-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QD/aX34QNsrobgvcQT2lNBfos9cDbJUkD/Q54ewnNB0p2ibYiiCfvboOi+E3Ra4U 4+DP5i/A07bfBen7rnBN5Q== 0000950144-04-003249.txt : 20040330 0000950144-04-003249.hdr.sgml : 20040330 20040330141641 ACCESSION NUMBER: 0000950144-04-003249 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 14 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INNOTRAC CORP CENTRAL INDEX KEY: 0001051114 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-BUSINESS SERVICES, NEC [7389] IRS NUMBER: 581592285 STATE OF INCORPORATION: GA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-23741 FILM NUMBER: 04699918 BUSINESS ADDRESS: STREET 1: 6655 SUGARLOAF PARKWAY CITY: DULUTH STATE: GA ZIP: 30097 BUSINESS PHONE: 678-584-4000 MAIL ADDRESS: STREET 1: 1828 MECA WAY CITY: NORCROSS STATE: GA ZIP: 30093 10-K 1 g87947e10vk.txt INNOTRAC CORPORATION SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission File No. 000-23741 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 No.) 6655 SUGARLOAF PARKWAY, DULUTH, GEORGIA 30097 ----------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (678) 584-4000 Securities registered pursuant to Section 12(b) of the Act: None. Name of each exchange on which registered: The Nasdaq National Market. Securities registered pursuant to Section 12(g) of the Act: Common Stock, Par Value $.10 Per Share. 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 checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes | | No |X|. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. | | The aggregate market value of the voting stock held by nonaffiliates (which for purposes hereof are all holders other than directors, executive officers and holders of 10% or more of the Registrant's outstanding Common Stock) of the Registrant as of June 30, 2003, the last business day of the Registrant's most recently completed second fiscal quarter was $23,214,338 based on the closing sale price of the Common Stock as reported by the Nasdaq National Market on such date. See Item 12. At February 29, 2004, there were 11,754,780 shares of Common Stock, par value $0.10 per share, outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's 2003 Annual Report to Shareholders, filed as an exhibit hereto, are incorporated by reference into Part II of this Annual Report on Form 10-K for the year ended December 31, 2003 (the "Report"). Portions of the Registrant's Proxy Statement for the 2004 Annual Meeting of Shareholders, to be filed with the Securities and Exchange Commission (the "Commission" or the "SEC"), are incorporated by reference into Part III of this Report. INNOTRAC CORPORATION TABLE OF CONTENTS PAGE ---- PART I ................................................................... 2 ITEM 1. BUSINESS ................................................ 2 CERTAIN FACTORS AFFECTING FORWARD-LOOKING STATEMENTS .... 8 EXECUTIVE OFFICERS OF REGISTRANT ........................ 13 ITEM 2. PROPERTIES .............................................. 14 ITEM 3. LEGAL PROCEEDINGS ....................................... 15 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ..... 15 PART II .................................................................. 15 ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS ..................................... 15 ITEM 6. SELECTED FINANCIAL DATA ................................. 16 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ..................... 16 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK .................................................... 17 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ............. 17 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE ..................... 17 ITEM 9A. CONTROLS AND PROCEDURES ................................. 17 PART III ................................................................. 18 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ...... 18 ITEM 11. EXECUTIVE COMPENSATION .................................. 18 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS .............. 18 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS .......... 19 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES .................. 19 PART IV .................................................................. 20 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K ................................................ 20 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS AS TO SCHEDULES ............................................... S-1 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS ......... S-2 PART I ITEM 1. BUSINESS Innotrac Corporation ("Innotrac" or the "Company"), founded in 1984 and headquartered in Atlanta, Georgia, provides order processing, order fulfillment and call center services to large corporations that outsource these functions. In order to perform call center and fulfillment functions in-house, a company may be required to develop expensive, labor-intensive infrastructures, which may divert its resources and management's focus from its principal or core business. By assuming responsibility for these tasks, Innotrac strives to improve the quality of the non-core operations of our clients and to reduce their overall operating costs. Innotrac receives most of their 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. 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 for shipment cost reduction - product sourcing and procurement - packaging solutions - back-order management - returns management - Customer Support Services: - inbound call center services - technical support and order status - returns and refunds processing - call centers integrated into fulfillment platform - cross-sell/up-sell services - collaborative chat - intuitive e-mail response The Company is 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 consumer telephones and wireless pager equipment ("Telecommunications products") and Digital Subscriber Line and Cable Modems ("Modems") for clients such as BellSouth Corporation ("BellSouth"), Qwest Communications International, Inc. ("Qwest") and Comcast Corporation ("Comcast") and their customers. The Company also provides a variety of these services for a significant number of retail, catalog and direct marketing companies such as The Coca-Cola Company, Ann Taylor Retail, Inc., Smith & Hawken, Ltd., Tactica International, Inc., Porsche Cars North America, Inc., Nordstrom.com LLC, Wilsons Leather Direct, Inc., Martha Stewart Living Omnimedia, Inc., and Thane International. We take orders for our 2 retail, catalog and direct marketing clients via the internet, through a customer service representative at our Pueblo and Reno call centers or through direct electronic transmission from our clients. These orders are processed through one of our order management systems and then transmitted to one of our seven fulfillment centers located across the country and are shipped to the end consumer or retail store location, as applicable, typically within 24 hours of when the order is received. Inventory is held on a consignment basis, with minor exceptions, and includes items such as shoes, clothing, accessories, books and outdoor furniture. The Company also provides these services for business-to-business ("B2B") clients including Books are Fun, Ltd. (a subsidiary of Readers' Digest), NAPA and The Walt Disney Company. The following table sets forth the percentage of revenues generated by the Company's various business lines during 2003 and 2002: 2003 2002 Telecommunications products 23.0% 26.5% Modems 19.4 19.3 Retail/Catalog 27.4 20.2 Direct Marketing 18.0 27.0 B2B 12.2 7.0 ----- ----- 100.0% 100.0% ===== =====
In order to reduce our industry and client concentration and to expand our national presence, in December 2000, we acquired Universal Distribution Services ("UDS"). Our UDS division provides integrated order processing, order management, fulfillment and customer relationship management services. UDS's customer base comprises traditional direct marketing companies including Thane International and Tactica International, Inc. It is located in a 275,000 square foot facility in Reno, Nevada. During 2001, we expanded UDS's business by taking advantage of our East Coast capabilities. Under the terms of Innotrac's merger agreement with UDS, the former shareholders of UDS could receive, as part of the consideration paid for their shares, annual contingent payments based on the operating income generated by our UDS division over a three-year period that commenced December 1, 2000. For the first year of the earn-out period, UDS's stockholders received approximately $13.7 million in cash and 310,000 shares of our common stock pursuant to this arrangement. No earnout amounts were earned in the second and third years. In July 2001, to further our strategy to diversify our industry and client concentration, we acquired iFulfillment, Inc. ("iFulfillment"). Our iFulfillment subsidiary specializes in fully integrated, automated, order fulfillment services for multi-channel retailers and catalogers including such clients as Nordstrom.com LLC, Wilsons Leather Direct, Inc. and Martha Stewart Living Omnimedia, Inc. It is located in a 354,000 square foot leased facility in Bolingbrook, Illinois. Due to the addition of a sizable new client in September 2002, we leased an additional 150,204 square feet in a nearby facility, which was expanded by 54,103 square feet in April 2003. This new facility has expansion space of an additional 51,254 square feet that we have an option to lease in the future. There are no immediate plans to exercise that option. In August 2002 we leased a 396,000 square foot fulfillment center near Cincinnati, in Hebron, Kentucky. This facility provides fulfillment for Smith & Hawken, Ltd. Capital expenditures associated with this facility were approximately $4.6 million and were funded through our bank line of credit. With our national footprint virtually complete, we are committed to deeper penetration within our existing business lines and continued diversification of our client base. Our long-term goal is to have our business mix spread evenly across a higher number of clients in diverse industries. We will continue to seek new clients and may open additional facilities in other geographic locations to service these needs. 3 FULFILLMENT SERVICES Providing effective turnkey fulfillment solutions for our clients' products is our primary business. Our capabilities in this area are described below: FULFILLMENT. We are committed to delivering our clients' products to their customers on a timely and accurate basis. Our personnel pick, pack, verify and ship product orders and requests for promotional, technical and educational literature, shoes, clothing, electronic equipment, accessories, books and outdoor furniture for our clients. We use several custom-designed, semi-automated packaging and labeling lines to pack and ship products as well as highly automated, conveyorized systems utilizing RF scanning and pick-to-light technologies. By utilizing these technologies, we are able to reduce labor costs and provide more timely shipments to our clients' customers. We streamline and customize the fulfillment procedures for each client based upon the client request and the tracking, reporting and inventory controls necessary to implement that client's marketing support program. We also offer comprehensive product return services whereby our personnel receive, log, test, repackage and dispose of products that are returned from end-users. Our Atlanta operations earned ISO 9001:2000 certification in 2002 and our Hebron, Kentucky operations earned ISO 9001:2000 certification in 2003. We are dedicated to providing quality service to our clients at every step in the fulfillment process. To ensure order accuracy, shipment inspection and system driven validation are performed to prove the contents exactly match the order prior to shipment. In addition, we have highly sensitive scales at the end of our packaging lines that also assist in ensuring the accuracy of every order. Our 2003 order accuracy rate exceeded 99.5%. INVENTORY MANAGEMENT. An integral part of our fulfillment services is the monitoring and control of a client's inventory. We provide automated inventory management and reporting to assure real-time stock counts of a client's products, literature and other items. Our inventory systems enable us to provide management information to maintain consistent and timely reorder levels and supply capabilities and also enable the client to quickly assess stock balances, pricing information, reorder levels and inventory values. We offer this information to the client on a real-time basis through our internet gateway or direct system integration. Inventory management data is also utilized in our reporting services. We utilize bar coding equipment in our inventory management systems, which improves the efficiency of stock management and selection. We also perform cycle counts throughout the year to check system-maintained item balances against physical item balances. Our facilities have several layers of security. When necessary, we dispose of clients' products utilizing established guidelines. Disposal procedures vary depending on the product and client business rules. PURCHASING MANAGEMENT. For certain clients, we place orders for products we fulfill with vendors chosen by those clients. Our purchasing management services include assisting a client in negotiating product pricing with the vendor, arranging returns and credits as well as forecasting product quantities required for normal business programs or promotions. PRODUCT CONSIGNMENT AND WAREHOUSING. For substantially all of our clients, we warehouse products on a consignment basis and fulfill orders on behalf of our customers for a fee. In certain cases (primarily BellSouth), we may purchase and own inventory, but on a significantly reduced risk basis as a result of client guarantees and contractual indemnifications. CUSTOMER SUPPORT SERVICES. Another of our core competencies is providing customer support services. We believe these services are critical to a comprehensive order processing and order fulfillment solution. Our customer support services are described below. INBOUND CALL CENTER SERVICES. Our customer service representatives take orders for certain clients and resolve questions regarding shipping, billing and order status as well as a variety of other questions. From time to time they may sell equipment, other products and telephone company services to customers who call us. To properly handle the call, Innotrac's automated call distributor identifies each inbound call by the toll-free number dialed and immediately routes the call to the interactive voice response ("IVR") system 4 or an Innotrac customer service representative. If the caller is placing an order they are immediately transmitted to a customer service representative trained to take the order and enter it into our systems for transmittal to the appropriate fulfillment center. If the customer has a question, complaint or needs return information, the IVR system attempts to resolve these issues by guiding the customer through a series of interactive questions. If IVR automatic resolution cannot solve the problem, the call is routed to one of our customer service representatives who are specially trained in the applicable client's business and products and answer using the client's name. Our customer service representatives can enter customer information into our call-tracking system, listen to a question and quickly access a proprietary network database using a graphical interface to answer a customer's question. A senior representative is available to provide additional assistance for complex or unique customer questions. Customer service representatives are also trained to handle introductory level technical support issues. Customer requests are generally resolved with a single call, whether answered by a trained representative or our automated systems. RETURNS AND REFUNDS PROCESSING. The representatives respond to customer calls about product returns and refunds and obtain information about customer service problems. They facilitate a customer's return of a product by providing a bar-coded label to the customer. When the returned item is processed and entered into our system, it automatically triggers a pre-set action for reshipment of a product or refund to the customer. TECHNOLOGY Our use of technology enables us to design and deliver services for each client's fulfillment and customer support needs. Our information technology group, or IT Group, has developed our database marketing support and management systems. Innotrac has a technical integration platform written in Java over an Oracle database, which contains a complete web interface and XML-based APIs that allows clients to transact with us electronically. We deploy the solution running on Sun Solaris and utilizing Veritas cluster server software, which provides a high availability computing environment. Veritas backup software, DLT tape libraries and Oracle Hot backup capabilities allow us to backup our production Oracle databases online without interruption to the business unit. Our burstable bandwidth allows us to quickly increase data capacity. Our EMC storage solutions provide rapid access to data and the ability to scale quickly depending on business demands. Network connectivity is achieved with Cisco routers and local directors. The open architecture of our computer system permits us to seamlessly interact with many different types of client systems. Our IT Group uses this platform to design and implement application software for each client's program, allowing clients to review their programs' progress on-line to obtain real-time comprehensive trend analysis, inventory levels and order status and to instantly alter certain program parameters. As the needs of a client evolve, our IT Group works with our client services team to modify the program on an ongoing basis. Information can be exchanged via direct system integration, EDI, internet access and direct-dial applications. We believe that our technology platform provides us with the resources to continue to offer leading edge services to current and new clients and to integrate our systems with theirs. We believe that the integrity of client information is adequately protected by our data security system and our off-site disaster back-up facilities. We utilize two primary warehouse management systems depending on our business line and our locations. In 2002, we completed the implementation of PKMS for clients at our Pueblo, Atlanta and Chicago-Romeoville warehouses. PKMS is an advanced fulfillment warehouse management system designed to support large volumes of transactions and users, which enable the effective management of high levels of throughput, from receiving through shipping. PKMS provides efficiencies in inventory management, outbound distribution and task management. Our Chicago-Bolingbrook and Cincinnati-Hebron facilities utilize an Optum warehouse management system, which is a highly configurable fulfillment solution for fast-moving, high volume, piece-pick operations suitable for our multi-channel retailers and catalogers. Our Reno facility utilizes an internally developed system, described below, suitable for its direct marketing customer base. We believe that these systems allow us to effectively and efficiently manage our warehouse operations to secure a competitive advantage in the fulfillment industry. 