. $ 1,368 $ 347
======== =======
Supplemental cash flow disclosures:
Cash paid for interest .............................................................. $ 116 $ 234
======== =======
Cash income tax refunds received, net of taxes paid ................................. $ - $ (533)
======== =======
See notes to condensed consolidated financial statements.
5
INNOTRAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004 AND 2003
(UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES
The accounting policies followed for quarterly financial reporting are
the same as those disclosed in the Notes to Consolidated Financial
Statements included in the Company's Annual Report on Form 10-K filed
with the Securities and Exchange Commission for the year ended December
31, 2003. Certain of the Company's more significant accounting policies
are as follows:
Accounting Estimates. The preparation of financial statements in
conformity with accounting principles generally accepted in the United
States of America 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.
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. The Company
accounts for goodwill and other acquired intangibles in accordance with
SFAS No. 142, "Goodwill and Other Intangible Assets". The Company tests
goodwill annually for impairment as of 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 in the first quarter of 2004
in accordance with SFAS No. 142, no impairment was determined to exist
at that time. Innotrac's goodwill carrying amount as of March 31, 2004
is $25.2 million.
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
bases of assets and liabilities using enacted tax rates in effect in
the years in which the differences are expected to reverse. A valuation
allowance was recorded against the net deferred tax asset as of
December 31, 2003 (see Note 4).
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.
6
INNOTRAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004 AND 2003
(UNAUDITED)
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").
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 condensed
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 income (loss) and net
income (loss) per share would have been the following pro forma amounts
(in 000's, except per share data)
THREE MONTHS ENDED MARCH 31,
-----------------------------
2004 2003
-------- ---------
Net income (loss) $ 227 $ (892)
Pro forma net income (loss) $ 120 $ (1,113)
Basic and diluted net income (loss) per share $ 0.02 $ (0.08)
Basic and diluted pro forma net income (loss) per share $ 0.01 $ (0.10)
Under the fair value based method, compensation cost, net of tax is
$107,000 and $221,000 for the three months ended March 31, 2004 and
2003, respectively.
During the three months ended March 31, 2004 and 2003, options
representing 75,750 and 15,000 shares were exercised, respectively.
2. FINANCING OBLIGATIONS
At March 31, 2004, the Company had a revolving credit agreement with a
bank for borrowings up to $40.0 million. Effective May 10, 2004, the
Company entered into a Loan Documents Modification Agreement which
reduced the size of the facility to $25.0 million (subject to borrowing
base limitations) and revised certain debt covenants. 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 $16.9 million at March 31, 2004. At March 31, 2004 the
Company had $10.8 million available under the revolving credit
agreement.
The financial covenants require the Company to maintain a minimum fixed
charge ratio of 1.30 to 1.00. The Company's fixed charge ratio at March
31, 2004 was 1.50 to 1.00. Additionally, the revolving credit agreement
contains a minimum tangible net worth requirement of $24.0 million. The
Company's tangible net worth at March 31, 2004 was $24.6 million.
Compliance with the minimum tangible net worth covenant and other
financial covenants is determined on a quarterly basis.
7
INNOTRAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004 AND 2003
(UNAUDITED)
The revolving credit agreement is classified as a current liability in
the Condensed Consolidated Balance Sheets because the revolving credit
agreement 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.
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
February 13, 2004, the Company fixed $5.0 million of its $6.1 million
of borrowings at the 90-day LIBOR rate of 2.63%. During the three
months ended March 31, 2004 and 2003, the Company incurred interest
expense related to the line of credit of approximately $39,000 and
$229,000, respectively, resulting in a weighted average interest rate
of 4.28%, and 3.94%, respectively. The Company also incurred unused
revolving credit facility fees of approximately $17,000 and $10,000
during the three months ended March 31, 2004 and 2003, respectively.
3. EARNINGS PER SHARE
The following table shows the shares (in 000's) used in computing
diluted earnings per share ("EPS") in accordance with Statement of
Financial Accounting Standards No. 128:
Three Months
Ended March 31
-----------------------
2004 2003
------ ------
Diluted earnings per share:
Weighted average shares outstanding............ 11,634 11,422
Employee and director stock options
and unvested restricted shares............... 900 --
------ ------
Weighted average shares assuming dilution..... 12,534 11,422
====== ======
Options outstanding to purchase 134,500 and 2.3 million shares of the
Company's common stock were not included in the computation of diluted
EPS for the three months ended March 31, 2004 and 2003, respectively,
because their effect was anti-dilutive.
