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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, 2005
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
---------------------------------------------------------
(Exact name of registrant as specified in its charter)
Georgia 58-1592285
------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
6655 Sugarloaf Parkway Duluth, Georgia 30097
------------------------------------------------------------------
(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 12, 2005
Common Stock $.10 par value per share 12,255,360 Shares
INNOTRAC CORPORATION
INDEX
Page
----
Part I. Financial Information
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets -
March 31, 2005 (Unaudited) and December 31, 2004 3
Condensed Consolidated Statements of Operations for the
Three Months Ended March 31, 2005 and 2004 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2005 and 2004 (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 19
Signatures 20
1
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
The following condensed consolidated financial statements of Innotrac
Corporation, a Georgia corporation ("Innotrac" or 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 as
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, 2005 are not necessarily indicative of the results
for the entire year ending December 31, 2005. These financial statements should
be read in conjunction with the consolidated financial statements and notes
thereto included in the Company's 2004 Annual Report on Form 10-K, which is
available on our website at www.innotrac.com.
2
INNOTRAC CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31, 2005 DECEMBER 31, 2004
-------------- -----------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents.................................................. $ 2,210 $ 1,377
Accounts receivable (net of allowance for doubtful accounts of $1,102 at
March 31, 2005 and $1,624 at December 31, 2004)........................ 17,583 18,405
Inventory.................................................................. 3,428 2,662
Prepaid expenses and other................................................. 1,716 1,986
-------------- -----------------
Total current assets............................................... 24,937 24,430
-------------- -----------------
Property and equipment:
Rental equipment........................................................... 519 556
Computer software and equipment............................................ 29,340 29,034
Furniture, fixtures and leasehold improvements............................. 4,941 4,957
-------------- -----------------
34,800 34,547
Less accumulated depreciation and amortization............................. (23,203) (22,048)
-------------- -----------------
11,597 12,499
-------------- -----------------
Goodwill........................................................................ 25,169 25,169
Other assets, net............................................................... 1,169 1,275
-------------- -----------------
Total assets....................................................... $ 62,872 $ 63,373
============== =================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable........................................................... $ 5,560 $ 6,023
Line of credit............................................................. 2,194 3,063
Accrued expenses and other................................................. 3,558 2,630
-------------- -----------------
Total current liabilities.......................................... 11,312 11,716
-------------- -----------------
Noncurrent liabilities:
Other noncurrent liabilities........................................... 1,032 1,098
-------------- -----------------
Total noncurrent liabilities....................................... 1,032 1,098
-------------- -----------------
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,
12,059,743 (2005) and 11,948,743 (2004) shares issued and
outstanding........................................................ 1,201 1,195
Additional paid-in capital................................................. 64,895 64,644
Accumulated deficit........................................................ (15,568) (15,280)
-------------- -----------------
Total shareholders' equity......................................... 50,528 50,559
-------------- -----------------
Total liabilities and shareholders' equity......................... $ 62,872 $ 63,373
============== =================
See notes to condensed consolidated financial statements.
3
Financial Statements-Continued
INNOTRAC CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED MARCH 31,
2005 2004
---------- ----------
(UNAUDITED) (UNAUDITED)
Revenues............................................... $ 19,239 $ 19,994
Cost of revenues....................................... 9,953 8,938
---------- ----------
Gross profit.......................... 9,286 11,056
---------- ----------
Operating expenses:
Selling, general and administrative expenses...... 8,255 9,484
Depreciation and amortization..................... 1,252 1,252
---------- ----------
Total operating expenses.................... 9,507 10,736
---------- ----------
Operating (loss) income............... (221) 320
---------- ----------
Other expense:
Interest expense................................. 67 93
---------- ----------
Total other expense.................. 67 93
---------- ----------
(Loss) income before income taxes...................... (288) 227
Income taxes........................................... - -
---------- ----------
Net (loss) income..................... $ (288) $ 227
========== ==========
(Loss) income per share:
Basic........................................... $ (0.02) $ 0.02
========== ==========
Diluted......................................... $ (0.02) $ 0.02
========== ==========
Weighted average shares outstanding:
Basic........................................... 12,000 11,634
========== ==========
Diluted......................................... 12,000 12,534
========== ==========
See notes to condensed consolidated financial statements.
