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INOC > SEC Filings for INOC > Form 10-Q on 13-Nov-2012All Recent SEC Filings

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Form 10-Q for INNOTRAC CORP


13-Nov-2012

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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; the effect on the Company of economic downturns; 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 in "Item 1A - Risk Factors" in our Annual Report on Form 10-K. We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

Overview

Innotrac Corporation ("Innotrac" or the "Company"), founded in 1984 and headquartered in Atlanta, Georgia, provides order processing, fulfillment and customer support "contact" center services to large corporations that outsource these functions. In order to perform contact 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 our clients and to reduce their overall operating costs.

We provide our services in the United States through an integrated network of eight fulfillment centers having a total footprint of 2.8 million square feet and one contact center which is expandable to over 400 workstations. Through Innotrac Europe, a joint venture created in 2011 and headquartered in Germany, we provide end to end fulfillment services in Europe through a network of operations with over 20 years of experience.

We receive most of our clients' orders either through inbound contact 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 fulfillment and customer support services interrelate and are sold as a package, however they are individually priced. Our clients may utilize our fulfillment services, our customer support services, or both, depending on their individual needs.

Our core competencies 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 and freight optimization modeling for shipment cost reduction ? product sourcing and procurement
? packaging solutions
? back-order management
? returns management
? eCommerce consulting and integration


MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Contact Center Services:
? inbound customer support services
? technical support and order status
? returns and refunds processing
? call center integrated into fulfillment platform ? cross-sell/up-sell services
? collaborative chat
? intuitive e-mail response

Business Mix - Revenues

                                              Three Months Ended          Nine Months Ended
                                                 September 30,              September 30,
     Business Line/Vertical                    2012          2011          2012         2011
       eCommerce / Direct-to-Consumer             75.2 %       67.9 %         73.0 %      63.6 %
       Direct Marketing                           14.6         16.1           16.2        20.1
     Modems & Telecommunications products          8.1         12.8            8.6        13.3
       Business-to-Business ("B2B")                2.1          3.2            2.2         3.0
                                                 100.0 %      100.0 %        100.0 %     100.0 %

Note: The above table is compiled by presenting the total of any individual client in a single Business Line/Vertical consistently in the years 2012 and 2011 based on the predominant category of the client's revenues for the year ended December 31, 2011.

eCommerce/Direct-to-Consumer and Direct Marketing. The Company is a major provider of fulfillment and customer support services to eCommerce/Direct to Consumer and Direct Marketing clients which include such companies as Target.com, a division of Target Corporation, Ann Taylor Retail, Inc., Microsoft, Inc., Beachbody, LLC and Thane International. Our revenues are a result of the number of orders and customer service calls received. Our client contracts generally do not guarantee volumes. We anticipate that the percentage of our revenues attributable to our eCommerce and direct-to-consumer clients will increase during the remainder of 2012 as we expect the growth in business from this group of clients to be higher than our other client categories.

Modems and Telecommunications. The Company has historically been a major provider of fulfillment and customer support services to the telecommunications industry. The consolidation in that industry over the last several years has resulted in a heavy concentration of volume in a few companies, and accordingly, concentration of the service providers to the telecommunication industry. We continue to provide fulfillment and technology services for several telecommunication companies however we project that the consolidation of service providers in this vertical will result in its percentage of our total revenue to continue to decline as the eCommerce/Direct-to-consumer vertical grows more quickly as a percentage of our total revenue.

Business-to-Business. The Company also provides fulfillment and customer support services for business-to-business ("B2B") clients, including NAPA and The Walt Disney Company. Although we continue to provide services to businesses in this vertical, we expect future revenues in this category to remain a smaller portion of our total business mix.