4. INCOME TAXES
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 March 31, 2004 and December 31, 2003 was
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 March 31, 2004 and 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. These factors, combined with losses in recent years, create
uncertainty about the ultimate realization of the gross deferred tax
asset
8
INNOTRAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004 AND 2003
(UNAUDITED)
in future years. Therefore a valuation allowance of approximately $9.8
million and $9.9 million has been recorded as of March 31, 2004 and
December 31, 2003, respectively. Income taxes associated with future
earnings will be offset by a reduction in the valuation allowance. For
the three months ended March 31, 2004, an income tax provision of
$91,000 was offset by a corresponding reduction of the deferred tax
asset 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.
5.COMMITMENTS AND CONTINGENCIES
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 26.7% of the shares outstanding on
March 31, 2004. 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.
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.
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 the three months ended
March 31, 2004 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.
6. RELATED PARTY TRANSACTIONS
In early 2004, the Company learned that certain trading activity of the
IPOF Group, an owner of more than 5% of the outstanding Common Stock,
may have violated the short swing profit rules under Section
9
INNOTRAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004 AND 2003
(UNAUDITED)
16(b) of the Securities Exchange Act of 1934. The Company promptly
conducted an investigation of the matter. On March 3, 2004, the Company
and the IPOF Group entered into a Settlement Agreement regarding the
potential Section 16(b) liability issues that provides for the
Company's recovery of $301,957.
10
ITEM 2 -
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
11
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 concentration
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
March 31
-----------------
Business Line/Vertical 2004 2003
- ---------------------- ------ ------
Telecommunications products 19.5% 21.7%
Modems 22.1 20.3
Retail/Catalog 22.9 26.3
Direct Marketing 24.5 17.1
B2B 11.0 14.6
----- -----
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, Qwest
Communications International, Inc. and Comcast Corporation and their
customers. Inventory for our telecommunications, DSL and cable modem
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,
DSL and cable modem 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 in 2004 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., 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 experienced in the second half of 2003, which represented an
increase of over $1.1 million from the first half of 2003.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Revenues attributable to our direct marketing clients increased in the
first quarter of 2004 due to a new product introduced by one of our
newer direct marketing clients. The direct marketing vertical was weak
throughout all of 2003, but has begun to rebound in the first quarter
of 2004. However, on April 30, 2004, one of our major direct marketing
clients reacquired 55% of the stock it had not previously owned. 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.
RESULTS OF OPERATIONS
The following table sets forth unaudited summary operating data,
expressed as a percentage of revenues, for the three months ended March
31, 2004 and 2003. The data has been prepared on the same basis as the
annual consolidated financial statements. In the opinion of management,
it reflects normal and recurring adjustments necessary for a fair
presentation of the information for the periods presented. 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 condensed
consolidated financial statements.
Three Months
Ended March 31
-----------------------
2004 2003
------ ------
Revenues.......................................... 100.0% 100.0%
Cost of revenues.................................. 44.7 47.2
----- -----
Gross margin................................... 55.3 52.8
Selling, general and administrative expenses...... 47.4 51.1
Depreciation and amortization..................... 6.3 8.0
----- -----
Operating income (loss) ...................... 1.6 (6.3)
Other expense, net................................ .5 1.3
----- -----
Income (loss) before income taxes............. 1.1 (7.6)
Income tax benefit ............................... -- 2.8
----- -----
Net income (loss)............................. 1.1% (4.8)%
===== =====
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2004 COMPARED TO THREE MONTHS ENDED MARCH 31, 2003
Revenues. Net revenues increased 9.1% to $20.0 million for the three months
ended March 31, 2004 from $18.3 million for the three months ended March 31,
2003. The increase in revenues is primarily due to an increase in volumes from
our direct marketing clients of approximately $1.7 million, along with an
increase of $694,000 from our DSL and cable modem clients, net of decreases in
our B2B and retail/catalog businesses of $478,000 and $245,000, respectively.