4
Financial Statements-Continued
INNOTRAC CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004
(IN THOUSANDS)
THREE MONTHS ENDED MARCH 31,
2005 2004
----------- -----------
(UNAUDITED) (UNAUDITED)
Cash flows from operating activities:
Net (loss) income............................................................. $ (288) $ 227
Adjustments to reconcile net (loss) income to net cash provided by
operating activities:
Depreciation and amortization................................................. 1,252 1,252
(Decrease) increase in allowance for doubtful accounts........................ (522) 525
Amortization of deferred compensation............. ........................... . - 33
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable................................ 1,344 (1,199)
(Increase) decrease in inventory.......................................... (766) 4,603
Decrease (increase) in prepaid expenses and other......................... 316 (433)
Decrease in accounts payable.............................................. (463) (107)
Increase in accrued expenses and other................................. 879 411
----------- -----------
Net cash provided by operating activities............................ 1,752 5,312
----------- -----------
Cash flows from investing activity:
Capital expenditures.......................................................... (290) (588)
----------- -----------
Cash flows from financing activities:
Net repayments under line of credit........................................... (869) (5,687)
Repayment of capital lease and other obligations.............................. (18) (19)
Stock reacquired to settle employee stock bonus withholding tax obligation.... - (286)
Exercise of employee stock options............................................ 258 408
----------- -----------
Net cash used in financing activities............................... (629) (5,584)
----------- -----------
Net increase (decrease) in cash and cash equivalents............................... 833 (860)
Cash and cash equivalents, beginning of period..................................... 1,377 2,228
----------- -----------
Cash and cash equivalents, end of period........................................... $ 2,210 $ 1,368
=========== ===========
Supplemental cash flow disclosures:
Cash paid for interest........................................................ $ 60 $ 116
=========== ===========
Cash income tax refunds received, net of taxes paid........................... $ - $ -
=========== ===========
See notes to condensed consolidated financial statements.
5
INNOTRAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005 AND 2004
(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, 2004.
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 2005 in
accordance with SFAS No. 142, no impairment was determined to exist at
that time. Innotrac's goodwill carrying amount as of March 31, 2005 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.
Accounting for 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
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 call center
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 the number of calls, minutes or hourly
rate basis. All other revenues are recognized as services are rendered.
6
INNOTRAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005 AND 2004
(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 thousands, except per share
data):
THREE MONTHS ENDED
MARCH 31,
------------------
2005 2004
------- -----
Net (loss) income $ (288) $ 227
Pro forma net (loss) income $ (398) $ 120
Basic and diluted net (loss) income per share $ (0.02) $0.02
Basic and diluted pro forma net (loss) income
per share $ (0.03) $0.01
Under the fair value based method, compensation cost, net of tax, would
have been $110,000 and $107,000 for the three months ended March 31, 2005
and 2004, respectively.
During the three months ended March 31, 2005 and 2004, options
representing 61,000 and 75,750 shares were exercised, respectively.
2. FINANCING OBLIGATIONS
The Company has a revolving bank credit agreement with a maximum borrowing
limit of $25.0 million, which expires in June 2005. Although the maximum
borrowing limit is $25.0 million, the credit facility limits borrowings to
a specified percentage of eligible accounts receivable and inventory,
which totaled $15.1 million at March 31, 2005. At March 31, 2005 the
Company had $12.9 million available under the revolving credit agreement.
The Company has granted a security interest in all of its assets 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 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, 2005 was 1.51 to 1.00. Additionally, the revolving credit agreement
contains a minimum tangible net worth requirement of $24.0 million. The
Company's tangible
7
INNOTRAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005 AND 2004
(UNAUDITED)
net worth at March 31, 2005 was $25.2 million. Compliance with the minimum
tangible net worth covenant and other financial covenants is determined on
a quarterly basis.
Interest on borrowings is payable monthly at rates equal to the prime
rate, or at the Company's option, LIBOR plus up to 225 basis points.
