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INOC > SEC Filings for INOC > Form 10-Q on 13-May-2013All Recent SEC Filings

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Form 10-Q for INNOTRAC CORP


13-May-2013

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, is an eCommerce provider integrating digital technology, order processing, fulfillment and customer support "contact" center services to support global brands of large corporations that outsource these functions. In order to perform these 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 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.

Innotrac receives 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.

Innotrac's 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

Contact Center Services:

? inbound customer support services


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

? 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

The Company provides a variety of services for a significant number of eCommerce, retail, and direct marketing companies such as Target.com, a division of Target Corporation, Ann Taylor Retail, Inc., Microsoft, AT&T, Beachbody, LLC and Thane International. We take orders for our eCommerce, retail and direct marketing clients via the Internet, through customer service representatives at our Pueblo, Colorado call center or through direct electronic transmissions 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 locations, as applicable, typically within 24 hours of when the order is received. Inventory is held on a consignment basis, with certain exceptions, and includes items such as clothing, brand name promotional accessories, books, electronics, small appliances, home accessories, sporting goods and toys.

The following table sets forth the percentage of service revenues generated by the Company's various customer business verticals during 2013 and 2012:

                                             Three Months Ended March 31,
          Business Line/Vertical               2013                2012
            eCommerce/Direct-to-Consumer            78.8 %              69.6 %
            Direct Marketing                        12.6                19.0
            B2B and Telecommunications               8.6                11.4
                                                   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 2013 and 2012 based on the predominant category of the client's revenues for the year ended 2013.

The Company is a major provider of fulfillment and customer support services to eCommerce/Direct to Consumer and Direct Marketing industries. For eCommerce and Direct to Consumer businesses, we provide complete integration capabilities between a client's order entry systems, Internet shopping carts, PCI Level 1 compliant credit card processors and product supply sources. Our warehouse management systems provide real time reporting on order fulfillment, stock availability and freight carrier shipment tracking to the end consumer. Our technology integration strategy provides the ability to quickly develop client specific gateways between the major providers of website design hosting services while providing EDI reporting to client based management systems.

Since 2011, Innotrac Europe GmbH, a joint venture with PVS Fulfillment-Services GmbH, has offered end-to-end fulfillment services in Europe. Innotrac Europe provides a fast to market solution to our United States based clients who want to enter the European market. Additionally, eCommerce providers and retailers in Europe have easy visibility to Innotrac's capabilities through on the ground marketing and business development efforts employed by Innotrac Europe.


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

The Company also provides services, including customer and distributor communication programs, retailer product rework/finishing services and supplier/retailer compliance reporting for business-to-business ("B2B") clients including NAPA, The Walt Disney Company, and Spanx. The Company has historically been a major provider of fulfillment and customer support services to the telecommunications industry. Consolidation in the industry at the product supply level and changes in the technology of delivery mediums used by the telecommunications industry since 2000 has resulted in a lesser concentration of our service revenues from this industry. Accordingly, we now present our service revenue by customer vertical information with B2B services and telecommunications as a single segment.

With facilities in Atlanta, Georgia; Pueblo, Colorado; Reno, Nevada; Bolingbrook, Illinois; Columbus, Ohio; Groveport, Ohio; and two facilities in Hebron, Kentucky, we offer a national footprint to our customers. We are committed to deeper penetration within our existing business lines and continued diversification of our client base. Our long-term goal is to focus on current market growth trends while spreading our business across a higher number of clients in diverse industries to provide stability during difficult economic periods and avoid the risks associated with high individual account concentration and seasonality. We will continue to seek new clients and may open additional facilities as needed to service our customers' business needs.

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, 2013 and 2012. 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 accompanying condensed consolidated financial statements.