5 As part of our UDS acquisition in December 2000 we acquired their internally-developed, customized order management system ("OMS") that is fully integrated with a customized warehouse management solution and includes front-end customer relationship management ("CRM") capabilities. In addition to existing Reno clients, in 2002, we added Martha Stewart Living Omnimedia and Smith & Hawken to that system. As part of the migration of those two new clients onto the system we added the requisite functionality and customization. The customized nature of the system required significant resources to properly scale the system to meet our clients' needs and resulted in a considerable increase in IT costs in 2002. These costs returned to normalized levels in 2003. Our Pueblo call center utilizes the Rockwell Spectrum Automatic Call Distributor, or ACD, switch to handle call management functions. The ACD system has the capacity to handle approximately 1,200 call center representatives and as of December 31, 2003 was supporting approximately 252 representatives. Additionally, the ACD system is integrated with software designed to enable management to staff and supervise the call center based on call length and call volume data compiled by the ACD system. Our call center in Reno employs an Aspect ACD Enterprise System switch and is currently supporting approximately 50 representatives. Our integrated systems allow the customer service representatives to enter orders received via telephone into their computer which transmits the data over T1 lines to one of our seven fulfillment centers' order management systems where it is processed. Shortly thereafter the product is picked, packed, verified and shipped to the customer. PERSONNEL AND TRAINING Our success in recruiting, hiring and training large numbers of employees and obtaining large numbers of hourly employees during peak periods for fulfillment and call center operations is critical to our ability to provide high quality fulfillment and customer support services. Call center representatives and fulfillment personnel receive feedback on their performance on a regular basis and, as appropriate, are recognized for superior performance. Additional training is provided to all fulfillment center employees quarterly and to our call center representatives on an as-needed basis. To maintain good employee relations and to minimize employee turnover, we offer competitive pay and hire primarily full-time employees who are eligible to receive a full range of employee benefits. As of March 1, 2004, we had over 800 full time employees supported by part time staff on an as-needed basis. Management believes that the demographics surrounding our facilities and our reputation, stability, compensation and benefit plans should allow us to continue to attract and retain qualified employees. Currently, we are not a party to any collective bargaining agreements. None of our employees are unionized. COMPETITION In tailoring services to client needs, we compete on the basis of quality, reliability of service, scope of locations, efficiency, technical capabilities, speed and price. We compete with many companies, some of which have greater resources than us, with respect to various portions of our business. Those companies include fulfillment businesses and call center operations. We believe that our comprehensive and integrated services differentiate us from many of those competitors. We continuously explore new outsourcing service opportunities, typically in circumstances where clients are experiencing inefficiencies in non-core areas of their businesses and management believes we can develop a superior outsourced solution on a cost-effective basis. We primarily compete with the in-house operations of our current and potential clients and also compete with certain companies that provide similar services on an outsourced basis. GOVERNMENT REGULATION The Caller ID services offered by our telecommunications clients are subject to various federal and state regulations. The legality of Caller ID has been challenged in cases decided under the Electronic Communications Privacy Act, or the ECPA, and several state statutes. In March 1994, a Federal Communications Commission, or FCC, report preempted certain state regulation of interstate calling party number parameter, or CPN, based services, the technology underlying Caller ID. This report requires 6 certain common carriers to transmit CPN and its associated privacy indicator (which allows telephone callers to block the display of their phone numbers on Caller ID display units) on an interstate call to connecting carriers without charge (the "Free Passage" rule). In connection with this report, the Department of Justice issued a memorandum which concluded that the installation or use of interstate Caller ID service is not prohibited by any federal wiretap statute and that, in general, the FCC has authority to preempt state laws that the FCC finds would hinder federal communications policy on Caller ID services. Court decisions since the FCC issued its March 1994 report have consistently held that Caller ID does not violate any state or federal wiretap statute. In May 1995, the FCC narrowed its March 1994 preemption of state public utilities blocking regulations by permitting subscribers to choose per-line blocking or per-call blocking on interstate calls, provided that all carriers were required to adopt a uniform method of overriding blocking on any particular call. At the same time, the FCC specifically preempted a California Public Utilities Commission, or CPUC, per-line blocking default policy, which required that all emergency service organizations and subscribers with nonpublished numbers, who failed to communicate their choice between per-call blocking and per-line blocking, be served with per-line blocking. The FCC's revised rules and regulations also require carriers to explain to their subscribers that their telephone numbers may be transmitted to the called party and that there is a privacy mechanism (i.e., the "blocking" feature) available on interstate calls, and explain how the mechanism can be activated. The CPUC, seeking to protect the caller's privacy, has ruled that a carrier can offer Caller ID or transmit CPN to interconnecting carriers only upon CPUC approval of its customer notification and education plan. The Telecommunications Act of 1996 introduced restrictions on telecommunications carriers' usage of customer proprietary network information, or CPNI. CPNI includes information that is personal to customers, including where, when and to whom a customer places a call, as well as the types of telecommunications services to which the customer subscribes and the extent these services are used. The FCC interprets the CPNI restrictions to permit telecommunications carriers, including BellSouth and Qwest, to use CPNI without customer approval to market services that are related to the customer's existing service relationship with his or her carrier. Before carriers may use CPNI to market services outside a customer's existing service relationships, the carrier must obtain express customer permission. Because we are dependent upon the efforts of our clients to promote and market their equipment and services, laws and regulations inhibiting those clients' ability to market these equipment and services to their existing customers could have a material adverse effect on our business, results of operations and financial condition. Telephone sales practices are regulated at both the federal and state level. These regulations primarily relate to outbound teleservices, which, in most cases, we outsource to another company. The few cases where Innotrac does conduct outbound teleservices are related solely to the support of our clients with catalog sales programs, and thus are exempt from the regulations most commonly associated with outbound teleservices. Outbound teleservices are regulated by the rules of the FCC under the Federal Telephone Consumer Protection Act of 1991, the Federal Telemarketing and Consumer Fraud and Abuse Prevention Act of 1994 as amended and various state regulations regarding telephone solicitations. We believe that we are in compliance with these federal statutes and the FCC rules thereunder and the various state regulations and that we would operate in compliance with those rules and regulations if we were to engage in outbound teleservice operations in the future. We work closely with our clients, companies we outsource outbound teleservices to and their respective advisors to ensure that we and our client are in compliance with these regulations. We cannot predict whether the status of the regulation of Caller ID services or e-commerce will change and what affect, if any, this change would have on us or our industry. 7 INTELLECTUAL PROPERTY We have used the service mark "Innotrac" since 1985 and have registered it and other marks used by us in our business through the US Patent and Trademark Office. The "innotrac.com" domain name has been a registered domain name since 1995. We also own several other internet domain names. Due to the possible use of identical or phonetically similar service marks by other companies in different businesses, there can be no assurance that our service marks will not be challenged by other users. Our operations frequently incorporate proprietary and confidential information. We rely upon a combination of contract provisions and trade secret laws to protect the proprietary technology we use and to deter misappropriation of our proprietary rights and trade secrets. CERTAIN FACTORS AFFECTING FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K contains certain forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995). These statements concern the Company's operations, performance and financial condition, including, in particular, the likelihood that Innotrac will succeed in developing and expanding its business, among other things. They are based upon a number of assumptions and estimates that are inherently subject to significant uncertainties. Many of these uncertainties are beyond Innotrac's control. Consequently, actual results may differ materially from those expressed or implied by such forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to, those set forth below. WE RELY ON A SMALL NUMBER OF LARGE CLIENTS. IF WE LOSE ONE OR MORE OF OUR LARGEST CLIENTS, OR IF REVENUES FROM OUR LARGEST CLIENTS DECLINE, OUR BUSINESS COULD BE ADVERSELY AFFECTED. Innotrac focuses on developing long-term contractual relationships with large corporations. A relatively small number of our clients account for a significant portion of our revenues. If we lose one or more of our largest clients, or if revenues from our largest clients decline, then our business, results of operations and financial condition could be materially adversely affected. Additionally, if one of these large clients is lost, or revenues from our largest clients decline, we cannot assure you that we will be able to replace or supplement that client with others that generate comparable revenues or profits. OUR WRITTEN CONTRACTS GENERALLY DO NOT GUARANTEE SPECIFIC VOLUME LEVELS AND CAN USUALLY BE TERMINATED ON LITTLE NOTICE. Although we have written agreements with most of our clients, our agreements generally do not assure specific volume or revenue levels. In addition, some agreements provide for termination for any reason on short notice. Our current agreement with BellSouth may be terminated by BellSouth for any reason upon 90 days notice. Furthermore, we are contractually bound to our facility leases until their term expires. If a client terminates their contract suddenly, we will still have an obligation under our leases. A SIGNIFICANT PORTION OF OUR BUSINESS IS CONCENTRATED IN THE TELECOMMUNICATIONS INDUSTRY, INCLUDING DSL AND CABLE MODEMS. Approximately 42% of our revenues in 2003 and approximately 46% of our revenues in 2002 were attributable to Telecommunications products and Modems clients. Consequently, we are particularly susceptible to negative changes affecting these industries in general. The telecommunications industry has suffered a material downturn since mid-2000 which has had a significant negative impact on our business. To ameliorate this risk, we have been diversifying our client base across more industries and clients, including through selective acquisitions. We cannot guarantee, however, that the telecommunications industry will strengthen in 2004 or not deteriorate further, or that our diversification strategy will be successful. 8 A SIGNIFICANT PORTION OF OUR BUSINESS IS CONCENTRATED IN THE DIRECT RESPONSE INDUSTRY. Approximately 18% of our revenues in 2003 and approximately 27% of our revenues in 2002 were attributable primarily to clients in the direct response industry. Consequently, we are particularly susceptible to negative changes that impact this industry and our clients in particular, including potential false advertising product claims and Federal Trade Commission regulation and enforcement. The direct response industry has suffered a material downturn since the third quarter of 2001, which has had a significant negative impact on our business. This general downturn has significantly weakened the financial strength and wherewithal of companies in this sector which increases our risk pertaining to future business, growth and the collectibility of accounts receivable from our existing clients. If any of our existing direct response clients were to default on their amounts due Innotrac, this would result in a material charge against earnings. One of theses clients has a material past due balance, although a significant reserve has been established at December 31, 2003 to help mitigate this risk. Additionally, it has been announced that one of our direct response clients is for sale. The impact of a change in ownership of this client could have a material impact on our results of operations in the future. COMPETITION MAY HURT OUR BUSINESS. We operate in highly competitive and price sensitive markets and expect this environment to persist and intensify in the future. Because our services comprise marketing and product consultation, sales channel management, fulfillment and back-end support, including our call center operations and returns processing, we have many competitors who offer one or more of these services. Our competitors include: - in-house marketing support operations of our current and potential clients; - other firms offering specific services, like fulfillment and call center operations; and - large marketing support services firms. A number of our competitors have developed or may develop financial and other resources greater than ours. Additional competitors with greater name recognition and resources may enter our markets. Our existing or potential clients' in-house operations are also significant competitors. Our performance and growth could be negatively impacted if: - existing clients demand and receive pricing concessions; - existing clients decide to provide, in-house, services they currently outsource; - potential clients retain or increase their in-house capabilities; or - existing clients consolidate their outsourced services with other companies. In addition, competitive pressures from current or future competitors could result in significant price erosion, which could in turn materially adversely affect our business, financial condition and results of operations. For more information about our