Consistent with prior periods, on February 14, 2005, the Company fixed
$2.0 million of its $2.2 million of borrowings at the 90-day LIBOR rate of
4.27%. Interest expense of approximately $20,000 and $35,000 related to
the 90-day LIBOR was incurred for the three months ended March 31, 2005
and 2004, respectively. During the three months ended March 31, 2005 and
2004, the Company also incurred interest expense related to the variable
portion of the line of credit of approximately $32,000 and $39,000,
respectively, resulting in a weighted average interest rate of 4.76% and
3.22%, respectively. The Company also incurred unused revolving credit
facility fees of approximately $13,000 and $17,000 during the three months
ended March 31, 2005 and 2004, respectively.
3. EARNINGS PER SHARE
The following table shows the shares (in thousands) used in computing
diluted earnings per share ("EPS") in accordance with Statement of
Financial Accounting Standards No. 128:
Three Months
Ended March 31,
2005 2004
------ ------
Diluted earnings per share:
Weighted average shares outstanding........... 12,000 11,634
Employee and director stock options and
unvested restricted shares................... - 900
------ ------
Weighted average shares assuming
Dilution..................................... 12,000 12,534
====== ======
Options outstanding to purchase 1.5 million shares and 134,500 shares of
the Company's common stock for the three months ended March 31, 2005 and
2004, respectively, were not included in the computation of diluted EPS
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, 2005 and December 31, 2004 was approximately
$12.7 million and $12.8 million, respectively. This deferred tax asset was
generated primarily by net operating loss carryforwards created mainly 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, 2004 that expires between
2020 and 2024.
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
8
INNOTRAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005 AND 2004
(UNAUDITED)
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 $9.7 million has been recorded as of March
31, 2005 and December 31, 2004, respectively. Income taxes associated with
future earnings will be offset by a reduction in the valuation allowance.
For the three months ended March 31, 2005, the deferred tax benefit of
$93,000 was offset by a corresponding increase of the deferred tax asset
valuation allowance. When, and if, the Company can return to consistent
profitability, and management determines that it is likely 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 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 28.0% of the shares outstanding on
March 31, 2005. 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. No
shares have been issued under the Rights Plan.
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. 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. During
the three months ended March 31, 2005 and 2004, the Company did not meet
the minimum employee requirements of 359 full-time employees, as measured
on a quarterly basis, incurring a penalty of approximately $5,000 and
$4,000 for the three months ended March 31, 2005 and 2004, respectively.
9
INNOTRAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005 AND 2004
(UNAUDITED)
6. RELATED PARTY TRANSACTION
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 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, which is due no later than March 3, 2006.
In March 2005, the Company learned that trading activity by members of the
IPOF Group may have further violated the short swing profit rules under
Section 16(b). The Company promptly initiated another investigation and is
presently engaged in discussions with the IPOF Group regarding the
recovery by the Company of disgorgeable profits of the IPOF Group pursuant
to Section 16(b).
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
eight fulfillment centers and two call centers in six 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 offerings include 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
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 past several
years.
BUSINESS MIX
Three Months Ended
March 31,
Business Line/Vertical 2005 2004
- ---------------------- ----- -----
Telecommunications 13.3% 19.5%
Modems 19.9 22.1
Retail/Catalog 26.5 22.9
Direct Marketing 27.8 24.5
Business-to-Business ("B2B") 12.5 11.0
----- -----
100.0% 100.0%
===== =====
Telecommunications and Modems. 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 other telecommunications products to companies such as BellSouth
Corporation and Qwest Communications International, Inc. and their customers.
Inventory for our telecommunications and DSL 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, DSL modems and ancillary equipment. We anticipate that the
percentage of our revenues attributable to telecommunications and DSL modem
clients will remain fairly constant for the remainder of the year due mainly to
increased volumes (but at lower margins as compared to 2004) from our DSL modem
business, which is still in a strong growth mode. The telephone and caller ID
equipment business is mature, yet steady.
