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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, 2003
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES ACT OF 1934
For the transition period from to
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Commission file number 000-23740
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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
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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 .
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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 12, 2003
---------------------------
Common Stock at $.10 par value 11,487,580 Shares
INNOTRAC CORPORATION
INDEX
Part I. Financial Information Page
----
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets -
March 31, 2003 (Unaudited) and December 31, 2002 3
Condensed Consolidated Statements of Operations for the
Three Months Ended March 31, 2003 and 2002 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2003 and 2002 (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 19
Item 4. Controls and Procedures 19
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
Certifications 22
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 generally accepted accounting principles
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, 2003 are not necessarily indicative of the results for the entire year
ending December 31, 2003. These financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's 2002 Annual Report on Form 10-K.
2
INNOTRAC CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS MARCH 31, 2003 DECEMBER 31, 2002
-------------- -----------------
(UNAUDITED)
Current assets:
Cash and cash equivalents ............................................... $ 347 $ 961
Accounts receivable (net of allowance for doubtful accounts of $807 at
March 31, 2003 and $1,169 at December 31, 2002) ...................... 16,238 14,203
Inventories, net ........................................................ 20,869 24,098
Deferred income taxes ................................................... 486 552
Prepaid expenses and other .............................................. 2,523 2,357
-------- --------
Total current assets ................................................ 40,463 42,171
-------- --------
Property and equipment:
Rental equipment ........................................................ 1,250 1,372
Computer software and equipment ......................................... 26,690 26,315
Furniture, fixtures and leasehold improvements .......................... 4,607 4,585
-------- --------
32,547 32,272
Less accumulated depreciation and amortization .......................... (14,633) (13,357)
-------- --------
17,914 18,915
-------- --------
Goodwill ................................................................... 24,988 24,988
Deferred income taxes ...................................................... 8,519 7,940
Other assets, net .......................................................... 1,258 1,485
-------- --------
Total assets ........................................................ $ 93,142 $ 95,499
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................................ $ 7,557 $ 13,517
Line of credit .......................................................... 20,060 --
Accrued expenses and other .............................................. 5,106 6,626
-------- --------
Total current liabilities ........................................... 32,723 20,143
-------- --------
Noncurrent liabilities:
Line of credit .......................................................... -- 14,372
Other noncurrent liabilities ............................................ 1,128 1,125
-------- --------
Total noncurrent liabilities ........................................ 1,128 15,497
-------- --------
Commitments and contingencies
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,
11,674,595 shares issued, 11,432,780 (2003) and 11,417,780 (2002)
shares outstanding .................................................... 1,167 1,167
Additional paid-in capital .............................................. 62,897 62,614
Retained deficit ........................................................ (4,111) (3,219)
Treasury stock: 241,815 (2003) and 256,815 (2002) shares held ........... (662) (703)
-------- --------
Total shareholders' equity .......................................... 59,291 59,859
-------- --------
Total liabilities and shareholders' equity .......................... $ 93,142 $ 95,499
======== ========
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, 2003 AND 2002
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED MARCH 31,
2003 2002
-------- --------
Revenues, net .................................................... $ 18,334 $ 21,048
Cost of revenues ................................................. 8,659 11,707
Special credits .................................................. -- (293)
-------- --------
Gross profit ............................................... 9,675 9,634
-------- --------
Operating expenses:
Selling, general and administrative expenses ................... 9,371 7,794
Special credits ................................................ -- (962)
Depreciation and amortization .................................. 1,469 1,218
-------- --------
Total operating expenses ................................... 10,840 8,050
-------- --------
Operating income (loss) .................................. (1,165) 1,584
-------- --------
Other (income) expense:
Interest expense ............................................... 246 83