competition, see "Business--Competition" in this Item 1. IF WE ARE NOT ABLE TO KEEP PACE WITH CHANGING TECHNOLOGY, OUR BUSINESS WILL BE MATERIALLY ADVERSELY AFFECTED. Our success depends significantly upon our ability to: - integrate new clients in a timely and cost efficient manner; - enhance existing services; - develop applications to meet our clients' needs; and - introduce new services and products to respond to technological developments. If we fail to maintain our technological capabilities or respond effectively to technological changes, our business, results of operations and financial condition could be materially adversely affected. We cannot assure you that we will select, invest in and develop new and enhanced technology on a timely basis in the 9 future in order to meet our clients' needs and maintain competitiveness. Our Reno systems, which house several of our largest clients, are completely customized and therefore not supported by third party providers. We are heavily reliant on a few developers. If these developers leave, it could materially adversely affect our business. We provide details about our technology in "Business--Technology" in this Item 1. OUR QUARTERLY RESULTS MAY FLUCTUATE, WHICH MAY CAUSE SIGNIFICANT SWINGS IN THE MARKET PRICE FOR OUR COMMON STOCK. Our operating results may fluctuate in the future based on many factors. These factors include, among other things: - changes in the telecommunications industry; - changes in the retail industry; - changes in the fulfillment and call center services industries; - changes in the timing and level of client-specific marketing programs, including the timing and nature of promotions; - changes in our existing client base; - pricing pressure or concessions; - increased competition; and - changes in customer purchasing patterns for products we fulfill. Due to these and any other unforeseen factors, it is possible that in some future quarter our operating results may be below the expectations of public market analysts and investors. If that variance occurs, our common stock price would likely decline materially. OUR COMMON STOCK LACKS LIQUIDITY AND IS HELD BY A SMALL NUMBER OF INVESTORS. As of December 31, 2003, Innotrac officers and directors owned approximately 55% of the outstanding common stock. Two institutional shareholders, IPOF Fund and Dimensional Fund Advisors, held 25.5% and 5.4%, respectively. These ownership positions have resulted in a lack of liquidity in our common stock. Additionally, if any of Innotrac's significant shareholders decided to liquidate its position, our common stock price would likely decline materially. IF OUR GOODWILL IS DEEMED IMPAIRED AS PART OF OUR ANNUAL (OR EARLIER) IMPAIRMENT TEST, THE IMPAIRMENT CHARGE WOULD RESULT IN A DECREASE IN OUR EARNINGS AND NET WORTH. Current accounting rules require that goodwill no longer be amortized but be tested for impairment at least annually. We have a significant amount of goodwill which, based upon a negative outcome of any impairment test in the future, could result in the write-down of all or a portion of goodwill and a corresponding reduction in earnings and net worth. NONCOMPLIANCE WITH ANY OF THE COVENANTS UNDER OUR REVOLVING CREDIT AGREEMENT ALLOWS THE LENDER TO DECLARE ANY OUTSTANDING BORROWING AMOUNTS TO BE IMMEDIATELY DUE AND PAYABLE. Our revolving line of credit agreement contains various restrictive financial and change of ownership control covenants. Noncompliance with any of the covenants allows the lender to declare any outstanding borrowing amounts to be immediately due and payable. At December 31, 2003 we were not in compliance with the fixed charge coverage ratio of 1.75 to 1.00 or the tangible net worth covenant of $34 million. However, we have received waivers relating to these covenants at December 31, 2003. The fixed charge 10 coverage ratio covenant has been reduced to 1.30 to 1.00 in all future periods and the tangible net worth covenant has been reduced to $24 million. DUE TO THE NATURE OF OUR BUSINESS WE HAVE A SIGNIFICANT AMOUNT OF UNSKILLED LABOR AND A HIGH TURNOVER RATE THEREBY INCREASING OUR EXPOSURE TO EMPLOYEE RELATED LITIGATION. Our fulfillment and call centers employ a sizable amount of unskilled labor and generate a high turnover rate. Furthermore, due to the downturn in the economy and its adverse affects on our business, we have had to terminate employees from time to time. Our exposure to litigation as a result of employee matters has recently increased. We are currently involved in litigation associated with several employee related matters. Management believes this litigation is currently immaterial, though it could become material in the future. IF WE ARE NOT ABLE TO CONTINUE TO MANAGE OUR INFRASTRUCTURE AND VOLUME GROWTH, OUR BUSINESS COULD BE ADVERSELY AFFECTED. Our operations, number of facilities and volume of packages shipped have grown significantly in recent years. Our business, results of operations and financial condition could be materially adversely affected if we cannot effectively manage our growth. Our continued success depends upon our ability to: - initiate, develop and maintain existing and new client relationships; - respond to competitive developments; - maintain pricing and margins; - continue to develop our sales infrastructure; - attract, train, motivate and retain management and other personnel; and - maintain the high quality of our services. IF THE TREND TOWARD OUTSOURCING DOES NOT CONTINUE, OUR BUSINESS WILL BE ADVERSELY AFFECTED. Our business, results of operations and financial condition could be materially adversely affected if the trend of businesses outsourcing services not directly related to their principal business activities declines or reverses, or if corporations bring previously outsourced functions back in-house. Particularly during general economic downturns, businesses may bring in-house previously outsourced functions in order to avoid or delay layoffs. OUR BUSINESS IS SUBJECT TO GOVERNMENT REGULATION, WHICH MAY LIMIT OUR ACTIVITIES OR INCREASE OUR COSTS. In connection with the limited amount of outbound telemarketing services that we provide, we must comply with federal and state regulations. These include the Federal Communications Commission's rules under the Federal Telephone Consumer Protection Act of 1991 and the Federal Trade Commission's regulations under the Federal Telemarketing and Consumer Fraud and Abuse Prevention Act of 1994, both of which govern telephone solicitation. When we conduct outbound telemarketing services, these rules and regulations would apply to that portion of our business. Furthermore, there may be additional federal and state legislation or changes in regulatory implementation. These changes could include interpretations under the Telecommunications Act of 1996 restricting the ability of telecommunications companies to use consumer proprietary network information, or CPNI. New legislation or regulatory implementation in the future may significantly increase compliance costs or limit our activities, our clients' activities or the activities of companies to which we outsource outbound telemarketing functions. Additionally, we could be responsible for failing to comply with regulations applicable to our clients or companies to which we outsource telemarketing. If unfavorable federal or state legislation or regulations affecting Caller ID service, internet service or other technology related to products we fulfill and provide customer support for are adopted, our business, 11 financial condition and results of operations could be materially adversely affected. See "Business -- Government Regulation" in this Item 1 for further information about government regulation of our business. IF WE ARE UNABLE TO INTEGRATE ACQUIRED BUSINESSES SUCCESSFULLY AND REALIZE ANTICIPATED ECONOMIC, OPERATIONAL AND OTHER BENEFITS IN A TIMELY MANNER, OUR PROFITABILITY MAY DECREASE. If we are unable to integrate acquired businesses successfully, we may incur substantial costs and delays in increasing our customer base. In addition, the failure to integrate acquisitions successfully may divert management's attention from Innotrac's existing business and may damage Innotrac's relationship with its key customers and suppliers. Integration of an acquired business may be more difficult when we acquire a business in a market in which we have little or no expertise, or with a corporate culture different from Innotrac's. 12 EXECUTIVE OFFICERS OF REGISTRANT The executive officers of Innotrac are as follows:
NAME AGE POSITION ---- --- -------- Scott D. Dorfman ... 46 Chairman of the Board, President and Chief Executive Officer David L. Gamsey .... 46 Senior Vice President, Chief Financial Officer, Treasurer and Secretary David L. Ellin ..... 45 Senior Vice President--Sales Larry C. Hanger .... 49 Senior Vice President--Client Services Robert J. Toner .... 40 Vice President--Logistics James R. McMurphy... 44 Vice President--Information Technology
Mr. Dorfman founded Innotrac and has served as Chairman of the Board, President and Chief Executive Officer since its inception in 1984. Prior to founding Innotrac, Mr. Dorfman was employed by Paymaster Checkwriter Company, Inc. (Paymaster), an equipment distributor. At Paymaster, Mr. Dorfman gained experience in distribution, tracking and inventory control by developing and managing Paymaster's mail order catalog. Mr. Gamsey has served as Senior Vice President, Chief Financial Officer and Secretary since May 2000. In 2001, Mr. Gamsey was appointed to Innotrac's Board of Directors. Prior to joining Innotrac, from September 1995 to May 2000, he served as Chief Financial Officer of AHL Services, Inc., a provider of contract staffing and outsourcing solutions. From 1988 to September 1995, Mr. Gamsey was a Managing Director of Investment Banking at the accounting firm Price Waterhouse LLP (now PricewaterhouseCoopers LLP). From 1987 to 1988, he served as Chief Financial Officer of Visiontech, Inc., a manufacturer of contact lenses, and from 1979 to 1987, he was a Senior Audit Manager for the accounting firm Arthur Andersen LLP. Mr. Gamsey is a certified public accountant. Mr. Ellin joined Innotrac in 1986 and currently serves as Senior Vice President--Sales. He has been a Director since December 1997. He held the position of Senior Vice President and Chief Operating Officer from November 1997 to December 2001 and served as Vice President from 1988 to November 1997. From 1984 to 1986, Mr. Ellin was employed by the Atlanta branch of WHERE Magazine, where he managed the sales and production departments. From 1980 to 1984, Mr. Ellin was employed by Paymaster, where he was responsible for Paymaster's sales and collections. Mr. Hanger joined Innotrac in 1994 and has served as Senior Vice President--Client Services since April 1999 and as a Director since December 1997. He served as Vice President--Business Development from November 1997 through April 1999. He served as Innotrac's Manager of Business Development from 1994 to November 1997, and was responsible for the management of the telecommunication equipment marketing and service business. From 1979 to 1994, Mr. Hanger served as Project Manager--Third Party Marketing at BellSouth Telecommunications, Inc., a regional telecommunications company, where he managed the marketing program for BellSouth's network services and was involved in implementing the billing options program for BellSouth with Innotrac. Mr. Toner joined Innotrac in June, 2001 as Vice President--Logistics. He brings 16 years of distribution, logistics, and transportation experience; 14 of those years were with McMaster-Carr Supply Company, a distributor of industrial supplies. Most recently, Mr. Toner was the General Manager for Webvan Group Inc., an Internet retailer, where he held the position of General Manager for East Coast operations. 13 Mr. McMurphy joined Innotrac in April, 2003 as Vice President and Chief Information Officer. Prior to joining Innotrac, Mr. McMurphy was with Capital One Financial Corporation, a leading credit card issuer and consumer lender, from March 2002 to April 2003, where he served as Chief Information Officer for one of their divisions. Prior to Capital One, from December 1996 through December 2001, he was Chief Information Officer for Pleasant Company, a division of Mattel Toys and makers of American Girl Dolls. In addition, prior to Mattel Toys, he served as a consultant for Price Waterhouse LLP (now Pricewaterhouse Coopers LLP). ITEM 2. PROPERTIES Currently, the Company leases all of its facilities. Our headquarters and fulfillment facilities are located in 250,000 square feet of leased space in Duluth, Georgia. Our corporate offices occupy 50,000 square feet of this facility and the remaining 200,000 square feet is fulfillment space. This site also includes approximately 3.5 acres that will be available for Innotrac's expansion requirements, if required. The lease for our Duluth facility commenced in October 1998 and has a term of 10 years with two five-year renewal options. The lease provides for an option to purchase the facility at the end of the first five years of the term or at the end of the first 10 years of the term. We have not yet determined whether to exercise this purchase option. In June 1999, we entered into a lease for a facility in Pueblo, Colorado with an initial term of five years with two five-year renewal options. The facility provides approximately 87,000 square feet of floor space. Approximately 45,000 square feet is used as a call center, as well as quality assurance, administrative, training and management space. This call center supports 370 workstations of which we utilized 252 at December 31, 2003. It currently operates from 5:00am MST to 11:00pm MST seven days per week. The remaining 42,000 square feet is used for fulfillment services. The initial term of this lease expires in September, 2004. We are currently in discussions with the landlord pertaining to this renewal. No decision has yet been made regarding exercising a renewal option. In October 1999, we entered into a lease for an additional fulfillment facility in Duluth, Georgia with an initial term of five years with one three-year renewal option. In August 2000, the Company entered into a lease extension and modification that expanded the facility space from approximately 52,000 square feet to 82,000 square feet. This lease expires in January, 2005. With the acquisition of UDS, located in Reno, Nevada, in December 2000, we operate a facility that consists of over 275,000 square feet and includes administrative office space, a 250,000 square foot fulfillment center and a call center that can support 200 workstations. UDS leases this facility through two lease agreements, which were initiated in October 2002 and October 2000. These agreements have lease terms of five years and seven years, respectively. Currently, the call center is configured with approximately 150 workstations, of which 50 were being utilized at December 31, 2003. The call center operates from 5:00 am PST to 8:00 pm PST Monday through Friday and 6:00 am PST to 2:30 pm PST Saturday and Sunday. With the acquisition of iFulfillment, we operate a 354,000 square foot facility in Bolingbrook, Illinois. The lease for this facility was initiated at the date of acquisition in July 2001 and we renewed for an additional five years, at a lower monthly rental rate, commencing January 1, 2003. This lease contains one additional five-year renewal option. This facility is used exclusively for fulfillment services and contains approximately 40,000 square feet of administrative office space. In August 2002, we entered into a lease for a new facility in Hebron, Kentucky with an initial term of five years with two renewal options; the first for one year and the second for three years. The facility provides approximately 396,000 square feet of fulfillment and warehouse space. This facility is fully occupied by our client, Smith & Hawken. 14 In September 2002, we entered into a lease for a new facility in Romeoville, Illinois with an initial term of five years and two months with two five-year renewal options. The facility provides approximately 204,307 square feet of fulfillment and warehouse space, of which approximately 175,000 is currently under lease. This facility is utilized exclusively by our client, Books Are Fun. ITEM 3. LEGAL PROCEEDINGS We are not a party to any material legal proceeding. We are, from time to time, a party to litigation arising in the normal course of our business. Our fulfillment and call centers employ a sizable amount of unskilled labor and generate a high turnover rate. Furthermore, due to the downturn in the economy and its adverse affects on our business, we have had to terminate employees from time to time. Our exposure to litigation as a result of employee matters has increased. Although, management believes that none of these actions, individually or in the aggregate, will have a material adverse effect on our financial position or results of operations, it is possible that such litigation and the related cost could become material in the future. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders of the Company during the fourth quarter of the fiscal year covered by this Report. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS The Company's Common Stock trades on the Nasdaq National Market under the symbol "INOC". The following table sets forth for the periods indicated the high and low sales prices of the Common Stock on the Nasdaq National Market.