Cost of Revenues. Cost of revenues increased 3.2% to $8.9 million for the three
months ended March 31, 2004 compared to $8.7 million for the three months ended
March 31, 2003. Cost of revenues increased slightly primarily due to an overall
increase in revenues.
Gross Margin. For the three months ended March 31, 2004, the Company's gross
margin increased by $1.4 million to $11.1 million, or 55.3% of revenues,
compared to $9.7 million, or 52.8% of revenues, for the three months ended March
31, 2003. This increase in gross margin was due primarily to greater operating
efficiencies throughout our facilities and a change in the business mix.
Selling, General and Administrative Expenses. S,G&A expenses for the three
months ended March 31, 2004 increased slightly on a dollar basis to $9.5
million, or 47.4% of revenues, compared to $9.4 million, or 51.1% of revenues,
for the same period in 2003. This net increase was attributable to $289,000
higher facility cost in the first quarter of 2004, offset partially by $195,000
of lower information technology related costs. The decrease as a percentage of
revenues is due to the overall increase in revenues.
Income Taxes. The Company's effective tax rate for the three months ended March
31, 2004 and 2003 was 0% and 36.5%, respectively. During 2003, a valuation
allowance was recorded against the Company's net deferred tax assets as losses
in recent years created uncertainty about the realization of tax benefits in
future years. Income taxes associated with earnings for the three months ended
March 31, 2004 were offset by a reduction of this valuation allowance resulting
in an effective tax rate of 0% for the three months ended March 31, 2004.
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 $1.4 million at March 31,
2004 as compared to $2.2 million at December 31, 2003. Additionally, the Company
had reduced its borrowings under its revolving credit facility (discussed below)
to $6.1 million outstanding at March 31, 2004 as compared to $11.8 million at
December 31, 2003. The Company generated positive cash flow from operations of
$5.0 million during the quarter ended March 31, 2004. The Company also generated
positive cash flow from operations for all of 2003. We anticipate positive cash
flows from operations during the remainder of 2004. One of the primary
contributors to generating cash in the first quarter of 2004 was a further
reduction in our wireless pager inventory of approximately $4.6 million. This
also contributed to a further reduction in borrowings under our revolving credit
facility of approximately $5.7 million. Capital expenditures were $588,000 in
the first quarter of 2004. We anticipate capital expenditures of approximately
$2.0 million to $2.5 million for all of 2004. This estimate is subject to
various contingencies, including the possible need to incur additional capital
expenditures related to new clients, the need to open new facilities or
significant new initiatives by existing clients.
The Company currently has a revolving credit agreement with a bank for
borrowings up to $25.0 million (subject to borrowing base limitation) maturing
in June 2005. We recently reduced 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. The Company
14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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. 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 under the credit agreement. Accordingly, in the event
of noncompliance, these amounts could be accelerated. Furthermore, the credit
facility limits borrowings to a specified percentage of eligible accounts
receivable and inventory, as defined, which totaled $16.9 million at March 31,
2004.
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 February 13,
2004, the Company fixed $5.0 million of its $6.1 million of borrowings at a
90-day LIBOR rate of 2.63%. During the three months ended March 31, 2004, and
2003 the Company incurred interest expense related to the line of credit of
approximately $39,000, and $229,000, respectively. At March 31, 2004, the
Company had $10.8 million available under the revolving credit agreement.
During the three months ended March 31, 2004, the Company generated $5.0 million
in cash flow from operating activities compared to a use of $5.9 million in cash
flow from operating activities in the same period in 2003. The increase in cash
provided from operating activities was primarily the result of disposing of $4.6
million in inventory, primarily wireless pagers. In 2003, the use of cash
primarily related to the payment for $6.2 million of wireless pager inventory
received in the fourth quarter of 2002.
During the three months ended March 31, 2004, net cash used in investing
activities for capital additions was $588,000 as compared to $397,000 in 2003.
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 three months ended March 31, 2004, the net cash used in financing
activities was $5.3 million compared to $5.7 million provided by financing
activities in the same period in 2003. The primary difference between years is
attributable to borrowings of $5.7 million under the credit facility in 2003
versus a reduction in outstanding borrowings of $5.7 million in 2004.