Other income ................................................... (6) (87)
-------- --------
Total other (income) expense ............................... 240 (4)
-------- --------
Income (loss) before income taxes ................................ (1,405) 1,588
Income tax (provision) benefit ................................... 513 (622)
-------- --------
Net income (loss) ........................................ $ (892) $ 966
======== ========
Earnings per share:
Basic .......................................................... $ (0.08) $ 0.08
======== ========
Diluted ........................................................ $ (0.08) $ 0.08
======== ========
Weighted average shares outstanding:
Basic .......................................................... 11,422 11,516
======== ========
Diluted ........................................................ 11,422 11,790
======== ========
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, 2003 AND 2002
(IN THOUSANDS)
THREE MONTHS ENDED MARCH 31,
2003 2002
------- --------
Cash flows from operating activities:
Net income (loss) .............................................................. $ (892) $ 966
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization ............................................. 1,469 1,218
Impairment and loss on fixed assets ....................................... -- 501
Deferred income taxes ..................................................... (513) 1,324
Amortization of deferred compensation ..................................... 18 18
Changes in operating assets and liabilities:
Increase in accounts receivable ........................................... (2,035) (8,017)
Decrease in inventories ................................................... 3,229 6,418
Increase in prepaid expenses and other assets ............................. (10) (920)
(Decrease) increase in accounts payable ................................... (5,961) 4,990
Decrease in accrued expenses and other .................................... (1,221) (1,989)
------- --------
Net cash provided by (used in) operating activities .................. (5,916) 4,509
------- --------
Cash flows from investing activities:
Capital expenditures ........................................................... (397) (2,821)
Earn-out payment ............................................................... -- (13,727)
Sale of marketable securities .................................................. -- 436
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Net cash used in investing activities ................................ (397) (16,112)
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Cash flows from financing activities:
Borrowings under line of credit ................................................ 5,688 2,334
Repayment of capital lease and other obligations ............................... (36) (71)
Issuance of treasury stock ..................................................... 47 --
------- --------
Net cash provided by financing activities ........................... 5,699 2,263
------- --------
Net decrease in cash and cash equivalents .......................................... (614) (9,340)
Cash and cash equivalents, beginning of period ..................................... 961 9,413
------- --------
Cash and cash equivalents, end of period ........................................... $ 347 $ 73
======= ========
Supplemental cash flow disclosures:
Cash paid for interest ......................................................... $ 234 $ 85
======= ========
Cash refunds received for income taxes ......................................... $ (533) $ (18)
======= ========
Noncash transactions:
Stock issued for business acquired ............................................. $ -- $ 1,550
======= ========
See notes to condensed consolidated financial statements.
5
INNOTRAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003 AND 2002
(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, 2002, except as discussed below. 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 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 second quarter of 2002
and again in the first quarter of 2003 in accordance with SFAS No. 142,
no impairment was determined to exist at those times. Innotrac's
goodwill carrying amount as of March 31, 2003 is $25.0 million.
Long-Lived Assets. In August 2001, the FASB issued SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS
No. 144 supercedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of," and the
accounting and reporting provisions of APB Opinion No. 30, "Reporting
the Results of Operations -- Reporting the Effects of Disposal of a
Segment of a Business and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," and amends APB Opinion No. 51,
"Consolidated Financial Statements."
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):
6
THREE MONTHS ENDED MARCH 31,
----------------------------
2003 2002
--------- --------
Net income (loss) $ (892) $ 966
Pro forma net income (loss) $ (1,113) $ 680
Diluted net income (loss) per share $ (0.08) $ 0.08
Pro forma net income (loss) per share $ (0.10) $ 0.06
Under the fair value based method, compensation cost, net of tax is
$221,000 and $286,000 for the three months ended March 31, 2003 and
2002, respectively.
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 is recorded against deferred tax assets if the Company
considers it is more likely than not that deferred tax assets will not
be realized (see Note 6).
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 EITF, the Company netted
reimbursements from customers, primarily for freight and postage fees,
against the related expenses within revenues.