HIGH LOW ------- ------ 2003 First Quarter ............................................ $4.600 $2.150 Second Quarter ........................................... $6.659 $3.950 Third Quarter ............................................ $8.340 $5.760 Fourth Quarter ........................................... $10.490 $7.750 Fiscal Year Ended December 31, 2003 ...................... $10.490 $2.150 2002 First Quarter ............................................ $7.220 $3.400 Second Quarter ........................................... $6.350 $4.119 Third Quarter ............................................ $5.719 $2.200 Fourth Quarter ........................................... $3.140 $1.800 Fiscal Year Ended December 31, 2002 ...................... $7.220 $1.800
The approximate number of holders of record of Common Stock as of March 18, 2004 was 72. The approximate number of beneficial holders of our Common Stock as of that date was 1,235. The Company has never declared cash dividends on the Common Stock. The Company intends to retain its earnings to finance the expansion of its business and does not anticipate paying cash dividends in the foreseeable future. Any future determination as to the payment of cash dividends will depend upon such factors as earnings, capital requirements, the Company's financial condition, restrictions in financing agreements and other factors deemed relevant by the Board of Directors. The payment of dividends by the Company is restricted by its revolving credit facility. Item 12 of Part III contains information concerning the Company's equity compensation plans. 15 ITEM 6. SELECTED FINANCIAL DATA The information contained under the heading "Selected Financial Data" in the Company's 2003 Annual Report to Shareholders, filed as an exhibit hereto, is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information contained under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's 2003 Annual Report to Shareholders, filed as an exhibit hereto, is incorporated herein by reference. OFF BALANCE SHEET ARRANGEMENTS The Company does not have any off balance sheet arrangements that have or are reasonably likely to have a current or future effect on the financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. AGGREGATE CONTRACTUAL OBLIGATIONS The following table sets forth the Company's contractual commitments by period. There are no additional purchase obligations or other long-term liabilities other than those reflected below. For additional information, see Note 7 to the consolidated financial statements (in 000's).
Payments Due by Period ------------------------------------------------------------------ Total Less than 1 year 1-3 years 4-5 years After 5 years ------- ---------------- --------- --------- ------------- Capital leases $ 151 $ 95 $ 56 $ -- $ -- Operating leases 27,844 7,779 13,514 6,551 -- Line of credit (1) 11,802 -- 11,802 -- --
(1) The provisions of the revolving line of credit agreement requires 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. Accordingly, in the event of noncompliance, these amounts could be accelerated. CRITICAL ACCOUNTING ESTIMATES OR ASSUMPTIONS 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. The Company makes estimates each reporting period associated with its reserve for uncollectible accounts. This estimate is based on the aging of the receivables. One direct marketing client, with a substantial past due balance at December 31, 2003, entered into a payment arrangement with Innotrac in February 2004 that would eliminate its past due amounts during the first half of 2004. Payments of approximately $1 million towards this past due amount were received during February and March, 2004. In spite of these arrangements and subsequent payments, and due primarily to the financial condition, payment history and aging of the receivables of this client, the Company still determined it prudent to establish a specific reserve of $1.1 million for this account at December 31, 2003. Management will continue to access the level of reserve needed against this account quarterly. The Company utilizes the liability method of accounting for income taxes. Under the liability method, deferred taxes are determined based on the difference between the financial and tax bases of assets and 16 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. A valuation allowance has been recognized for the full amount of the $9.9 million deferred tax asset as losses in recent years create uncertainty about the realization of the tax benefits in future years. Income taxes associated with future earnings will be offset by a reduction in the 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. Innotrac has a tax net operating loss carryforward of $31.5 million at December 31, 2003 that expires between 2020 and 2023. With the adoption of Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" effective January 1, 2002, the Company tests goodwill annually for impairment at 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 2003 and again in the first quarter of 2004 in accordance with SFAS No. 142, no impairment was determined to exist at those times. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information contained under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations--Quantitative and Qualitative Disclosures About Market Risk" in the Company's 2003 Annual Report to Shareholders, filed as an exhibit hereto, is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information contained under the headings "Report of Independent Auditors" and "Consolidated Financial Statements and Notes to the Consolidated Financial Statements" in the Company's 2003 Annual Report to Shareholders, filed as an exhibit hereto, is incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On April 22, 2002 the Board of Directors, upon the recommendation of the Audit Committee, dismissed its independent accountants, Arthur Andersen LLP, and appointed Deloitte & Touche LLP as its new independent accountants, effective April 22, 2002. This matter was previously reported on a Form 8-K filed April 24, 2002. ITEM 9A. CONTROLS AND PROCEDURES Our management, with the participation of the Chief Executive and Chief Financial Officers, evaluated our disclosure controls and procedures (as defined in federal securities rules) as of December 31, 2003. No system of controls, no matter how well designed and operated, can provide absolute assurance that the objectives of the system of controls are met, and no evaluation of controls can provide absolute assurance that the system of controls has operated effectively in all cases. Our disclosure controls and procedures however are designed to provide reasonable assurance that the objectives of disclosure controls and procedures are met. Based on the evaluation discussed above, our CEO and CFO have concluded that our disclosure controls and procedures were effective as of the date of that evaluation to provide reasonable assurance that the objectives of disclosure controls and procedures are met. There were no changes in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, Innotrac's internal control over financial reporting. 17 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information contained under the headings "Election of Directors" and "Compliance With Section 16(a) of the Exchange Act" in the definitive Proxy Statement used in connection with the solicitation of proxies for the Company's 2004 Annual Meeting of Shareholders, to be filed with the Commission, is hereby incorporated herein by reference. Pursuant to Instruction 3 to Paragraph (b) of Item 401 of Regulation S-K, information relating to the executive officers of the Company is included in Item 1 of this Report. The Company has a separately designated Audit Committee that consists of Mr. Martin Blank, Mr. Joel Marks and Mr. Bruce Benator. Both Mr. Marks and Mr. Benator are financial experts. Mr. Benator is not deemed to be independent under Item 7(d)(3)(iv). Mr. Marks is independent and will serve as the Company's Audit Committee financial expert commencing in 2004. Mr. Marks is a seasoned financial executive and previously served as the Chief Financial Officer of a Nasdaq-listed company and is a certified public accountant. Mr. Benator will no longer be a member of the Audit Committee in 2004. He will be replaced effective March 1, 2004 by Mr. Alston Gardner. Effective March 1, 2004, the Company adopted a Code of Business Conduct and Ethics which includes rules of conduct for Senior Officers of the Company. This Code has been included herein as an exhibit, has been posted to the Company's website and has been distributed to all of our employees. ITEM 11. EXECUTIVE COMPENSATION The information contained under the heading "Executive Compensation" in the definitive Proxy Statement used in connection with the solicitation of proxies for the Company's 2004 Annual Meeting of Shareholders, to be filed with the Commission, is hereby incorporated herein by reference. The information contained in the Proxy Statement under the headings "Compensation Committee Report on Executive Compensation" and "Stock Performance Graph" shall not be deemed incorporated herein by such reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS The information contained under the headings "Voting Securities and Principal Shareholders" and "Equity Compensation Plans" in the definitive Proxy Statement used in connection with the solicitation of proxies for the Company's 2004 Annual Meeting of Shareholders, to be filed with the Commission, is hereby incorporated herein by reference. For purposes of determining the aggregate market value of the Company's voting stock held by nonaffiliates, shares held by all current directors and executive officers of the Company and holders of 10% or more of the Company's Common Stock have been excluded. The exclusion of such shares is not intended to, and shall not, constitute a determination as to which persons or entities may be "affiliates" of the Company as defined by the Commission. 18 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information contained under the heading "Related Party Transactions" in the definitive Proxy Statement used in connection with the solicitation of proxies for the Company's 2004 Annual Meeting of Shareholders, to be filed with the Commission, is hereby incorporated herein by reference. ITEM 14. PRINCIPAL AUDITOR FEES AND SERVICES The information contained under the heading "Independent Auditors" in the definitive Proxy Statement used in connection with the solicitation of proxies for the Company's 2004 Annual Meeting of Shareholders, to be filed with the Commission, is hereby incorporated herein by reference. 19 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND EXHIBITS 1. FINANCIAL STATEMENTS The following financial statements and notes thereto are incorporated herein by reference in Item 8 of this Report. Independent Auditors' Reports Consolidated Balance Sheets as of December 31, 2003 and 2002 Consolidated Statements of Operations for the years ended December 31, 2003, 2002 and 2001 Consolidated Statements of Shareholders' Equity for the years ended December 31, 2003, 2002 and 2001 Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001 2. FINANCIAL STATEMENT SCHEDULES Report of Independent Auditors' as to Schedules Schedule II - Valuation and Qualifying Accounts 3. EXHIBITS The following exhibits are required to be filed with this Report by Item 601 of Regulation S-K:
EXHIBIT NUMBER DESCRIPTION OF EXHIBITS - -------------- ----------------------- 2.1 Agreement and Plan of Merger dated December 8, 2000, by and among the Registrant, UDS, Patrick West, Daniel Reeves and The Estate of John R. West (incorporated by reference to Exhibit 10.24 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2001 (Commission File No. 000-23741), filed with the commission on March 28, 2002) 3.1 Amended and Restated Articles of Incorporation of the Registrant, (incorporated by reference to Exhibit 3.1 to the Registrant's Amendment No. 1 to Registration Statement on Form S-1 (Commission File No. 333-42373), filed with the Commission on February 11, 1998) 3.2 Amended and Restated By-laws of the Registrant (incorporated by reference to Exhibit 3.2 to the Registrant's Registration Statement on Form S-1/A (Commission File No. 333-79929), filed with the Commission on July 22, 1999)
20 4.1 Form of Common Stock Certificate of the Registrant (incorporated by reference to Exhibit 4.1 to the Registrant's Amendment No. 1 to Registration Statement on Form S-1 (Commission File No. 333-42373), filed with the Commission on February 11, 1998) 4.2(a) Rights Agreement between Company and Reliance Trust Company as Rights Agent, dated as of December 31, 1997 (incorporated by reference to Exhibit 4.2 to the Registrant's Amendment No. 1 to Registration Statement on Form S-1 (Commission File No. 333-42373), filed with the Commission on February 11, 1998) (b) First Amendment to the Rights Agreement dated as of November 30, 2000 between the Company, Reliance Trust Company and SunTrust Bank (incorporated by reference to Exhibit 4.2(b) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2000 (Commission File No. 000-23741), filed with the Commission on March 30, 2001) (c) Second Amendment to the Rights Agreement dated as of August 14, 2003 between the Company and SunTrust Bank (incorporated by reference to Exhibit 4.2 to Amendment No. 1 to the Registrant's Quarterly Report on Form 10-Q/A for the quarterly period ended June 30, 2003 (Commission File No. 000-23741), filed with the Commission on August 20, 2003) (d) Third Amendment to the Rights Agreement dated as of November 24, 2003 between the Company and SunTrust Bank (incorporated by reference to Exhibit 4.2(d) to Amendment No. 2 to the Registrant's Registration of Securities on Form 8-A/A (Commission File No. 000-23741), filed with the Commission on November 25, 2003) 10.1+ 2000 Stock Option and Incentive Award Plan and amendment thereto (incorporated by reference to Exhibit 4.3 and 4.4 to the Registrant's Form S-8 (Commission File No. 333-54970) filed with the Commission on February 5, 2001) 10.2(a) Sublease Agreement, dated May 26, 1999, by and between HSN Realty LLC and Universal Distribution Services, Inc. (incorporated by reference to Exhibit 10.8 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2000 (Commission File No. 000-23741), filed with the Commission on March 30, 2001) (b) Lease, dated March 23, 2000 by and between Dermody Industrial Group and Universal Distribution Services, Inc. (incorporated by reference to Exhibit 10.2(b) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2002 (Commission File No. 000-23741), filed with the Commission on March 31, 2003) 10.3(a) Master Lease Agreement and Addendums, dated March 20, 2000, by and between Computer Sales International, Inc. and the Registrant (incorporated by reference to Exhibit 10.9(a) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2000 (Commission File No. 000-23741), filed with the Commission on March 30, 2001) (b) First Amendment to Master Lease Agreement dated June 8, 2000, by and between Computer Sales International, Inc. and the Registrant (incorporated by reference to Exhibit 10.9(b) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2000 (Commission File No. 000-23741), filed with the