Additionally, during 2004, the Company generated cash of $408,000 through the
exercise of previously granted employee stock options. We anticipate that
additional employee stock options will be exercised during the second quarter of
2004 resulting in additional 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 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.
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 the condensed consolidated financial
statements appearing in our Annual Report on Form 10-K for the year ended
December 31, 2003. 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:
Goodwill and Other Acquired Intangibles. The Company accounts for goodwill and
other intangible assets in accordance with SFAS No. 142, "Goodwill and Other
Intangible Assets". 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 March 31, 2004 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 performed a goodwill valuation in the first quarter of 2004. The
valuation supported that the fair value of the reporting unit at January 1, 2004
exceeded the carrying amount of the net assets, including goodwill, and thus no
impairment was determined to exist. The Company performs 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 gross deferred tax asset as of March 31,
2004 and December 31, 2003 was 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. These factors, combined
with losses in recent years, create uncertainty about the ultimate realization
of the gross deferred tax asset in future years. Therefore a valuation allowance
of approximately $9.8 million and $9.9 million has been recorded as of March 31,
2004 and December 31, 2003. Income taxes associated with future earnings will be
offset by a reduction in the valuation allowance. For the three months ended
March 31, 2004, an income tax provision of $91,000 was offset by a corresponding
reduction of the deferred tax asset 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
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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
March 31, 2004 and 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. Although the terms of this arrangement were subsequently
breached, payments of approximately $1.7 million towards this past due amount
were received in February through May 2004. Due primarily to the financial
condition, payment history and aging of the receivables of this client, the
Company established a specific reserve of $1.1 million for this account at
December 31, 2003. This specific reserve was increased to $1.8 million at March
31, 2004 due primarily to the breach of the previous arrangement and further
deterioration in the aging of the remaining receivable which totaled
approximately $3.0 million at March 31, 2004. Management will continue to assess
the level of reserve needed against this account on a quarterly basis.
17
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
Management believes the Company's exposure to market risks (investments,
interest rates and foreign currency) 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. The Company does not transact any
sales in foreign currency. 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 this 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 discussed in our Annual Report on Form 10-K
for the year ended December 31, 2003 and other filings on file with the
Securities and Exchange Commission.
ITEM 4 - CONTROLS AND PROCEDURES
Our management, with the participation of the Chief Executive and Chief
Financial Officers, evaluated our disclosure controls and procedures (as defined
in federal securities rules) as of March 31, 2004. No system of controls, no
matter how well designed and operated, can provide absolute assurance that the
objectives of the system of controls are met, and no evaluation of controls can
provide absolute assurance that the system of controls has operated effectively
in all cases. Our disclosure controls and procedures however are designed to
provide reasonable assurance that the objectives of disclosure controls and
procedures are met. Based on the evaluation discussed above, our CEO and CFO
have concluded that our disclosure controls and procedures were effective as of
the date of that evaluation to provide reasonable assurance that the objectives
of disclosure controls and procedures are met.
There were no changes in our internal control over financial reporting that have
materially affected, or are reasonably likely to materially affect, Innotrac's
internal control over financial reporting during the first quarter of 2004.
18
PART II - OTHER INFORMATION
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.1 Loan Documents Modification Agreement between Innotrac Corporation
and SouthTrust Bank, dated May 10, 2004.
31.1 Certification of Chief Executive Officer Pursuant to Rule
13a-14(a)/15d - 14(a).
31.2 Certification of Chief Financial Officer Pursuant to Rule
13a-14(a)/15a - 14(a).
32.1 Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350.
32.2 Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350.
(b) Reports on Form 8-K:
On March 30, 2004, the Company furnished to the Commission pursuant to
Item 12 of Form 8-K its press release announcing the Company's
financial results for the fourth quarter and year ended December 31,
2003.
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INNOTRAC CORPORATION
----------------------------
(Registrant)
Date: May 14, 2004 By: /s/ Scott D. Dorfman
-----------------------------------
Scott D. Dorfman
President, Chief Executive
Officer and Chairman of the
Board (Principal Executive
Officer)
Date: May 14, 2004 /s/ David L. Gamsey
-----------------------------------
David L. Gamsey
Senior Vice President, Chief
Financial Officer and Secretary
(Principal Financial and
Accounting Officer)
20