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 and nine months ended September 30, 2012 and 2011. The data has been prepared on the same basis as the annual 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             Nine Months Ended
                                              September 30,                 September 30,
                                           2012           2011            2012          2011

Service revenues                              86.0 %         90.3 %          87.7 %        87.1 %
Freight revenues                              14.0            9.7            12.3          12.9
  Total Revenues                             100.0 %        100.0 %         100.0 %       100.0 %

Cost of service revenues                      40.3           41.4            41.7          39.8
Freight expense                               13.5            9.5            11.9          12.8
Selling, general and administrative
expenses                                      37.7           47.1            39.7          46.0
Depreciation and amortization                  3.9            4.3             3.7           4.3
  Operating income (loss)                      4.6           (2.3 )           3.0          (2.9 )
Other expense, net                            (0.3 )         (0.2 )          (0.3 )        (0.2 )
  Income (loss) before income taxes            4.3           (2.5 )           2.7          (3.1 )
Income tax benefit                               -              -               -             -
Net income (loss) attributable to
noncontrolling interest                          -              -               -             -
  Net income (loss)                            4.3 %         (2.5 )%          2.7 %        (3.1 )%

Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011

Service Revenues. Net service revenues increased 25.3% to $22.1 million for the three months ended September 30, 2012 from $17.6 million for the three months ended September 30, 2011. This increase was attributable to a $4.8 million increase in revenue from our eCommerce clients and a $239,000 increase in revenue from our direct marketing clients due to the addition of several new clients and increases in volumes from existing clients, offset by i) a $436,000 decrease in revenue from our modems and telecommunications clients due to a decrease in volume; and ii) a $100,000 decrease in revenue from our B2B clients due to the reduction in volume.

Freight Revenues. The Company's freight revenues increased 90.4% to $3.6 million for the three months ended September 30, 2012 from $1.9 million for the three months ended September 30, 2011. The $1.7 million increase in freight revenues is primarily attributable to new clients that utilize Company owned freight accounts. Changes between reporting periods in freight revenue do not have a material impact on our operating profitability due to pricing practices for direct freight costs.


MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cost of Service Revenues. Cost of service revenues increased 28.4% to $10.4 million for the three months ended September 30, 2012, compared to $8.1 million for the three months ended September 30, 2011. Cost of service revenues as a percent of service revenues increased slightly to 46.9% from 45.8% mainly due to a higher usage of temporary labor in the third quarter of 2012 when compared to the third quarter of 2011 in response to new customer activity using a higher percentage of temporary labor as the Company gauges its long term staffing needs for such new customer activity.

Freight Expense. The Company's freight expense increased 86.7% to $3.5 million for the three months ended September 30, 2012 compared to $1.9 million for the three months ended September 30, 2011 due to the increase in freight revenue as discussed above.

Selling, General and Administrative Expenses. S,G&A expenses for the three months ended September 30, 2012 increased to $9.7 million compared to $9.2 million for the same period in 2011. S,G&A expenses as a percent of total revenues decreased to 37.7% from 47.1% for the comparable three months ended September 30, 2012 and 2011, respectively. The increase in S,G&A expenses primarily resulted from a $164,000 increase in facility and facility management costs due to the addition of several new clients and a $324,000 net increase in all other S,G&A costs, which includes increased sales commissions related to new clients, recruitment costs for open positions and adjustments to the Company's worker's compensation claims reserve. S,G&A expenses as a percentage of total revenue decreased due to the service revenue increases being achieved with lesser increases in supporting SG&A expenses.

Interest Expense. Interest expense for the three months ended September 30, 2012 and 2011 was $90,000 and $44,000, respectively. Interest expense related to capital leases increased to $25,000 during the three months ended September 30, 2012 compared to $3,000 during the same quarter in 2011. Interest expense related to the new Equipment Loan was $19,000 for the three months ended September 30, 2012.

Income Taxes. The Company's effective tax rate for the three months ended September 30, 2012 and 2011 was 0%. A valuation allowance continues to be recorded against the Company's net deferred tax assets as historical losses have created uncertainty about the realization of tax benefits in future years. Income taxes associated with the profits from the three months ended September 30, 2012 and losses from the three months ended September 30, 2011 were offset by a respective corresponding decrease and increase of the valuation allowance resulting in an effective tax rate of 0% for the three months ended in the respective periods.

Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011

Service Revenues. Net service revenues increased 24.0% to $63.9 million for the nine months ended September 30, 2012 from $51.5 million for the nine months ended September 30, 2011. This increase was attributable to i) a $13.6 million increase in revenue from our eCommerce clients due to the addition of several new clients and increases in volumes from existing clients, and ii) a $537,000 increase in revenue from our direct marketing clients due to the addition of a new client and increases in volumes from existing clients, offset by a $1.7 million decrease in revenue from our modems and telecommunications clients due to a decrease in volume.

Freight Revenues. The Company's freight revenues increased 17.8% to $9.0 million for the nine months ended September 30, 2012 from $7.6 million for the nine months ended September 30, 2011. The $1.4 million increase in freight revenues is primarily attributable to increased volumes from a new direct marketing client and other existing direct marketing and ecommerce clients which use our freight accounts partially offset by two of our direct marketing clients transitioning all or a portion of their freight usage from Company owned freight accounts to their own freight account during the first half of 2011. Changes between reporting periods in freight revenue do not have a material impact on our operating profitability due to pricing practices for direct freight costs.


MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cost of service revenues. Cost of service revenues increased 29.0% to $30.3 million for the nine months ended September 30, 2012, compared to $23.5 million for the nine months ended September 30, 2011. Cost of service revenues as a percent of service revenues increased slightly to 47.5% from 45.6% mainly due to a higher usage of temporary labor during the nine months ended September 30, 2012 when compared to the same period in 2011 in response to a change in the mix of revenues by client and new customer activity using a higher percentage of temporary labor as the Company gauges its long term staffing needs for such new customer activity.

Freight Expense. The Company's freight expense increased 14.3% to $8.6 million for the nine months ended September 30, 2012 compared to $7.6 million for the nine months ended September 30, 2011 due to the decrease in freight revenue as discussed above.

Selling, General and Administrative Expenses. S,G&A expenses for the nine months ended September 30, 2012 increased to $28.9 million, or 39.7% of total revenues, compared to $27.2 million, or 46.0% of total revenues, for the same period in 2011. The increase in S,G&A expenses primarily resulted from a $806,000 increase in facility and facility management costs due to the addition of several new clients, a $429,000 increase in information technology costs due to costs related to new client implementations and a $507,000 net increase in all other S,G & A costs, which includes increased sales commissions related to new clients and adjustments to the Company's worker's compensation claims reserve. S,G&A expenses as a percentage of total revenue decreased due to the service revenue increases being achieved with lesser increases in supporting SG&A expenses.

Interest Expense. Interest expense for the nine months ended September 30, 2012 and September 30, 2011 was $212,000 and $138,000, respectively. The average daily amount of debt outstanding on the Credit Facility remained flat at $278,000 during the nine months ended September 30, 2012 compared to $304,000 during the same period in 2011. Interest expense related to capital leases increased to $52,000 during the nine months ended September 30, 2012 compared to $14,000 during the same period in 2011. Interest expense related to the new Equipment Loan was $20,000 for the nine months ended September 30, 2012.

Income Taxes. The Company's effective tax rate for the nine months ended September 30, 2012 and 2011 was 0%. A valuation allowance continues to be recorded against the Company's net deferred tax assets as historical losses have created uncertainty about the realization of tax benefits in future years. Income taxes associated with the profits from the nine months ended September 30, 2012 and losses from the nine months ended September 30, 2011 were offset by a respective corresponding decrease and increase of the valuation allowance resulting in an effective tax rate of 0% for the nine months ended in the respective periods.