21 Commission on March 30, 2001) (c) Second Amendment to Master Lease Agreement dated September 28, 2000, by and between Computer Sales International, Inc. and the Registrant (incorporated by reference to Exhibit 10.9(c) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2000 (Commission File No. 000-23741), filed with the Commission on March 30, 2001) (d) Third Amendment to Master Lease Agreement dated October 9, 2002, by and between Computer Sales International, Inc. and the Registrant (incorporated by reference to Exhibit 10.3(d) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2002 (Commission File No. 000-23741), filed with the Commission on March 31, 2003) 10.4(a) Amended and Restated Loan and Security Agreement between the Registrant and SouthTrust Bank, N.A., dated January 25, 1999 (incorporated by reference to Exhibit 10.14 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1998 (Commission File No. 0-23741), filed with the Commission on March 26, 1999) (b) First Amendment to Amended and Restated Loan and Security Agreement by and between the Registrant and SouthTrust Bank, N.A., dated April 29, 1999 (incorporated by reference to Exhibit 10.14(b) to the Registrant's Registration Statement on Form S-1 (Commission File No. 333-79929), filed with the Commission on June 3, 1999) (c) Letter Modification/Waiver to Amended and Restated Loan and Security Agreement, as amended, effective August 14, 2000 (incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2000 (Commission File No. 0-23741), filed with the Commission on November 13, 2000) (d) Letter of Amendment to Amended and Restated Loan and Security Agreement by and between the Registrant and SouthTrust Bank, N.A. effective September 10, 2001 (Incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2001 (Commission File No. 0-23741) filed with the Commission on November 13, 2001) (e) Letter Modification/Waiver to Amended and Restated Loan and Security Agreement, as amended, effective May 31, 2002 (incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2002 (Commission File No. 000-23740) filed with the Commission on August 13, 2002) (f) Letter Modification/Waiver to Amended and Restated Loan and Security Agreement, as amended, effective November 13, 2002 (incorporated by reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2002 (Commission File No. 000-23740) filed with the Commission on November 19, 2002) (g) Letter Modification to Amended and Restated Loan and Security Agreement, dated February 18, 2003, as amended, effective January 1, 2003 (incorporated by reference to Exhibit 10.4(g) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2002 (Commission File No. 000-23741), filed with the Commission on March 31, 2003)
22 (h) Second Amended and Restated Loan and Security Agreement by and between the Registrant and SouthTrust Bank, N.A., dated April 3, 2003 (incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2003 (Commission File No. 000-23740), filed with the Commission on May 14, 2003) (i)* Letter Modification/Waiver to Second Amended and Restated Loan and Security Agreement, as amended, effective February 6, 2004 (j)* Letter Modification to Second Amended and Restated Loan and Security Agreement, as amended, effective February 26, 2004 (k)* Letter Modification/Wavier to Second Amended and Restated Loan and Security Agreement, as amended, effective March 26, 2004 10.5+ 2002 Senior Executive Incentive Compensation Plan (incorporated by reference to Exhibit 10.14 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2001 (Commission File No. 000-23741), filed with the Commission on March 28, 2002) 10.6(a)+ Amended and Restated Employment Agreement dated August 21, 2000, by and between David L. Gamsey and the Registrant (incorporated by reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10Q/A for the quarterly period ended June 30, 2000 (Commission File No. 0-23741), filed with the Commission on August 21, 2000) (b)+ Amendment to Amended and Restated Employment Agreement dated February 14, 2001, by and between David L. Gamsey and the Registrant (incorporated by reference to Exhibit 4.2(b) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2000 (Commission File No. 000-23741), filed with the Commission on March 30, 2001) 10.7+ Employment Agreement dated August 31, 2000, by and between Scott D. Dorfman and the Registrant (incorporated by reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2000 (Commission File No. 0-23741), filed with the Commission on November 13, 2000) 10.8+ Employment Agreement dated August 31, 2000, by and between David L. Ellin and the Registrant (incorporated by reference to Exhibit 10.3 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2000 (Commission File No. 0-23741), filed with the Commission on November 13, 2000) 10.9+ Employment Agreement dated August 31, 2000, by and between Larry C. Hanger and the Registrant (incorporated by reference to Exhibit 10.4 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2000 (Commission File No. 0-23741), filed with the Commission on November 13, 2000) 10.10 Operating Agreement dated December 28, 2000, by and among the Registrant, Return.com Online, LLC, and Mail Boxes Etc., USA, Inc. (incorporated by reference to Exhibit 10.22 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2000 (Commission File No. 000-23741), filed with the Commission on March 30, 2001) 10.11 Agreement to Discharge Debt, dated April 17, 2001, between Return.com Online
23 LLC and Mail Boxes Etc., USA, Inc. (incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2001 (Commission File No. 0-23741), filed with the Commission on May 14, 2001) 10.12 Agreement to Terminate Services and Marketing Agreement, dated April 17, 2001, between Return.com Online LLC, Mail Boxes Etc., USA, Inc. and the Registrant (incorporated by reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2001 (Commission File No. 0-23741), filed with the Commission on May 14, 2001) 10.13(a) Lease, dated July 23, 2001, by and between The Lincoln National Life Insurance Company and iFulfillment, Inc. (incorporated by reference to Exhibit 10.23 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2001 (Commission File No. 000-23741), filed with the Commission on March 28, 2002) (b) Lease, dated August 5, 2002, by and between The Lincoln National Life Insurance Company and the Registrant (incorporated by reference to Exhibit 10.13(b) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2002 (Commission File No. 000-23741), filed with the Commission on March 31, 2003) 10.14+ Employment Agreement dated December 31, 2001, by and between Robert J. Toner, Jr. and the Registrant (incorporated by reference to Exhibit 10.24 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2001 (Commission File No. 000-23741), filed with the Commission on March 28, 2002) 10.15+ Employment Agreement dated December 8, 2000, by and between Patrick J. West and the Registrant (incorporated by reference to Exhibit 10.24 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2001 (Commission File No. 000-23741), filed with the Commission on March 28, 2002) 10.16(a) Lease, dated April 23, 2002, by and between ProLogis Development Services Incorporated and the Registrant (incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2002 (Commission File No. 000-23740) filed with the Commission on November 19, 2002) (b) First Amendment to Lease Agreement dated October 15, 2002 by and between ProLogis Development Services Incorporated and the Registrant (incorporated by reference to Exhibit 10.16(b) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2002 (Commission File No. 000-23741), filed with the Commission on March 31, 2003) 10.17(a) Lease, dated September 17, 2002, by and between The Prudential Insurance Company of America and the Registrant (incorporated by reference to Exhibit 10.17 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2002 (Commission File No. 000-23741), filed with the Commission on March 31, 2003) (b) First Amendment to Lease Agreement dated April 4, 2003 by and between The Prudential Insurance Company of America and the Registrant (incorporated by reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for
24 the quarterly period ended March 31, 2003 (Commission File No. 000-23740), filed with the Commission on May 14, 2003) 10.18+ Employment Agreement dated April 7, 2003, by and between James McMurphy and the Registrant (incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2003 (Commission File No. 000-23741), filed with the Commission on August 14, 2003) 10.19(a) Agreement dated August 14, 2003 by and between IPOF Fund, LP, an Ohio limited partnership ("IPOF"), David Dadante, an individual resident of Ohio and the general partner of IPOF and the Registrant (incorporated by reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q/A for the quarterly period ended June 30, 2003 (Commission File No. 000-23740), filed with the Commission on August 20, 2003) (b) First Amendment dated November 24, 2003 to the Agreement by and between IPOF Fund, LP, an Ohio limited partnership ("IPOF"), David Dadante, an individual resident of Ohio and the general partner of IPOF and the Registrant (incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K (Commission File No. 000-23740), filed with the Commission on November 24, 2003) 13.1* Portions of the Registrant's Annual Report to Shareholders for 2003 incorporated into this Form 10-K 14.1* Code of Business Conduct and Ethics 21.1* List of Subsidiaries 23.1* Consent of Deloitte & Touche LLP 23.2* Notice Regarding Consent of Arthur Andersen LLP 24.1* Power of Attorney 31.1* Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a) 31.2* Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a) 32.1* Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 32.2* Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350
* Filed herewith. + Management contract or compensatory plan or arrangement required to be filed as an exhibit. (b) REPORTS ON FORM 8-K On November 7, 2003, the Company furnished to the Commission pursuant to Items 7 and 12 of Form 8-K its press release announcing the Company's financial results for the third quarter of 2003. On November 24, 2003, the Company filed and furnished its Form 8-K announcing the amendment of its Rights Agreement pursuant to Items 5, 7 and 9 of Form 8-K. 25 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS AS TO SCHEDULES PURSUANT TO SECURITIES AND EXCHANGE COMMISSION RULE 2-02 OF REGULATION S-X, THE FOLLOWING REPORT IS A COPY OF A REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP, WHICH HAS CEASED OPERATIONS, AND HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP. ARTHUR ANDERSEN LLP REPORTED ON SUCH FINANCIAL STATEMENTS PRIOR TO THE RECLASSIFICATIONS AND REVISIONS DISCUSSED IN NOTE 2 AND NOTE 16 OF THE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. We have audited in accordance with auditing standards generally accepted in the United States, the financial statements of INNOTRAC CORPORATION AND SUBSIDIARY included in this Form 10-K and have issued our report thereon dated February 8, 2002. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. /s/ Arthur Andersen LLP ARTHUR ANDERSEN LLP Atlanta, Georgia February 8, 2002 S-1 INNOTRAC CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Balance at Charged to Balance at Beginning Charged to Other End of Description of Period Expenses Accounts Deductions Period - ----------- ---------- ---------- ---------- ---------- ---------- (in 000's) Provision for uncollectble accounts Year ended December 31, 2003 .......................... $ 959 $ 1,571 $ -- $ (834) $1,696 2002 .......................... $3,263 $(1,329) $ -- $ (975) $ 959 2001 .......................... $3,416 $ 3,813 $ 50 $(4,016) $3,263 Provisions for returns and allowances Year ended December 31, 2003 .......................... $ 10 $ 29 $ -- $ (27) $ 12 2002 .......................... $ 193 $ 52 $ -- $ (235) $ 10 2001 .......................... $ 725 $ 211 $ 843 $(1,586) $ 193 Provisions for restructuring charge Year ended December 31, 2003 .......................... $ 277 $ -- $ -- $ (277) $ -- 2002 .......................... $1,831 $ (807) $ -- $ (747) $ 277 2001 .......................... $2,831 $ -- $(100) $ (900) $1,831
S-2 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, on the 30th day of March, 2004. INNOTRAC CORPORATION /s/ Scott D. Dorfman ------------------------------------------ Scott D. Dorfman Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer) Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant in the capacities indicated on the 30th day of March 2004. Signature Title - --------- ----- /s/ Scott D. Dorfman Chairman of the Board, President and Chief Executive - ----------------------- Officer (Principal Executive Officer) Scott D. Dorfman Senior Vice President, Chief Financial Officer, /s/ David L. Gamsey Treasurer and Secretary (Principal Financial and - ----------------------- David L. Gamsey Accounting Officer) /s/ David L. Ellin Senior Vice President--Sales and Director - ----------------------- David L. Ellin /s/ J. Alston Gardner Director - ----------------------- J. Alston Gardner /s/ Bruce V. Benator Director - ----------------------- Bruce V. Benator /s/ Martin J. Blank Director - ----------------------- Martin J. Blank /s/ Joel E. Marks Director - ----------------------- Joel E. Marks EX-10.4.(I) 3 g87947exv10w4wxiy.txt WAIVER TO 2ND AMENDED LOAN SECURITY AGREEMENT EXHIBIT 10.4(i) [SOUTHTRUST BANK LOGO] One Georgia Center 600 West Peachtree Street Atlanta, Georgia 30308 February 6, 2004 Mr. David L. Gamsey Chief Financial Officer Innotrac Corporation 6655 Sugarloaf Parkway Duluth, Georgia 30097 RE: Fixed Charge Coverage Waiver Dear David: In response to your request, SouthTrust Bank grants a modification/waiver and consent of the outlined covenants contained in the Amended Loan and Security Agreement between Innotrac Corporation and SouthTrust Bank: 12.3 Fixed Charge Coverage Ratio As of December 31, 2003, this covenant requires that the Fixed Charge Coverage Ratio be least 1.75 times at the end of each fiscal quarter, on a rolling four quarters basis. The waiver of this covenant is for December 31, 2003. Sincerely, /s/ Noble Jones -------------------- Noble Jones Vice President EX-10.4.(J) 4 g87947exv10w4wxjy.txt SECOND AMENDED LOAN AND SECURITY AGREEMENT EXHIBIT 10.4(j) [SOUTHTRUST BANK LOGO] One Georgia Center 600 West Peachtree Street Atlanta, Georgia 30308 February 26, 2004 Mr. David L. Gamsey Chief Financial Officer Innotrac Corporation 6655 Sugarloaf Parkway Duluth, Georgia 30097 RE: Amended Loan and Security Agreement between Innotrac Corporation and SouthTrust Bank Dear David: In response to your request, SouthTrust Bank will begin working to document the approved changes to your Loan and Security Agreement, as follows: 1. The amount of the Facility will be reduced to $25,000,000, at your request, due to Innotrac's decreased borrowing needs. 2. The Fixed Charge Coverage Ratio (Section 12.3) will be amended to be at least 1.30 times, effective December 31, 2003, through maturity of the line on June 1, 2005. As you know this covenant previously required an increase in the ratio from 1.25 times to 1.75 time on December 31, 2003. All remaining covenants and terms of the Loan and Security Agreement will remain the same, including but not limited to: A. Minimum tangible net worth covenant shall remain at $34 million. B. Maximum Liabilities to Tangible Net Worth covenant shall remain at 1.50:1. These changes are being made subject to there being no changes to the draft financial information you have provided to us for the December 31, 2003 fiscal year-end, and our understanding that your auditors will not make any changes to the financials when certified by them. David, we appreciate Innotrac's relationship with SouthTrust, and look forward to working with you in the future. Sincerely /s/ Noble Jones ----------------------- Noble Jones Vice President EX-10.4.(K) 5 g87947exv10w4wxky.txt WAIVER TO 2ND AMENDED LOAN SECURITY AGREEMENT Exhibit 10.4(K) (SOUTHTRUST BANK LOGO) One Georgia Center 600 West Peachtree Street Atlanta, Georgia 30308 March 26, 2004 Mr. David L. Gamsey Chief Financial Officer Innotrac Corporation 6655 Sugarloaf Parkway Duluth, Georgia 30097 RE: Amended Loan and Security Agreement between Innotrac Corporation and SouthTrust Bank Dear David: In response to your request, SouthTrust Bank will begin working to document the approved changes to your Loan and Security Agreement, as follows: 1. The amount of the Facility will be reduced to $25,000,000, at your request, due to Innotrac's decreased borrowing needs. 2. The Fixed Charge Coverage Ratio (Section 12.3) will be amended to be at least 1.30 times, effective December 31, 2003, through maturity of the line on June 1, 2005. As you know this covenant previously required an increase in the ratio from 1.25 times to 1.75 time on December 31, 2003. 3. The Minimum Tangible Net Worth covenant requirement shall be $24 million, effective December 31, 2003, due to the valuation allowance that was recorded against deferred tax assets in the amount of $9.9 million. All remaining covenants and terms of the Loan and Security Agreement will remain the same, including, but not limited to, the Maximum Liabilities to Tangible Net Worth covenant which requires the ratio to remain below 1.50:1. These changes are being made based on the December 31, 2003, financial information you have provided to us. A covenant waiver fee in the amount of $15,000, will be debited from your account. David, we appreciate Innotrac's relationship with SouthTrust, and look forward to working with you in the future. Sincerely, /s/ Noble Jones ------------- Noble Jones Vice President EX-13.1 6 g87947exv13w1.txt PORTIONS OF THE REGISTRANT'S ANNUAL REPORT EXHIBIT 13.1 SELECTED FINANCIAL DATA The following table sets forth selected financial data for the Company. The selected historical statements of operations data for each of the years ended December 31, 2003, 2002, 2001, 2000 and 1999 and the selected historical balance sheet data for the periods then ended have been derived from the Company's audited Consolidated Financial Statements for the years ended December 31, 2003, 2002, 2001, 2000 and 1999. As discussed in Note 2 to the Consolidated Financial Statements, the Company adopted Emerging Issues Task Force ("EITF") No. 01-14, "Income Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses Incurred" on January 1, 2002, which requires the presentation of reimbursed out-of-pocket expenses on a gross basis as revenues and expenses. In accordance with the adoption of EITF 01-14, reimbursements from customers, which primarily represent freight and postage fees, are presented on a gross basis for each of the years ended December 31, 2003, 2002, 2001, 2000 and 1999.