2. SPECIAL CHARGES AND SPECIAL CREDITS
At March 31, 2003 and December 31, 2002, the Company had approximately
$207,000 and $277,000, respectively, in accruals related to the special
charges recorded during the year ended December 31, 2000. The remaining
accruals at March 31, 2003 relate to exiting the front-end e-commerce
and web hosting business. Cash payments relating to these accruals for
the three months ended March 31, 2003 were
7
approximately $70,000. The Company recognized a credit of approximately
$1.3 million during the three months ended March 31, 2002, related to
gains realized on sales of inventory items and cash collected for
accounts receivable, both of which were written off as special charges
in previous periods. These amounts were recorded as a reduction of the
special credit line item in the condensed consolidated statements of
operations. We expect that the remaining accrual, which is associated
with one specific client, will be fully utilized by the end of 2003.
3. FINANCING OBLIGATIONS
The Company has a revolving credit agreement with a bank for borrowings
up to $40 million that matures in June 2005. The Company and its
subsidiaries have pledged all of its assets and provided guarantees to
the lender as collateral under this revolving credit agreement. At
March 31, 2003 and December 31, 2002, the Company had approximately
$20.1 million and $14.4 million, respectively, outstanding in
borrowings under the line of credit. The revolving line of 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 Company entered into a Second Amended and Restated Loan and
Security Agreement (the "Agreement") with its lenders on April 3, 2003.
The Agreement requires the Company to maintain a lockbox arrangement
with the lenders and contains provisions limiting borrowings under the
Agreement to a margin or borrowing base, as defined, which totaled
$24.8 million at March 31, 2003 and $31.5 million at December 31, 2002.
At March 31, 2003 and December 31, 2002 the Company had $4.8 million
and $17.1 million, respectively, available under the revolving credit
agreement. The Agreement relaxed certain of the prior financial
covenants. The financial covenants now require the Company to maintain
tangible net worth, as defined in the Agreement, which includes
deferred taxes, of at least $32.5 million at March 31, 2003, a debt to
tangible net worth ratio of not more than 1.5 to 1 at March 31, 2003
and a fixed charge coverage ratio of 1.75 to 1 by December 31, 2003.
The quarterly tangible net worth requirement escalates to $33.0 million
at June 30, 2003 and September 30, 2003, $34.0 million at December 31,
2003 and escalates by $250,000 for each fiscal quarter thereafter. At
March 31, 2003, the Company was in compliance with all covenants under
the Agreement.
Due to the provisions of the Agreement, 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, the outstanding borrowings under the Agreement have been
classified as a current liability at March 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
February 13, 2003, the Company fixed $10.0 million of its $20.1 million
of borrowings at a 90-day LIBOR rate of 2.84%. During the three months
ended March 31, 2003 and 2002, the Company incurred interest expense
related to the line of credit of approximately $229,000 and $34,000,
respectively, resulting in a weighted average interest rate of 3.94%
and 3.05%, respectively. The Company also incurred unused revolving
credit facility fees of approximately $10,000 and $22,000 during the
three months ended March 31, 2003 and 2002, respectively.
As of March 31, 2003 and December 31, 2002, the Company had
outstanding letters of credit totaling approximately $420,000 issued
in connection with routine business requirements.
8
4. 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,
----------------------
2003 2002
------ ------
Diluted earnings per share:
Weighted average shares outstanding 11,422 11,516
Employee and director stock options -- 274
------ ------
Weighted average shares assuming dilution 11,422 11,790
====== ======
Options and warrants outstanding to purchase shares of the Company's
common stock aggregating 2.3 million and 1.1 million were not included
in the computation of diluted EPS for the three months ended March 31,
2003 and 2002, respectively, because their effect was anti-dilutive.
5. 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; the
adoption did not have a material impact on the Company's consolidated
financial position, results of operations or cash flows.
In November 2002, the FASB issued Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Other." FIN 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 disclosure requirements of the Interpretation are effective
for financial statements of the interim or annual periods ending after
December 15, 2002. The Company adopted FIN No. 45 on January 1, 2003;
the adoption had no impact on the Company's consolidated financial
position, results of operations or cash flows.