                                                              Three Months Ended March 31,
                                                            2013                2012

Service revenues                                                     86.9 %              88.2 %
Freight revenues                                                     13.1                11.8
  Total Revenues                                                    100.0 %             100.0 %

Cost of service revenues                                             43.0                42.8
Freight expense                                                      12.6                11.5
Selling, general and administrative expenses                         37.4                40.3
Depreciation and amortization                                         3.2                 3.4
  Operating income                                                    3.8                 2.0
Other expense, net                                                    0.3                 0.2
  Income before income taxes                                          3.5                 1.8
Income tax (provision) benefit                                          -                   -
Net income (loss) attributable to noncontrolling interest               -                   -
  Net income                                                          3.5 %               1.8 %


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

Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012

Service Revenues. Net service revenues increased 19.5% to $25.5 million for the three months ended March 31, 2013 from $21.3 million for the three months ended March 31, 2012. This increase was attributable to a $5.0 million increase in revenue from our eCommerce clients due to the addition of several new eCommerce clients and increases in volumes from existing clients offset by a $642,000 decrease in revenue from existing Direct Marketing clients due to a reduction in volume.

Freight Revenues. The Company's freight revenues increased 35.1% to $3.9 million for the three months ended March 31, 2013 from $2.9 million for the three months ended March 31, 2012. The $1.0 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 the Company's lower margins on our freight business.

Cost of Service Revenues. Cost of service revenues increased 22.1% to $12.6 million for the three months ended March 31, 2013, compared to $10.3 million for the three months ended March 31, 2012. Cost of service revenues as a percent of service revenues increased slightly to 49.5% from 48.5% mainly due to customer mix in the first quarter of 2013 when compared to the first quarter of 2012.

Freight Expense. The Company's freight expense increased 33.7% to $3.7 million for the three months ended March 31, 2013 compared to $2.8 million for the three months ended March 31, 2012 due to the increase in freight revenue as discussed above.

Selling, General and Administrative Expenses. SG&A expenses for the three months ended March 31, 2013 increased 12.4% to $11.0 million compared to $9.7 million for the same period in 2012. SG&A expenses as a percent of total revenues decreased to 37.4% from 40.3% for the comparable three months ended March 31, 2013 and 2012, respectively. The increase in SG&A expenses primarily resulted from a $398,000 increase in facility and facility management costs due to the addition of several new clients and an $816,000 net increase in all other SG&A costs, which includes increased sales commissions related to new clients, recruitment costs for open positions and information technology costs. SG&A expenses as a percentage of total revenue decreased due to the Company maximizing its operating leverage through the growth in revenue from eCommerce clients.

Interest Expense. Interest expense for the three months ended March 31, 2013 and 2012 was $78,000 and $53,000, respectively. Interest expense related to capital leases increased to $17,000 during the three months ended March 31, 2013 compared to $10,000 during the same quarter in 2012. Interest expense related to the Equipment Loan was $16,000 for the three months ended March 31, 2013.

Income Taxes. The Company's effective tax rate for the three months ended March 31, 2013 and 2012 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 March 31, 2013 and March 31, 2012 were offset by a respective corresponding decrease of the valuation allowance resulting in an effective tax rate of 0% for the three 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 of 0.75% on undrawn amounts under the Credit Facility. 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 $3.5 million for 2013,

b. 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.

For the period ending March 31, 2013, the Company reported a twelve month trailing fixed charge ratio of greater than 1.2, resulting in the Availability Block being reduced to $2.5 million as provided by the Third Amendment. The Company expects the fixed charge ratio to remain above 1.2 for the remainder of 2013.

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 March 31, 2013 the Company was in compliance with all terms of the Credit Facility.

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 March 31, 2013, there was $1.5 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.


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

The total collateral, excluding the equipment value supporting the Equipment Loan, under the Credit Facility at March 31, 2013 amounted to $14.0 million. Excluding the Equipment Loan, there were no amounts borrowed under the Credit Facility at March 31, 2013 however the value of the availability block and letters of credit outstanding at that date totaled $3.6 million. As a result, the Company had $10.4 million of borrowing availability under the Credit Facility at March 31, 2013.