RESULTS FOR YEAR ENDED DECEMBER 31: 2003 2002 2001 2000 1999 -------- -------- --------- --------- --------- (IN 000'S, EXCEPT PER SHARE AMOUNTS) Revenues $74,740 $82,420 $121,859 $202,975 $258,267 Cost of revenues 35,157 46,444 68,153 161,972 206,739 Special (credits) charges -- (293) -- 16,462 -- -------- -------- --------- --------- --------- Gross profit 39,583 36,269 53,706 24,541 51,528 -------- -------- --------- --------- --------- OPERATING EXPENSES: Selling, general and administrative 36,444 37,332 43,329 38,209 30,460 Special (credits) charges (30) 404 -- 17,801 -- Depreciation and amortization 5,622 5,336 4,864 4,168 3,414 -------- -------- --------- --------- --------- TOTAL OPERATING EXPENSES 42,036 43,072 48,193 60,178 33,874 -------- -------- --------- --------- --------- Operating (loss) income (2,453) (6,803) 5,513 (35,637) 17,654 -------- -------- --------- --------- --------- Interest expense (income), net 741 318 (532) 80 1,370 Other expense (income) 15 (124) (20) 141 60 -------- -------- --------- --------- --------- TOTAL OTHER EXPENSE (INCOME) 756 194 (552) 221 1,430 -------- -------- --------- --------- --------- (Loss) income before income taxes and minority interest (3,209) (6,997) 6,065 (35,858) 16,224 Income tax (provision) benefit (8,772) 2,578 (2,573) 14,084 (6,389) -------- -------- --------- --------- --------- Net (loss) income before minority interest (11,981) (4,419) 3,492 (21,774) 9,835 Minority interest, net of income taxes -- -- (893) (199) -- -------- -------- --------- --------- --------- NET (LOSS) INCOME $(11,981) $(4,419) $4,385 $(21,575) $9,835 ======== ======== ========= ========= ========= Net (loss) income per share-basic $(1.04) $(0.38) $0.39 $(1.92) $0.99 Net (loss) income per share-diluted $(1.04) $(0.38) $0.38 $(1.92) $0.98 COMMON STOCK INFORMATION: Average number of common shares outstanding-basic 11,542 11,516 11,318 11,212 9,911 Book value per common share(1) $4.31 $5.20 $5.59 $5.23 $7.99 YEAR-END FINANCIAL POSITION: Current assets $29,721 $41,619 $58,093 $76,150 $94,810 Current liabilities 20,117 20,143 35,717 34,175 24,930 Property and equipment, net 14,750 18,915 14,500 13,717 8,922 Total assets 70,962 95,499 99,393 97,145 104,218 Long-term obligations 1,083 15,497 393 166 75 Total liabilities 21,200 35,640 36,110 34,341 25,005 Total shareholders' equity $49,762 $59,859 $63,283 $58,635 $79,213
(1) Book value per common share is calculated by dividing total shareholders' equity at year end by the basic average number of common shares outstanding. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion may contain certain forward-looking statements that are subject to conditions that are beyond the control of the Company. Actual results may differ materially from those expressed or implied by such forward-looking statements. Factors that could cause actual results to differ include, but are not limited to, the Company's reliance on a small number of major clients; risks associated with the terms and pricing of our contracts; reliance on the telecommunications and direct marketing industries and the effect on the Company of the downturns, consolidation and changes in those industries in the past two years; risks associated with the fluctuations in volumes from our clients; risks associated with upgrading, customizing, migrating or supporting existing technology; risks associated with competition; and other factors discussed in more detail under "Business-Certain Factors Affecting Forward-Looking Statements" in our Annual Report on Form 10-K. OVERVIEW Innotrac Corporation ("Innotrac" or the "Company"), founded in 1984 and headquartered in Atlanta, Georgia, is a full-service fulfillment and logistics provider serving enterprise clients and world-class brands. The Company employs sophisticated order processing and warehouse management technology and operates seven fulfillment centers and two call centers in five cities spanning all time zones across the continental United States. We receive most of our clients' orders either through inbound call center services, electronic data interchange ("EDI") or the Internet. On a same-day basis, depending on product availability, the Company picks, packs, verifies and ships the item, tracks inventory levels through an automated, integrated perpetual inventory system, warehouses data and handles customer support inquiries. Our core service offering includes the following: - Fulfillment Services: - sophisticated warehouse management technology - automated shipping solutions - real-time inventory tracking and order status - purchasing and inventory management - channel development - zone skipping for shipment cost reduction - product sourcing and procurement - packaging solutions - back-order management - returns management - Customer Support Services: - inbound call center services - technical support and order status - returns and refunds processing - call centers integrated into fulfillment platform - cross-sell/up-sell services - collaborative chat - intuitive e-mail response 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Today, the Company is primarily focused on five diverse lines of business, or industry verticals. This is a result of a significant effort made by the Company to diversify both its industry and client base over the last three years. Prior to 2000, the Company was primarily focused on the telecommunications industry, with over 90% of its revenues being derived through this vertical. While a large portion of the Company's revenues are still derived from this industry group, the chart below is indicative of the diversification efforts achieved in recent years. BUSINESS MIX
Business Line/Vertical 2003 2002 - ---------------------- ---- ---- Telecommunications products 23.0% 26.5% Modems 19.4 19.3 Retail/Catalog 27.4 20.2 Direct Marketing 18.0 27.0 B2B 12.2 7.0 ----- ----- 100.0% 100.0% ===== =====
The Company continues to be a major provider of fulfillment and customer support services to the telecommunications industry. In spite of a significant contraction and consolidation in this industry in the past several years, the Company continues to provide customer support services and fulfillment of telephones, Caller ID equipment, Digital Subscriber Line ("DSL") and Cable Modems and other telecommunications products to companies such as BellSouth Corporation ("BellSouth"), Qwest Communications International, Inc. ("Qwest") and Comcast Corporation ("Comcast") and their customers. Inventory for our telecommunications and DSL clients is held on a consignment basis, with the exception of certain BellSouth inventory, for which we are contractually indemnified, and includes items such as telephones, Caller ID equipment, wireless pagers, DSL and cable modems and ancillary equipment. We anticipate that the percentage of our revenues attributable to telecommunications and DSL clients will remain fairly constant during 2004. Based on client forecasts, we are anticipating a decrease of approximately $1.6 million in our wireless pager business as our one client in this area has decided to exit, offset by an increase in our DSL and cable modem business which is still in a strong growth mode. The telephone and Caller ID equipment business is mature, yet steady. The Company also provides a variety of these services for a significant number of retail, catalog and direct marketing clients which include such companies as The Coca-Cola Company, Ann Taylor Retail, Inc., Smith & Hawken, Ltd., Tactica International, Inc. (a subsidiary of Helen of Troy), Porsche Cars North America, Inc., Nordstrom.com LLC, Wilsons Leather Direct, Inc., Martha Stewart Living Omnimedia, Inc., and Thane International. We take orders for our retail, catalog and direct marketing clients via the internet, through a customer service representative at our Pueblo and Reno call centers or through direct electronic transmission from our clients. The orders are processed through one of our order management systems and then transmitted to one of our seven fulfillment centers located across the country and are shipped to the end consumer or retail store location, as applicable, typically within 24 hours of when the order is received. Inventory for our retail, catalog and direct marketing clients is held on a consignment basis, with minor exceptions, and includes items such as shoes, dresses, accessories, books and outdoor furniture. Our revenues are sensitive to the number of orders and customer service calls received. Our client contracts do not guarantee volumes. We anticipate that the percentage of our revenues attributable to our retail and catalog clients will increase during 2004 due to the anticipated additions of new channels, product lines and divisions for existing clients, along with internal growth and a strengthening of the overall economy. This would also be consistent with actual sales volumes 3 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS experienced in the second half of 2003, which represented an increase of over $1.1 million from the first half of 2003. Revenues attributable to our direct marketing clients may decrease further in 2004 due to their lack of new "hit" products and an anticipated decrease in advertising to attract consumers. The direct marketing vertical was weak throughout all of 2003. Further, it has been announced that one of our major direct marketing clients is for sale. The impact of a change in ownership of this client cannot be estimated at this time, but could materially impact our future results of operations if our services for this client were reduced or discontinued. The Company also provides these services for business-to-business ("B2B") clients including Books Are Fun, Ltd. (a subsidiary of Reader's Digest), NAPA and The Walt Disney Company. This is a small, but growing area of our business. ACQUISITIONS In order to reduce our industry and client concentration and to expand our national presence, in December 2000, we acquired Universal Distribution Services ("UDS"). Our UDS division provides integrated order processing, order management, fulfillment and customer relationship management services. UDS's customer base comprises traditional direct marketing companies including Thane International and Tactica International, Inc. It is located in a 275,000 square-foot facility in Reno, Nevada. During 2001, we expanded UDS's business by taking advantage of our East Coast capabilities. Under the terms of Innotrac's merger agreement with UDS, the former shareholders of UDS could receive, as part of the consideration paid for their shares, annual contingent payments based on the operating income generated by our UDS division over a three-year period that commenced December 1, 2000. For the first year of the earnout period, UDS's stockholders received approximately $13.7 million in cash and 310,000 shares of our common stock pursuant to this arrangement. No earnout amounts were earned in the second and third years. In July 2001, to further our strategy to diversify our industry and client concentration, we acquired iFulfillment, Inc. ("iFulfillment"). Our iFulfillment subsidiary specializes in fully integrated, automated, order fulfillment services for multi-channel retailers and catalogers including such clients as Nordstrom.com LLC, Wilsons Leather Direct, Inc. and Martha Stewart Living Omnimedia, Inc. It is located in a 354,000 square- foot leased facility in Bolingbrook, Illinois. Due to the addition of a sizable new client in September 2002, we leased an additional 150,204 square feet in a nearby facility, which was expanded by 54,103 square feet in April 2003. This new facility has expansion space of an additional 51,254 square feet that we have an option to lease in the future. There are no immediate plans to exercise that option. In August 2002 we leased a 396,000 square-foot fulfillment center near Cincinnati, in Hebron, Kentucky. This facility is used exclusively to provide fulfillment services for Smith & Hawken, which is the Company's single largest retail client, under the terms specified in a contract with Smith & Hawken, which is for a term of six years. Capital expenditures associated with this facility were approximately $4.6 million and were funded through our bank line of credit. With our national footprint virtually complete, we are committed to deeper penetration within our existing business lines and continued diversification of our client base. Our long-term goal is to have our business mix spread evenly across a high number of clients in diverse industries. We will continue to seek new clients and may open additional facilities in other geographic locations to service these needs. During 2002, the Company incurred significant start-up and associated technology costs for new client implementations. We added Martha Stewart Living Omnimedia and Smith & Hawken to our Reno system. As part of the migration of those two new clients onto the system we added the requisite functionality and customization. The customized nature of the system required significant resources to properly scale the system to meet our client's needs and resulted in a considerable increase in IT costs in 2002. Approximately $2.6 million of these costs were eliminated in 2003. 4 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The following table sets forth summary operating data, expressed as a percentage of revenues, for the years ended December 31, 2003, 2002 and 2001. 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 Consolidated Financial Statements and notes thereto.