6. INCOME TAXES
Innotrac's net deferred tax asset as of March 31, 2003 is approximately
$9.0 million. This net deferred tax asset was generated by net
operating loss carryforwards created primarily by two events, the
special charge of $34.3 million recorded in 2000 and the net loss
generated in 2002. Innotrac has a tax net operating loss carryforward
of $27.6 million at December 31, 2002 that expires between 2018 and
2020. Although the Company has generated financial reporting and tax
losses in 2000 and 2002, the Company was profitable in 2001. Further,
2000 and 2002 were the only years with losses since Innotrac began its
operations in 1984. Management believes that its net operating loss
carryforwards will be utilized before
9
their expiration through future earnings. This assessment is based on
management's expectations of increased revenues, lower selling, general
and administrative expenses, reduced capital expenditures and no
impairment losses related to goodwill in the future.
Innotrac's ability to generate the expected amounts of taxable income
from future operations is dependent upon general economic conditions,
competitive pressures on sales and margins and other factors beyond
management's control. There can be no assurance that Innotrac will meet
its expectations for future taxable income in the carryforward period.
However, management considered the above factors in reaching the
conclusion that it is more likely than not that future taxable income
will be sufficient to fully realize the net deferred tax asset recorded
at March 31, 2003. The amount of the net deferred tax asset considered
realizable, however, could be reduced in the near term if estimates of
future taxable income during the carryforward period are reduced.
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
industry; risks associated with changing technology and supporting
existing technology; risks associated with competition and other
factors discussed in more detail under the heading "Certain Factors
Affecting Forward-Looking Statements" in Part I, Item 1 of our Annual
Report on Form 10-K for the year ended December 31, 2002.
OVERVIEW
Innotrac Corporation ("Innotrac" or the "Company"), founded in 1984 and
headquartered in Atlanta, Georgia, provides order processing, order
fulfillment and call center services to large corporations that
outsource these functions. In order to perform call center and
fulfillment functions in-house, a company may be required to develop
expensive, labor-intensive infrastructures, which may divert its
resources and management's focus from its principal or core business.
By assuming responsibility for these tasks, Innotrac strives to improve
the quality of the non-core operations of their clients and to reduce
their overall operating costs. Innotrac enables their clients to manage
their sales channels efficiently by utilizing their core competencies,
which include:
- 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
The Company fulfills products that include Digital Subscriber Line
and Cable Modems ("Modems") and consumer phones and wireless pager
equipment ("Telecommunications products") for clients such as
BellSouth
11
Corporation ("BellSouth"), Qwest Communications International, Inc.
("Qwest") and Comcast Corporation ("Comcast") and their customers.
During the quarters ended March 31, 2003 and 2002, approximately 21.7%
and 27.4% of revenues, respectively, were generated from
Telecommunications products and 20.3% and 20.6% of revenues,
respectively, were from Modems.
The Company also provides a variety of these services for a significant
number of retail, catalog and direct marketing companies such as
Nordstrom, Inc., Ann Taylor Stores Corporation, Smith & Hawken, Ltd.,
The Coca-Cola Company, Tactica International, Inc., Porsche Cars North
America, Inc., Wilsons Leather and Martha Stewart Living Omnimedia,
Inc. During the quarters ended March 31, 2003 and 2002, 26.3% and 13.7%
of revenues, respectively, were from retail and catalog clients and
17.1% and 34.4% of revenues, respectively, were from direct marketing
clients.