Retail, Catalog and Direct Marketing. The Company also provides a variety of
these services for a significant number of retail, catalog and direct marketing
clients, including such companies as The Coca-Cola Company, Ann Taylor Retail,
Inc., Smith & Hawken, Ltd., Porsche Cars North America, Inc., Nordstrom.com LLC,
and Thane International. We take orders for our retail, catalog and direct
marketing clients via the Internet, through customer service representatives 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 eight 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. Despite the end of the Tactica International, Inc.
business, which represented 5.0% of total revenues for the three months ended
March 31, 2004 and the end of the Martha Stewart Living Omnimedia business in
March 2005, which represented 1.2% and 4.4% of total revenues for the three
months ended March 31, 2005 and 2004, respectively, we anticipate that the
percentage of our revenues attributable to our retail and catalog clients will
remain fairly consistent during 2005 due to the anticipated additions of new
channels, product lines and division for existing clients, along with internal
growth and a strengthening of the overall economy.
On October 21, 2004, Tactica International, Inc. ("Tactica"), one of the
Company's direct response clients, filed a voluntary petition for relief under
Chapter 11 in U.S. Bankruptcy Court. On October 25, 2004 the
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Bankruptcy Court approved, on an interim basis, a Stipulation and Consent Order
("Stipulation") entered into between Tactica and Innotrac, whereby Tactica has
acknowledged the validity of Innotrac's claim and Innotrac's first priority
security interest in and warehouseman's lien on Tactica's inventory held by
Innotrac. This Stipulation allowed Tactica to continue to sell its inventory
while reducing the receivables owed by Tactica to Innotrac. The Stipulation
required that the proceeds from the sale of such inventory be split with
Innotrac 55%/45% on the first $1.6 million in customer orders and 60%/40%
thereafter upon receipt of Tactica customer payments. Additionally, Tactica was
required to prepay Innotrac for any services prior to its inventory being
shipped. Tactica defaulted on the Stipulation and on January 18, 2005, Innotrac
issued a Notice of Default to Tactica. In March 2005, Innotrac and Tactica
reached a verbal agreement that would permit Innotrac to liquidate the Tactica
inventory in order to pay down the receivable balance, with any excess proceeds
to be remitted to Tactica. Innotrac, Tactica and the Creditor's Committee have
reached an agreement on the terms of the liquidation and an additional amount of
the proceeds to be remitted to the unsecured creditors, which is expected to be
approved by the court by the end of May 2005. Based on this agreement and
management's estimate of the net realizable value of the inventory, the reserve
associated with the Tactica receivable was reduced from $1.2 million to $775,000
at March 31, 2005. As of March 31, 2005, Tactica owed $2.8 million in principal
to Innotrac for past fulfillment and call center services.
Business-to-Business. 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, 2005 and 2004. 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,
2005 2004
------ -----
Revenues............................................. 100.0% 100.0%
Cost of revenues..................................... 51.7 44.7
------ -----
Gross margin...................................... 48.3 55.3
Selling, general and administrative expenses......... 42.9 47.4
Depreciation and amortization........................ 6.5 6.3
------ -----
Operating (loss) income.......................... (1.1) 1.6
Other expense, net................................... 0.4 0.5
------ -----
(Loss) income before income taxes................ (1.5) 1.1
Income taxes......................................... - -
------ -----
Net (loss) income................................ (1.5)% 1.1%
====== =====
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2005 COMPARED TO THREE MONTHS ENDED MARCH 31, 2004
Revenues. Net revenues decreased 3.8% to $19.2 million for the three months
ended March 31, 2005 from $20.0 million for the three months ended March 31,
2004. This decrease was primarily attributable to the conclusion of two programs
for a major client and the termination of services for Tactica International,
Inc. and Martha Stewart Living Omnimedia business, partially offset by revenues
from several new clients and increased volumes from our direct marketing
clients.
Cost of Revenues. Cost of revenues increased 11.4% to $10.0 million for the
three months ended March 31, 2005, compared to $8.9 million for the three months
ended March 31, 2004. The cost of revenue increase was primarily due to an
increase in freight and labor expense related to the increase in volume for our
direct marketing clients and increased labor costs associated with increased
volumes for our retail/catalog and B2B clients.