YEAR ENDED DECEMBER 31, 2003 2002 2001 ----- ----- ----- Revenues, net 100.0% 100.0% 100.0% Cost of revenues 47.0 56.4 55.9 Special charges (credits), net -- (0.4) -- ----- ----- ----- Gross profit 53.0 44.0 44.1 Selling, general and administrative 48.8 45.3 35.6 Special charges, net -- 0.5 -- Depreciation and amortization 7.5 6.5 4.0 ----- ----- ----- Operating (loss) income (3.3) (8.3) 4.5 Other expense (income) 1.0 0.2 (0.5) ----- ----- ----- (Loss) income before taxes and minority interest (4.3) (8.5) 5.0 Income tax (provision) benefit (11.7) 3.1 (2.1) ----- ----- ----- Net (loss) income before minority interest (16.0) (5.4) 2.9 Minority interest, net of income taxes -- -- (0.7) ----- ----- ----- Net (loss) income (16.0)% (5.4)% 3.6% ===== ===== =====
SPECIAL CHARGES The Company recorded special charges of $34.3 million during the year ended December 31, 2000. At December 31, 2003 and 2002, the Company had approximately $0 and $277,000, respectively, in remaining accruals related to the special charges recorded during the year ended December 31, 2000. Cash payments relating to the special charge accruals for the years ended December 31, 2003 and 2002 were approximately $277,000 and $716,000, respectively. The Company recognized approximately $3.0 million of special credits during the year ended December 31, 2002, related to gains realized on sales of inventory items which were previously written off as special charges in previous periods, cash collected for accounts receivable that were written off as special charges in previous periods, redeployment of leased computer hardware for which the leases were fully accrued for as special charges in previous periods, and client contract amendments which resulted in reduced liabilities. These amounts were recorded as a reduction in the special charge line items in the Consolidated Statements of Operations. 5 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS During 2002, the Company also recognized an additional $3.1 million in special charges. Approximately $2.4 million of these charges were related to capitalized hardware and software costs for systems purchased specifically for a potential new client which were subsequently not utilized as originally planned. The loss of the potential customer indicated that the carrying value of the asset group was potentially not recoverable, and therefore, an impairment test under the provisions of SFAS No. 144 was performed. As the fair market value of the asset group was not readily determinable, a discounted, probability weighted cash flow model was utilized as a basis to determine fair value. As a result of the cash flow analysis, a $2.4 million impairment charge was recorded. Of the remaining charges, approximately $500,000 related to the write-down to net realizable value of specified fixed assets obtained as part of the December 2000 acquisition of UDS which were being utilized for one specific customer who ceased conducting business with UDS. The balance of approximately $200,000 was related to severance costs for positions which were eliminated. YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002 Revenues. The Company's net revenues decreased 9.3% to $74.7 million for the year ended December 31, 2003 from $82.4 million for the year ended December 31, 2002. The decrease in revenues is primarily due to a $3.6 million reduction in business with Warranty Corporation of America ("WACA"), which lost one of its significant clients in the fourth quarter of 2002, a significant $10.5 million decrease in revenues from our two primary direct marketing clients, Thane and Tactica, and a decision by BellSouth to exit their wireless pager business, which resulted in a decrease of revenues of approximately $1.4 million. The reduction in the WACA business began in the fourth quarter of 2002 and as of December 31, 2003, we are no longer providing any services for WACA. Additionally, the direct marketing industry remains soft. However, we have recently received new programs from our direct marketing clients for 2004 and added one new significant direct marketing client towards the end of 2003. The BellSouth wireless program will be in a support mode only during 2004 which will result in a further reduction in revenues to Innotrac of approximately $1.6 million. This decline in revenues was offset by growth in our retail and B2B businesses with Smith & Hawken and Books Are Fun with revenues increasing by approximately $8.3 million in 2003. We believe that we will see additional growth from each of these clients in 2004 based on new programs, channels and initiatives that we are already assisting with. Cost of Revenues. The Company's cost of revenues decreased 24.3% to $35.2 million for the year ended December 31, 2003 compared to $46.4 million for the year ended December 31, 2002. Cost of revenues decreased primarily due to a 30.8% decrease in freight costs associated with lower volumes, a lower revenue base as discussed above and more efficient operations. The year ended December 31, 2002 also included some inefficiencies associated with startup operations for Smith & Hawken, Books Are Fun, Martha Stewart and Ann Taylor. All of these accounts commenced operations with Innotrac during 2002. Special Credits. There were no special charges or credits during 2003. During the year ended December 31, 2002, the Company recognized approximately $293,000 related to gains realized on sales of inventory items previously written down as part of the 2000 special charge. Gross Profit. For the year ended December 31, 2003, the Company's gross profit increased to $39.6 million, or 53.0% of revenues, compared to $36.3 million, or 44.0% of revenues, for the year ended December 31, 2002. The increase in gross profit was due primarily to a reduction in freight costs, improved operating efficiencies in the call centers and fulfillment centers and elimination of significant new client startup costs. Selling, General and Administrative Expenses. S,G&A expenses for the year ended December 31, 2003 decreased 2.4% to $36.4 million or 48.8% of revenues compared to $37.3 million or 45.3% of revenues for the year ended December 31, 2002. The decrease in expenses in 2003 was mainly attributable to a reduction in information technology personnel and the conversion of information technology consultants to employees at lower rates, which resulted in a $2.6 million reduction. This was offset by higher facility costs of $2.2 million 6 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS associated with full year rents in Hebron and Romeoville and an increase of approximately $700,000 in our accounts receivable reserve. Start-up expenses associated with new client implementations were also included in the 2002 results. The increase in S,G&A expense as a percentage of revenues was primarily due to a reduced revenue base. Special (Credits)/Charges. During 2003, the Company recorded a special credit of $30,000 associated with the settlement of a severance claim at an amount lower then previously reserved for in 2002. During 2002, the Company recorded special charges of $3.1 million primarily related to the impairment of capitalized hardware and software costs for systems not being utilized as originally planned. This was offset by the reversal of a portion of the 2000 special charges totaling approximately $2.7 million related to accounts receivable reserves that were no longer required, the redeployment of leased computer hardware which were previously fully reserved for as special charges, and client contract amendments which resulted in decreased future obligations to the Company. Income Taxes. During 2003, a valuation allowance has been recognized for the full amount of the deferred tax asset as losses in recent years create uncertainty about the realization of the tax benefits in future years. The valuation allowance of approximately $9.9 million resulted in an overall tax provision of approximately $8.8 million. YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001 Revenues. The Company's revenues decreased 32.4% to $82.4 million for the year ended December 31, 2002 from $121.9 million for the year ended December 31, 2001. The decrease in revenues is primarily due to the loss of the SBC contract which ended on November 30, 2001 and represented approximately $15.3 million of revenues during the year ended December 31, 2001; completion of the transition from an inventory ownership to a fee-for-service model; and a 50.1% or $13.6 million decrease in freight revenues due to clients utilizing their own direct billed freight accounts. This decline in revenues was partially offset by the re-initiation of fulfillment services of customer premise equipment ("CPE") during the third quarter of 2001 and the expansion of services to include wireless pager equipment with BellSouth during the fourth quarter of 2001. Additionally, the revenue decline was also partially offset by the commencement of the Martha Stewart contract in the first quarter of 2002 and the Smith and Hawken, Ann Taylor and Books Are Fun contracts in the third quarter of 2002. Cost of Revenues. The Company's cost of revenues decreased 31.9% to $46.4 million for the year ended December 31, 2002 compared to $68.2 million for the year ended December 31, 2001. $13.6 million of this decrease was attributable to a reduction in pass-through freight costs. A reduction in call center direct costs from the loss of the SBC contract in December 2001 and the subsequent closure of the Atlanta call center in January 2002 also contributed to the decrease in cost of revenues during 2002 as compared to 2001. This decline in cost of revenues was partially offset by expenses incurred in the second half of 2002 relating to additional fulfillment labor required to handle the start-up of several new fulfillment clients as outlined above. Special Credits. The Company recognized approximately $293,000 of special credits in 2002 related to gains realized on sales of inventory items previously written down as part of the 2000 special charge. There were no special charges or special credits in 2001. Gross Profit. For the year ended December 31, 2002, the Company's gross profit decreased to $36.3 million, or 44.0% of revenues, compared to $53.7 million, or 44.1% of revenues, for the year ended December 31, 2001. The decrease in gross profit was due primarily to the revenue decrease discussed above. Selling, General and Administrative Expenses. S,G&A expenses for the year ended December 31, 2002 decreased 13.8% to $37.3 million or 45.3% of revenues compared to $43.3 million or 35.6% of revenues for 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS the year ended December 31, 2001. The decrease in expenses in 2002 was mainly attributable to charges recorded during the first quarter of 2001, primarily for (i) the impairment of software development costs and severance costs related to Return.com and (ii) a significant decrease in bad debt expense in 2002. The decline in S,G&A costs was partially offset by increased information technology and start-up expenses associated with new client implementations during 2002. The increase in S,G&A expense as a percentage of revenues was primarily due to the reduction in revenues discussed above. Special Charges. The Company recorded special charges of $3.1 million during 2002 primarily related to the impairment of capitalized hardware and software costs for systems not being utilized as originally planned. This was offset by the reversal of a portion of the 2000 special charges totaling approximately $2.7 million related to accounts receivable reserves that were no longer required, the redeployment of leased computer hardware which were previously fully reserved for as special charges, and client contract amendments which resulted in decreased future obligations to the Company. There were no special charges in 2001. Income Taxes. The Company's effective tax rate for the years ended December 31, 2002 and 2001 was a benefit of 36.8% and a provision of 42.4%, respectively. The decrease in the absolute rate was principally due to the impact of certain items not deductible for tax purposes in the prior period. LIQUIDITY AND CAPITAL RESOURCES The Company funds its operations and capital expenditures primarily through cash flow from operations and borrowings under a credit facility with a bank. The Company had cash and cash equivalents of approximately $2.2 million at December 31, 2003 as compared to $961,000 at December 31, 2002. Additionally, the Company had reduced its borrowings under its revolving credit facility (discussed below) to $11.8 million outstanding at December 31, 2003 as compared to $14.4 million at December 31, 2002. The Company generated positive cash flow from operations and free cash flow during 2003. We anticipate positive cash flows from operations again in 2004. One of the primary contributors to generating cash in 2004 will be a further reduction in our wireless pager inventory of approximately $5.5 million. This should also result in a further reduction in borrowings under our revolving credit facility. Capital expenditures were a modest $1.2 million in 2003 versus capital expenditures of $12.8 million in 2002. We anticipate capital expenditures of approximately $2.0 million in 2004. This estimate is subject to various contingencies, including the possible need to incur additional capital expenditures related to new clients or significant new initiatives by existing clients. The Company currently has a revolving credit agreement with a bank for borrowings up to $40.0 million. We intend to reduce the size of this facility from $40.0 million to $25.0 million as the Company does not anticipate a need for the larger amount. We also anticipate that outstanding amounts under the revolving credit facility should decrease in 2004 as our wireless pager inventory is sold and related accounts receivables collected. 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. Accordingly, in the event of noncompliance, these amounts could be accelerated. Furthermore, borrowings under the revolving credit agreement are subject to borrowing base limitations. In May 2002, the Company extended its credit facility until June 2005. The Company and its subsidiary have granted a security interest in all of their assets and the subsidiary has provided a guarantee to the lender as collateral under this revolving credit agreement. The revolving credit agreement contains various restrictive financial and change of ownership control covenants. Noncompliance with any of the covenants allows the lender to declare any outstanding borrowing amounts to be immediately due and payable. The credit facility 8 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS limits borrowings under the agreement to a specified percentage of eligible accounts receivable and inventory, as defined, which totaled $18.5 million at December 31, 2003. The financial covenants required the Company to maintain a fixed charge coverage ratio of 1.75 to 1.00 by December 31, 2003. At December 31, 2003, the Company was not in compliance with this fixed charge ratio. However, the Company received a waiver from the bank and that covenant was amended and reduced to a lower ratio of 1.30 to 1.00 for the balance of the term. The Company's fixed charge ratio at December 31, 2003 was 1.40 to 1.00. Additionally, the revolving credit agreement contains a minimum tangible net worth requirement of $34 million. Tangible net worth is computed as shareholders' equity less goodwill, other intangible assets and certain deferred costs. Included in the bank's definition of tangible net worth is the carrying amount of the deferred tax asset. Accordingly, as a valuation allowance was recorded at December 31, 2003 for the entire deferred asset balance of $9.9 million, the Company was no longer in compliance with the tangible net worth requirement of $34 million. However, the Company received a waiver from the bank and that covenant was amended and reduced to $24 million for the balance of the term. 