The Company also provides these services for business-to-business
("B2B") clients including Books are Fun (a division of Readers' Digest)
and The Walt Disney Company. During the quarters ended March 31, 2003
and 2002, 14.6% and 3.9% of revenues, respectively, were from B2B
clients.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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, 2003 and 2002. 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,
2003 2002
------ ------
Revenues 100.0% 100.0%
Cost of revenues 47.2 55.6
Special credits -- (1.4)
------ ------
Gross margin 52.8 45.8
Selling, general and administrative expenses 51.1 37.1
Special credits -- (4.6)
Depreciation and amortization 8.0 5.8
------ ------
Operating (loss) income (6.3) 7.5
Other expense, net 1.3 --
------ ------
(Loss) income before income taxes (7.6) 7.5
Income tax benefit (provision) 2.8 (2.9)
------ ------
Net (loss) income (4.8)% 4.6%
====== ======
SPECIAL CHARGES AND SPECIAL CREDITS
At March 31, 2003 and December 31, 2002, the Company had approximately $207,000
and $277,000, respectively, in accruals related to the special charges recorded
during the year ended December 31, 2000. The remaining accruals at March 31,
2003 relate to exiting the front-end e-commerce and web hosting business. Cash
payments relating to these accruals for the three months ended March 31, 2003
were approximately $70,000. The Company recognized a credit approximately $1.3
million during the three months ended March 31, 2002, related to gains realized
on sales of inventory items and cash collected for accounts receivable, both of
which were written off as special charges in previous periods. These amounts
were recorded as a reduction of the special credit line item in the condensed
consolidated statements of operations. We expect that the remaining accrual,
which is associated with one specific client, will be fully utilized by the end
of 2003.
13
THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
Revenues. Net revenues decreased 12.9% to $18.3 million for the three months
ended March 31, 2003 from $21.0 million for the three months ended March 31,
2002. The decrease in revenues is primarily due to a decrease in volumes from
our direct marketing clients along with a substantial decline in associated
pass-through freight revenues and expenses. This decline in revenues was offset
by the commencement of the Smith & Hawken, Ann Taylor and Books Are Fun
contracts in the third quarter of 2002.
Cost of Revenues. Cost of revenues decreased 26.0% to $8.7 million for the three
months ended March 31, 2003 compared to $11.7 million for the three months ended
March 31, 2002. Cost of revenues decreased primarily due to the reduction in
pass-through freight costs associated with the decline in volumes from our
direct marketing clients. This decline in cost of revenues was offset by
additional fulfillment labor costs incurred to support the new clients mentioned
above, which commenced operations during the third quarter of 2002.
Special Credits. The Company recognized approximately $293,000 related to gains
realized on sales of inventory items previously written off as part of the 2000
special charge during the three months ended March 31, 2002.
Gross Margin. For the three months ended March 31, 2003, the Company's gross
margin increased by $41,000 to $9.7 million, or 52.8% of revenues, compared to
$9.6 million, or 45.8% of revenues, for the three months ended March 31, 2002.
This increase was due primarily to the decrease in reimbursable freight costs
during the three months ended March 31, 2003.
Selling, General and Administrative Expenses. S,G&A expenses for the three
months ended March 31, 2003 increased to $9.4 million, or 51.1% of revenues,
compared to $7.8 million, or 37.1% of revenues, for the same period in 2002. The
increase in expenses primarily relates to expenses associated with the addition
of two new fulfillment facilities located near Chicago and Cincinnati which were
opened during the second half of 2002.
Special Credits. During the three months ended March 31, 2002, the Company
collected cash of $962,000 on accounts receivable which were previously fully
reserved for as part of the 2000 special charge. The special charge reserve was
reversed as a credit to income within the special credit line item on the
statement of operations in an amount equal to the cash received.
Income Taxes. The Company's effective tax rate for the three months ended March
31, 2003 and 2002 was 36.5% and 39.2%, respectively. The decrease in the
absolute rate was principally due to the greater impact of certain items not
deductible for tax purposes in 2002.
14
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 $347,000 at March 31,
2003 as compared to $961,000 at December 31, 2002. Additionally, the Company had
borrowings under its revolving credit facility (discussed below) of $20.1
million outstanding at March 31, 2003 as compared to $14.4 million at December
31, 2002. The primary use of cash was to reduce accounts payable during the
first quarter of 2003.