Gross Profit. For the three months ended March 31, 2005, the Company's gross
profit decreased by $1.8 million to $9.3 million, or 48.3% of revenues, compared
to $11.1 million, or 55.3% of revenues, for the three months ended March 31,
2004. This decrease in gross profit was due primarily to a change in the
business mix to clients with lower margin revenue.
Selling, General and Administrative Expenses. S,G&A expenses for the three
months ended March 31, 2005 decreased to $8.3 million, or 42.9% of revenues,
compared to $9.5 million, or 47.4% of revenues, for the same period in 2004.
This net decrease was primarily attributable to a $440,000 reduction in the
allowance for doubtful accounts related to the Tactica receivable recorded in
2005, compared to an additional $464,000 in the allowance for doubtful accounts
related to the Tactica receivable recorded in 2004, and $206,000 of lower
account services related costs in 2005 as compared in 2004.
Interest Expense. Interest expense for the three months ended March 31, 2005
decreased to $67,000, compared to $93,000 for the same period in 2004. This
decrease was attributable to a reduction in borrowings from the line of credit
during the three months ended March 31, 2005 compared to the same period in
2004.
Income Taxes. The Company's effective tax rate for the three months ended March
31, 2005 and 2004 was 0%. At December 31, 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 losses and earnings for the three months ended
March 31, 2005 and 2004 were offset by a corresponding increase or reduction of
this valuation allowance resulting in an effective tax rate of 0% for the three
months ended March 31, 2005 and 2004.
LIQUIDITY AND CAPITAL RESOURCES
The Company funds its operations and capital expenditures primarily through cash
flow from operations and borrowings under a bank credit facility. The Company
had cash and cash equivalents of approximately $2.2 million at March 31, 2005 as
compared to $1.4 million at December 31, 2004. Additionally, the Company had
reduced its borrowings under its revolving credit facility (discussed below) to
$2.2 million outstanding at March 31, 2005, as compared to $3.1 million at
December 31, 2004. The Company generated positive cash flow from operations of
$1.8 million during the three months ended March 31, 2005. We anticipate
positive cash flows from operations during the remainder of 2005. In 2004, one
of the primary contributors to generating cash in the first three months was a
further reduction in 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.
14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company currently has a revolving credit agreement with a bank maturing in
June 2005. Although the facility has a maximum borrowing limit of $25.0 million,
the credit facility limits borrowings to a specified percentage of eligible
accounts receivable and inventory, which totaled $15.1 million at March 31,
2005. The Company has granted a security interest in all of its assets 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.
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. Consistent with
prior periods, on February 14, 2005, the Company fixed $2.0 million of its $2.2
million of borrowings at the 90-day LIBOR rate of 4.27%. Interest expense of
approximately $20,000 and $35,000 related to the 90-day LIBOR was incurred for
the three months ended March 31, 2005 and 2004, respectively. During the three
months ended March 31, 2005 and 2004, the Company also incurred interest expense
related to the variable portion of the line of credit of approximately $32,000
and $39,000, respectively, resulting in a weighted average interest rate of
4.76%, and 3.22%, respectively. The Company also incurred unused revolving
credit facility fees of approximately $13,000 and $17,000 during the three
months ended March 31, 2005 and 2004, respectively. At March 31, 2005, the
Company had $12.9 million of additional availability under the revolving credit
agreement.
During the three months ended March 31, 2005, the Company generated $1.8 million
in cash flow from operating activities compared to $5.3 million in the same
period in 2004. The decrease in cash provided from operating activities was
primarily the result of the reduction of $4.6 million in inventory in 2004
compared to an increase in inventory of $766,000 in 2005 offset by a net
decrease in accounts receivable of $822,000 in 2005 compared to a net increase
of $674,000 in 2004.
During the three months ended March 31, 2005, net cash used in investing
activities for capital additions was $290,000 as compared to $588,000 in 2004.