Liquidity and Capital Resources

The Company has a revolving credit facility (the "Credit Facility") with Wells Fargo, N.A. (the "Bank") which has a maximum borrowing limit of $15.0 million. The Credit Facility is used to fund the Company's capital expenditures, operational working capital and seasonal working capital needs. The Credit Facility was renewed on March 27, 2009 when the Company entered into the Fourth Amendment and Restatement to the Credit Facility with the Bank, setting forth the new terms of the Credit Facility. The Credit Facility has been further amended by the First, Second and Third Amendments on May 14, 2010, March 30, 2011 and March 29, 2012 respectively. The amended Credit Facility includes a maturity date of June 30, 2013 and continues the Bank's security interest in all of the Company's assets.


MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Third Amendment, among other terms, provided for inclusion of the Equipment Loan within the $15.0 million borrowing limit and amended the definition of the assets of the Company included in the collateral supporting the Credit Facility to include up to $1.8 million of fulfillment equipment as valued by an independent appraiser. The Equipment Loan has a five year repayment term and will be paid back in 60 equal $30,000 monthly payments with an equal offsetting monthly reduction in the value of the selected fulfillment equipment included as collateral under the Credit Facility.

Interest on borrowings outstanding under the Credit Facility, other than amounts advanced under the Equipment Loan, is payable monthly at specified rates of either, at the Company's option, the Base Rate (as defined in the Credit Facility) plus between 2.00% and 2.50%, or the LIBOR Rate (as defined in the Credit Facility) plus between 3.00% and 3.50%, in each case with the applicable margin depending on the Company's Average Excess Availability (as defined in the Credit Facility). Interest on amounts advanced and outstanding under the Equipment Loan will be payable monthly at an annual interest rate of, at the Company's option, either the Base Rate (as defined in the Credit Facility) plus 3.00% or the LIBOR Rate (as defined in the Credit Facility) plus 4.0%. The Company pays a specified fee on undrawn amounts under the Credit Facility which fee was one-half of one percent, or 0.5% on and before March 30, 2011, the date of Second Amendment to the Credit Agreement, and is three quarters of one percent, or 0.75% thereafter. After an event of default, all loans will bear interest at the otherwise applicable rate plus 2.00% per annum.

The Credit Facility contains financial, affirmative and negative covenants by the Company as are usual and customary for financings of this kind which can result in the acceleration of the maturity of amounts borrowed under the Credit Facility, including, without limitation, a restriction on cash dividends, a change in ownership control covenant, a subjective material adverse change covenant and financial covenants. As amended by the First, Second and Third Amendments, the Credit Facility includes the following financial covenants:
a. an annual capital expenditure limit of $6.0 million for the 12 months ended December 31, 2012 and $3.5 million for 2013,

b. an Availability Block (as defined by the Credit Facility) of $3.0 million from January 1, 2012 to March 29, 2012 when the Third Amendment was signed,

c. after March 29, 2012 an Availability Block of $4.0 million, which block will be reduced to $3.0 million when the twelve month trailing fixed charge ratio (as defined by the Credit Facility) exceeds 1.1, and further reduced to $2.5 million when both the trailing twelve month fixed charge ratio has a) exceeded 1.2 for three consecutive months and b) is projected to exceed 1.2 for the immediately upcoming three consecutive months.

During the three months ended September 30, 2012, the Company estimated that capital expenditures for the twelve months ended December 31, 2012 required to support new business would exceed the $6.0 million limit. Based on this estimate and the Company's discussions with the Bank, the limit was raised to $6.4 million for 2012. Additionally, in September, the Company reported a twelve month trailing fixed charge ratio of greater than 1.1 resulting in the Availability Block being reduced to $3.0 million as provided by the Third amendment. The Company expects the fixed charge ratio to remain above 1.1 for the remainder of 2012.

The provisions of the Credit Facility require that the Company maintain a lockbox arrangement with the Bank, and allows the Bank to declare any outstanding borrowings to be immediately due and payable as a result of noncompliance with any of the covenants. Accordingly, in the event of noncompliance, the Company's payment obligations with respect to such borrowings could be accelerated. Therefore, amounts outstanding on the Company's Credit Facility and any amount outstanding on the Equipment Loan, which is in the $15.0 million Credit Facility Limit, are classified as a current liabilities. As of September 30, 2012 the Company was in compliance with all terms of the Credit Facility.


MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Under the terms of the Credit Facility, the maximum borrowing limit of $15.0 million is limited to borrowings at a specified percentage of eligible accounts receivable and inventory, plus up to $1.8 million appraised value of equipment. As of September 30, 2012, there was $1.7 million advanced under the equipment loan. Additionally, the terms of the Credit Facility provide that the amount borrowed and outstanding at any time combined with certain reserves for rental payments, letters of credit outstanding and an availability block be subtracted from the Credit Facility limit or the value of the total collateral to arrive at an amount of unused availability to borrow.

The total collateral, excluding the equipment value supporting the Equipment Loan, under the Credit Facility at September 30, 2012 amounted to $14.1 million. Excluding the Equipment Loan, there were no amounts borrowed under the Credit Facility at September 30, 2012 however the value of the availability block and letters of credit outstanding at that date totaled $4.2 million. As a result, the Company had $9.9 million of borrowing availability under the Credit Facility at September 30, 2012.

For both the three months ended September 30, 2012 and September 30, 2011, we recorded less than $1,000 of interest expense on the Credit Facility, at a weighted average interest rate of 3.27% for the three months ended September 30, 2012 and a weighted average interest rate of 3.23% for the three months ended September 30, 2011. The rate of interest being charged on the Credit Facility at September 30, 2012 was 3.21%. The Company also incurred unused Credit Facility fees of approximately $23,000 and $27,000 for the three months ended September 30, 2012 and 2011 respectively, which unused Credit Facility fees are included in the total interest expense of $90,000 and $44,000 for the three months ended September 30, 2012 and 2011 respectively.

For the nine months ended September 30, 2012, we recorded interest expense of $7,000 on the Credit Facility at a weighted average interest rate of 3.28%. For the nine months ended September 30, 2011, we recorded interest expense of $7,000 on the Credit Facility at a weighted average rate of 3.14%. The Company also incurred unused revolving credit facility fees of approximately $75,000 and $69,000 for the nine months ended September 30, 2012 and 2011, respectively. Additionally, the Company reported total interest expense of $212,000 and $138,000 the nine months ended September 30, 2012 and 2011, respectively.

For the nine months ended September 30, 2012, the Company generated positive cash from operating activities of $1.7 million compared to $4.7 million cash from its operating activities in the same period of 2011. The $3.0 million decrease for the nine months ended September 30, 2012 from the same period in 2011 was due to the net change in all operating assets and liabilities using $3.1 million of cash during the nine months ended September 30, 2012 compared to providing $4.0 million during the same period in 2011, offset by the Company generating a net income of $2.0 million for the nine months ended September 30, 2012 compared to generating a net loss of $1.8 million in the same period in 2011. The $7.1 million decrease in cash provided by operating assets and liabilities for the nine months ended September 30, 2012 compared to 2011 resulted mainly from the combined effect of i) $5.2 million decrease in cash provided by accounts receivable for the nine months ended September 30, 2012 compared to the same period in 2011 due to higher growth in revenue during 2012 compared to revenue growth in 2011, ii) $2.6 million greater decreases in inventory occurring in 2011 than in 2012 as a result of the end of an inventory buyback program in 2011 for a single client discussed below, and iii.) $1.0 million greater increase in prepaid and other long-term assets and greater decrease in long-term liabilities related to the impact of straight lining rent expense for our facilities and prepaid maintenance items, offset by a $1.7 million decrease in cash used in accounts payable and accrued expenses in 2012 compared to 2011. The $1.7 million decrease in cash used for accounts payable and accrued expenses was primarily due to an overall increase in vendor payables balance outstanding as of September 30, 2012 due to an increase in temporary employees and amounts due other suppliers to support the increased volume in 2012.

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