The Company has a revolving credit agreement with a bank for borrowings up to
$40 million that matures in June 2005. The Company and its subsidiaries have
pledged all of its assets and provided guarantees to the lender as collateral
under this revolving credit agreement. At March 31, 2003 and December 31, 2002,
the Company had approximately $20.1 million and $14.4 million, respectively,
outstanding in borrowings under the line of credit. The revolving line of 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 Company entered into a Second Amended and Restated Loan and Security
Agreement (the "Agreement") with its lender on April 3, 2003. The Agreement
requires the Company to maintain a lockbox arrangement with the lenders and
contains provisions limiting borrowings under the Agreement to a margin or
borrowing base, as defined, which totaled $24.8 million at March 31, 2003 and
$31.5 million at December 31, 2002 and relaxed certain of the prior financial
covenants. The financial covenants now require the Company to maintain tangible
net worth, as defined in the Agreement, of at least $32.5 million at March 31,
2003, a debt to tangible net worth ratio of not more than 1.5 to 1 at March 31,
2003 and a fixed charge coverage ratio of 1.75 to 1 by December 31, 2003. The
quarterly tangible net worth requirement escalates to $33.0 million at June 30,
2003 and September 30, 2003, $34.0 million at December 31, 2003 and escalates by
$250,000 for each fiscal quarter thereafter. At March 31, 2003, the Company was
in compliance with all covenants under the Agreement.
Due to the provisions of the Agreement, 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, the outstanding borrowings
under the Agreement have been classified as a current liability at March 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 February 13,
2003, the Company fixed $10.0 million of its $20.1 million of borrowings at a
90-day LIBOR rate of 2.84%. During the three months ended March 31, 2003 and
2002, the Company incurred interest expense related to the line of credit of
approximately $229,000 and $34,000, respectively, resulting in a weighted
average interest rate of 3.94% and 3.05%, respectively. At March 31, 2003, the
Company had $4.8 million available under the revolving credit agreement.
During the three months ended March 31, 2003, the Company used approximately
$5.9 million in cash flows from operating activities compared to generating $4.5
million in cash flows from operating activities in the same period in 2002. The
decrease in cash flows from operating activities was primarily the result of a
decrease of $1.9 million in net income, a decrease in accounts payable, accrued
expenses and inventory offset by an increase in accounts receivable.
15
During the three months ended March 31, 2003, net cash used in investing
activities was $397,000 as compared to $16.1 million in 2002. This difference
was due to a $13.7 million earn-out payment made in February 2002 resulting from
prior acquisitions and $2.8 million in capital expenditures in 2002, primarily
for capitalized technology costs, compared with $397,000 in 2003.
During the three months ended March 31, 2003, net cash provided by financing
activities was $5.7 million compared to $2.3 million in the same period in 2002.
The $3.4 million increase was primarily due to additional borrowings under the
credit facility which were primarily used to reduce accounts payable.
The Company's primary long-term contractual commitments consist of capital and
operating leases. See the discussion of "Liquidity and Capital Resources" in our
Annual Report on Form 10-K for the year ended December 31, 2002 and Note 7 to
the consolidated financial statements therein. The Company has no long-term
purchase commitments.
The Company estimates that its cash and financing needs through 2003 will be met
by cash flows from operations and its credit facility. The Company may need to
raise additional funds in order to take advantage of unanticipated
opportunities, such as acquisitions of complementary businesses. 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.
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 1 of this Form 10-Q and in Note 2 included in the
Company's Annual Report on 10-K for the year ended December 31, 2002. Those that
we believe that 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 - 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. 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 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. 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 2003 in accordance with SFAS No. 142, no impairment was
determined to exist at that time.
16
Innotrac's goodwill carrying amount as of March 31, 2003 was $25.0 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 2003. The third party valuation supported
that the fair value of the reporting unit at January 1, 2003 exceeded 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, 2003. The Company will perform
this impairment test annually as of January 1 or sooner if circumstances
indicate. There can be no assurance however that future valuations will continue
to support this determination, or that goodwill will not be found to be impaired
in the future.