For the three months ended March 31, 2013 and March 31, 2012, we recorded $130 and $3,000 of interest expense on the Credit Facility, at a weighted average interest rate of 3.02% for the three months ended March 31, 2013 and a weighted average interest rate of 3.35% for the three months ended March 31, 2012. The rate of interest being charged on the Credit Facility at March 31, 2013 was 3.20%. The Company also incurred unused Credit Facility fees of approximately $23,000 and $26,000 for the three months ended March 31, 2013 and 2012 respectively, which unused Credit Facility fees are included in the total interest expense of $78,000 and $53,000 for the three months ended March 31, 2013 and 2012 respectively.

For the three months ended March 31, 2013, the Company generated cash from operating activities of $736,000 compared to using $388,000 of cash flow for operations in the same period of 2012. The $1.1 million increase in cash generated by operating activities for the three months ended March 31, 2013 from the same period in 2012 was due primarily to an increase in net income of $0.6 million for the three months ended March 31, 2013 compared to the same period in 2012 and to the net change in all operating assets and liabilities using $1.2 million of cash during the three months ended March 31, 2013 compared to using $1.7 million during the same period in 2012. The $0.5 million increase in cash provided by operating assets and liabilities for the three months ended March 31, 2013 compared to 2012 resulted mainly from the $3.2 million of cash provided by accounts receivable in 2013 compared to $837,000 in 2012 offset by a decrease in accounts payable and accruals of $4.2 million in the three months ended March 31, 2013 compared to $2.4 million in the three months ended March 31, 2012. The $3.2 million increase in cash provided by accounts receivable was primarily due to a decrease in accounts receivable from the higher seasonal balance at December 31, 2012 as a result of collections. The $4.2 million increase in cash used by accounts payable and accruals was due to the payment of vendor payables for temporary employees and other suppliers to support the increased volume during the seasonal fourth quarter of 2012.

During the three months ended March 31, 2013 and 2012, net cash used in investing activities consisted mainly of capital expenditures and were $0.4 million and $1.7 million respectively. The $0.4 million of investing activities for the three months ended March 31, 2013 was mainly capital expenditures for all facilities which is comparable to the $0.6 million spent in the three months ending March 31, 2012 for capital expenditures excluding the new Groveport facility. The $1.7 million of investing activities for the three months March 31, 2012 includes i) $1.1 million of purchased equipment for the build out of our new fulfillment center in Groveport, Ohio and ii) $0.6 million for all other capital expenditures.

As of March 31, 2013 and March 31, 2012, there were no borrowings under the line of credit. The average daily borrowings outstanding on the Credit Facility for the three months ended March 31, 2013 and 2012 were $17,000 and $317,000, respectively. The maximum borrowing outstanding on the Credit Facility for any one day during the three months ended March 31, 2013 and 2012 were $598,000 and $2.1 million, respectively. During the three months ended March 31, 2013 and 2012, the Company repaid $103,000 and $114,000 of principal outstanding on capital leases respectively. Additionally, during the three months ended March 31, 2012, the Company incurred $15,000 of loan commitment fees as a result of the Third Amendment to the Credit Agreement. No loan commitment fees were incurred in the three months ending March 31, 2013.


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

The Company estimates that its cash and financing needs through at least the next twelve months will be met by available cash, additional cash flows from operations and availability under the Credit Facility. Since the Credit Facility matures on June 30, 2013, the Company has entered into discussions with several banks including Wells Fargo, N.A. to secure a bank facility beyond that date. As a result of those discussions, the Company expects to be able to secure a new facility at terms at least as favorable as the existing Credit Facility. However, as set forth in the Company's 2012 Annual Report on Form 10-K, if the Company is unable to negotiate a new credit facility, the Company's liquidity could be adversely impacted.

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 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, 2012. 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.

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.

Accounting for Income Taxes. Innotrac utilizes the liability method of accounting for income taxes in accordance with ASC topic No. 740 - 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, 2013 and December 31, 2012 was approximately $21.8 million and $22.3 million, respectively. This deferred tax asset was generated primarily by net operating loss carryforwards created by net losses in prior years. Innotrac has Federal net operating loss carryforwards of $52.1 million at December 31, 2012 that expires between 2021 and 2033.

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 $19.8 million and $20.3 million has been recorded as of March 31, 2013 and December 31, 2012, respectively. Income taxes associated with future earnings will be offset by the . . .

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