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, 2005, the net cash used in financing
activities was $629,000 compared to $5.6 million in the same period in 2004. The
primary difference between years is attributable to a reduction in outstanding
borrowings of $869,000 in 2005 compared to 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,
compared to $258,000 generated in 2005.
The Company estimates that its cash and financing needs through 2005 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 four years and
anticipates doing so again in 2005. 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
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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
to the condensed consolidated financial statements in this Form 10-Q and Note 2
to the consolidated financial statements appearing in our Annual Report on Form
10-K for the year ended December 31, 2004. 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, 2005 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 an 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 2005. The
valuation supported that the fair value of the reporting unit at January 1, 2005
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.
Accounting for 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 more likely than not that
deferred tax assets will not be realized. Innotrac's gross deferred tax asset as
of March 31, 2005 and December 31, 2004 was approximately $12.7 million and
$12.8 million, respectively. 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, 2004 that expires between 2020 and 2024.
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.
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 $9.7 million
has been recorded as of March 31, 2005 and December 31, 2004. Income taxes
associated with future earnings will be offset by a reduction in the valuation
allowance. For the three months ended March 31, 2005, an income tax benefit of
$93,000 was offset by a corresponding increase 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 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.
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company makes estimates each reporting period associated with its reserve
for uncollectible accounts. These estimates are based on the aging of the
receivables and known specific facts and circumstances. One of Innotrac's direct
marketing clients, Tactica, with a substantial past due balance at March 31,
2005 and December 31, 2004, filed for Chapter 11 bankruptcy protection on
October 21, 2004. Subsequently, Innotrac and Tactica entered into a Stipulation
and Consent Order whereby the client has acknowledged the validity of the
Company's claim and first priority security interest in and warehouseman's lien
on Tactica's inventory held by Innotrac. In March 2005, Innotrac and Tactica
reached a verbal agreement that would permit Innotrac to liquidate the Tactica
inventory in order to pay down the receivable balance, with any excess proceeds
to be remitted to Tactica. Innotrac, Tactica and the Creditor's Committee have
reached an agreement on the terms of the liquidation and an additional amount of
the proceeds to be remitted to the unsecured creditors, which is expected to be
approved by the court by the end of May 2005. Based on this agreement and
management's estimate of the net realizable value of the inventory, the reserve
associated with the Tactica receivable was reduced from $1.2 million to $775,000
at March 31, 2005. As of March 31, 2005, Tactica owed $2.8 million in principal
to Innotrac for past fulfillment and call center services.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS" No. 123(R), "Share-Based
Payment," which revises SFAS No. 123, "Accounting for Stock-Based Compensation."
The revised Statement clarifies and expands SFAS No. 123's guidance in several
areas, including measuring fair value, classifying an award as equity or as a
liability, and attributing compensation cost to reporting periods. The revised
statement supercedes Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"), and its related implementation guidance.
Under the provisions of SFAS 123(R), the alternative to use APB 25's intrinsic
value method of accounting that was provided in SFAS No. 123, as originally
issued, is eliminated, and entities are required to measure liabilities incurred
to employees in share-based payment transactions at fair value. The Company
currently accounts for its stock-based compensation plans under 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. SFAS No. 123(R) is effective for the Company
beginning January 1, 2006.
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, 2004 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 Officer and the
principal financial officer, evaluated our disclosure controls and procedures
(as defined in federal securities rules) as of March 31, 2005. 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 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 principal financial officer 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 2005.
18
PART II - OTHER INFORMATION
ITEM 6 - EXHIBITS
Exhibits:
31.1 Certification of Chief Executive Officer Pursuant to Rule
13a-14(a)/15d - 14(a).
31.2 Certification of principal 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 principal financial officer Pursuant to 18
U.S.C. Section 1350.
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 16, 2005 By: /s/ Scott D. Dorfman
-----------------------------------------------
Scott D. Dorfman
President, Chief Executive Officer and Chairman
of the Board (Principal Executive Officer)
Date: May 16, 2005 /s/ Christine A. Herren
-----------------------------------------------
Christine A. Herren
Senior Director and Controller (Principal
Financial Officer and Principal Accounting
Officer)
20