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 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 March 31,
2003 is approximately $9.0 million. This net deferred tax asset was generated by
net operating loss carryforwards created primarily by two events, the special
charge of $34.3 million recorded in 2000 and the net loss generated in 2002.
Innotrac has a tax net operating loss carryforward of $27.6 million at December
31, 2002 that expires between 2018 and 2020. Although the Company has generated
financial reporting and tax losses in 2000 and 2002, the Company was profitable
in 2001. Further, 2000 and 2002 were the only years with losses since Innotrac
began its operations in 1984. Management believes that its net operating loss
carryforwards will be utilized before their expiration principally through
future earnings. This assessment is based on management's expectations of
increased revenues, lower selling, general and administrative expenses, reduced
capital expenditures and no impairment losses related to goodwill in the future.
Innotrac's ability to generate the expected amounts of taxable income from
future operations is dependent upon general economic conditions, competitive
pressures on sales and margins and other factors beyond management's control.
There can be no assurance that Innotrac will meet its expectations for future
taxable income in the carryforward period. However, management considered the
above factors in reaching the conclusion that it is more likely than not that
future taxable income will be sufficient to fully realize the net deferred tax
asset recorded at March 31, 2003. The amount of the net deferred tax asset
considered realizable, however, could be reduced in the near term if estimates
of future taxable income during the carryforward period are reduced.
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; the adoption did not have a material impact on the Company's
consolidated financial position, results of operations or cash flows.
17
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. The additional disclosure requirements
of SFAS No. 148 are included in Note 1 of the financial statements within this
10-Q.
In November 2002, the FASB issued Interpretation ("FIN") No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Other." FIN 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 disclosure
requirements of the Interpretation are effective for financial statements of the
interim or annual periods ending after December 15, 2002. The Company adopted
FIN No. 45 on January 1, 2003; the adoption had no impact on the Company's
consolidated financial position, results of operations or cash flows.
18
ITEM 3 - 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's 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, 2002 and other
filings on file with the Securities and Exchange Commission.
ITEM 4 - CONTROLS AND PROCEDURES
Our management, including the chief executive and chief financial officers,
supervised and participated in an evaluation of our disclosure controls and
procedures (as defined in federal securities rules) within the 90 days before we
filed this report. Based on that evaluation, our CEO and CFO have concluded that
our disclosure controls and procedures were effective as of the date of that
evaluation.
There were no significant changes in our internal controls or in other factors
that could significantly affect these controls subsequent to the date of their
evaluation.
19
PART II - OTHER INFORMATION
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.1 Second Amended and Restated Loan and Security
Agreement between Innotrac Corporation and SouthTrust
Bank.
10.2 First Amendment to Lease Agreement dated April 4,
2003 by and between The Prudential Insurance Company
of America and Innotrac Corporation
99.1 Certification of Chief Executive Officer Pursuant to
18 U.S.C.ss.1350.
99.2 Certification of Chief Financial Officer Pursuant to
18 U.S.C.ss.1350.
(b) Reports on Form 8-K:
The Company did not file any reports on Form 8-K during the
three months ended March 31, 2003.
20
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, 2003 /s/ Scott D. Dorfman
--------------------
Scott D. Dorfman
President, Chief Executive Officer and Chairman
of the Board (Principal Executive Officer)
Date: May 14, 2003 /s/ David L. Gamsey
--------------------
David L. Gamsey
Senior Vice President, Chief Financial Officer
and Secretary (Principal Financial and Accounting
Officer)
21
CERTIFICATIONS
I, Scott D. Dorfman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Innotrac
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003 /S/ Scott D. Dorfman
--------------------------
Scott D. Dorfman
President, Chief Executive Officer and Chairman
of the Board (Principal Executive Officer)
22
CERTIFICATIONS
I, David L. Gamsey, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Innotrac
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003 /S/ David L. Gamsey
----------------------------------
David L. Gamsey
Senior Vice President, Chief Financial Officer
and Secretary (Principal Financial Officer)
23