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. On November 13, 2003, the Company fixed $6.0 million of its $11.8 million of borrowings at a 90-day LIBOR rate of 2.68%. During the years ended December 31, 2003, 2002 and 2001 the Company incurred interest expense related to the line of credit of approximately $704,000, $266,100 and $0, respectively, resulting in a weighted average interest rate of 3.80%, 3.75% and 0%, respectively. At December 31, 2003, the Company had $6.7 million available under the revolving credit agreement. During the year ended December 31, 2003, the Company generated $3.8 million in cash flow from operating activities compared to $3.9 million in cash flow from operating activities in the same period in 2002. The slight decrease in cash from operating activities was primarily the result of a decrease of $7.8 million in accounts payable associated with a large inventory purchase made in December 2002 and paid in January 2003, increase in trade accounts receivable of $2.6 million and a reduction in accrued expenses of $3.8 million primarily attributable to a reduction in outstanding credits due customers, the settlement of various legal claims and a reduction in accrued severance. These items were offset by a decrease in inventories of $13.2 million, primarily wireless pagers. During the year ended December 31, 2003, net cash used in investing activities was $1.4 million as compared to $25.9 million in 2002. The 2002 amounts included a $13.7 million earn-out payment made in February 2002 and $12.8 million in capital expenditures, primarily in conjunction with the Company's new facility in Hebron, Kentucky and capitalized technology costs. Capital expenditures in 2003 were $1.2 million. 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 year ended December 31, 2003, the net cash used in financing activities was $1.2 million compared to $13.6 million provided by financing activities in the same period in 2002. The primary difference between years is attributable to borrowings of $14.4 million under the credit facility in 2002 versus a reduction in outstanding borrowings of $2.6 million in 2003. Additionally, during 2003, the Company generated cash of $1.6 million through the exercise of previously granted employee stock options. We anticipate approximately $5.5 million in further reductions will take place by the end of 2004 and that additional employee stock options will be exercised resulting in cash payments to the Company. The Company estimates that its cash and financing needs through 2004 will be met by cash flows from operations and its credit facility. The Company has generated positive cash flows from operations in each of the last three years and anticipates doing so again in 2004. The Company may need to raise additional funds in order to take advantage of unanticipated opportunities, such as acquisitions of complementary businesses or 9 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS the opening of new facilities. There can be no assurance that the Company will be able to raise any such capital on terms acceptable to the Company or at all. The Company's primary long-term contractual commitments consist of capital and operating leases. As of December 31, 2003, the Company did not have any off balance sheet arrangements that have or are reasonably likely to have a current or future effect on the financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. In addition, the Company had none of the following as of December 31, 2003: guarantees of other entities' obligations, structured finance arrangements, synthetic leases, repurchase obligations or similar commercial or financing commitments. Additionally, the Company does not trade in commodity contracts. The following table sets forth the Company's contractual commitments by period. There are no additional purchase obligations or other long-term liabilities other than those reflected below. For additional information, see Note 7 to the Consolidated Financial Statements (in 000's).
Payments Due by Period ------------------------------------------------------------------ Total Less than 1 year 1-3 years 4-5 years After 5 years ------- ---------------- --------- --------- ------------- Capital leases $ 151 $ 95 $ 56 $ -- $ -- Operating leases 27,844 7,779 13,514 6,551 -- Line of credit (1) 11,802 -- 11,802 -- --
(1) The provisions of the revolving line of 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. Accordingly, in the event of noncompliance, these amounts could be accelerated. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS Management believes the Company's exposure to market risks is immaterial. Innotrac holds no market risk- sensitive instruments for trading purposes. At present, the Company does not employ any derivative financial instruments, other financial instruments or derivative commodity instruments to hedge any market risks and does not currently plan to employ them in the future. To the extent that the Company has borrowings outstanding under its credit facility, the Company will have market risk relating to the amount of borrowings due to variable interest rates under the credit facility. The Company believes its 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 noted in Note 7 to the Consolidated Financial Statements, and the Company has no long-term purchase commitments. CRITICAL ACCOUNTING POLICIES Critical accounting policies are those policies that can have a significant impact on the presentation of our financial position and results of operations and demand the most significant use of subjective estimates and management judgment. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Specific risks inherent in our application of these critical policies are described below. For all of these policies, we caution that future events rarely develop exactly as forecasted, and the best estimates routinely require adjustment. These policies often require difficult judgments on complex matters that are often subject to multiple sources of authoritative guidance. Additional information concerning our accounting policies can be found in Note 2 to our Consolidated Financial Statements. 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: 10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Goodwill and Other Acquired Intangibles. Goodwill represents the cost of an acquired enterprise in excess of the fair market value of the net tangible and identifiable intangible assets acquired. Goodwill and other acquired intangibles related to business combinations prior to July 1, 2001 were being amortized over 5-20 years on a straight-line basis, which represented management's estimation of the related benefit to be derived from the acquired business. The Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets, "effective January 1, 2002, which changed the accounting for goodwill and other indefinite life intangibles from an amortization method to an impairment only approach. Under SFAS No. 142, goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. Innotrac's goodwill carrying amount as of December 31, 2003 was $25.2 million. This asset relates to the goodwill associated with the Company's acquisition of Universal Distribution Services ("UDS") in December 2000 (including the earnout payment made to the former UDS shareholders in February 2002), and the acquisition of iFulfillment, Inc. in July 2001. In accordance with SFAS No. 142, the Company contracted with an independent third party valuation firm to perform a valuation in the first quarter of 2004. The third party valuation supported that the fair value of the reporting unit at January 1, 2004 exceeds the carrying amount of the net assets, including goodwill, and thus no impairment currently exists. Management has reviewed and concurs with the major assumptions used in the third party's valuation at January 1, 2004. The Company will perform this impairment test annually as of January 1 or sooner if circumstances indicate. Deferred Tax Asset. Innotrac utilizes the liability method of accounting for income taxes. Under the liability method, deferred taxes are determined based on the difference between the financial and tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. A valuation allowance is recorded against deferred tax assets if the Company considers it is more likely than not that deferred tax assets will not be realized. Innotrac's net deferred tax asset as of December 31, 2003 is $9.9 million. This deferred tax asset was generated primarily by net operating loss carryforwards created primarily by the special charge of $34.3 million recorded in 2000 and the net losses generated in 2002 and 2003. Innotrac has a tax net operating loss carryforward of $31.5 million at December 31, 2003 that expires between 2020 and 2023. Innotrac's ability to generate the expected amounts of taxable income from future operations is dependent upon general economic conditions, collection of existing outstanding accounts receivable, competitive pressures on sales and margins and other factors beyond management's control. Due to these factors, combined with losses in recent years creates uncertainty about the ultimate realization of the gross deferred tax asset in future years. Therefore a full valuation allowance of approximately $9.9 million has been recorded in 2003. Income taxes associated with future earnings will be offset by a reduction in the 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. The Company makes estimates each reporting period associated with its reserve for uncollectible accounts. These estimates are based on the aging of the receivables. One direct marketing client, with a substantial past due balance at December 31, 2003, entered into a payment arrangement with Innotrac in February 2004 that would eliminate the past due amounts during the first half of 2004. Payments of approximately $1 million towards this past due amount were received in February and March, 2004. In spite of these arrangements and subsequent payments, and due primarily to the financial condition, payment history and aging of the receivables of this client, the Company still determined it prudent to establish a specific reserve of $1.1 million 11 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS for this account at December 31, 2003. Management will continue to assess the level of reserve needed against this account quarterly. RECENT ACCOUNTING PRONOUNCEMENTS In June 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This Statement requires recording costs associated with exit or disposal activities at their fair values when a liability has been incurred. Under previous guidance, certain exit costs were accrued upon management's commitment to an exit plan, which is generally before an actual liability has been incurred. The Company adopted SFAS No. 146 on January 1, 2003. Adoption of SFAS No. 146 did not have a material impact on the Company's consolidated financial position, results of operations or cash flows. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment to FASB Statement No. 123," which is effective for fiscal years beginning after December 15, 2002. SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company accounts for stock-based compensation under Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." The Company intends to continue to account for stock-based employee compensation under APB No. 25. Note 2 to the Consolidated Financial Statements includes the additional disclosure requirements of SFAS No. 148 as required by entities which continue to account for stock-based employee compensation under APB No. 25. In November 2002, the FASB issued Interpretation ("FIN") No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN No. 45 requires footnote disclosure of the guarantees or indemnification agreements a company issues. With certain exceptions, these agreements will also require a company to prospectively recognize an initial liability for the fair value, or market value, of the obligations it assumes under the guarantee. The initial recognition and initial measurement provisions of this Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The Company adopted FIN No. 45 on January 1, 2003. Adoption of FIN No. 45 did not have a material impact on the Company's consolidated financial position, results of operations or cash flows. 12 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of Innotrac Corporation: We have audited the accompanying consolidated balance sheets of Innotrac Corporation and its subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, shareholders' equity and cash flows for the years then ended. Our audits also included the 2003 and 2002 financial statement schedule listed in the Index at Item 15 as Schedule II. These financial statements and financial statement schedule are the responsibility of the Corporation's management. Our responsibility is to express an opinion on the 2003 and 2002 financial statements and financial statement schedule based on our audits. The financial statements and financial statement schedule as of December 31, 2001 and for the year then ended, before the reclassifications and inclusion of disclosure discussed in Notes 2 and 16 to the financial statements, were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those financial statements and stated that such 2001 financial statement schedule, when considered in relation to the 2001 basic financial statements taken as a whole, presented fairly, in all material respects, the information set forth therein, in their report dated February 8, 2002. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the 2003 and 2002 consolidated financial statements present fairly, in all material respects, the financial position of Innotrac Corporation and its subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the 2003 and 2002 financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects the information set forth therein. As discussed in Note 2 to the financial statements, in 2002 the Corporation changed its method of accounting for goodwill and other intangible assets to conform to Statement of Financial Accounting Standards No. 142 (SFAS No. 142). As discussed above, the financial statements of Innotrac Corporation and its subsidiaries as of December 31, 2001 and for the year then ended, were audited by other auditors who have ceased operations. These consolidated financial statements have been revised as follows: (a) As described in Note 2 under the heading "Revenue Recognition," the Corporation adopted EITF Issue No. 01-14, "Income Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses Incurred," on January 1, 2002. We audited the reclassification described in Note 2 that was applied to conform the 2001 financial statements to the comparative presentation required by EITF Issue No. 01-14. Our audit procedures with respect to the reclassifications of out-of-pocket freight and postage expenses included (i) comparing the amounts shown for out-of-pocket expenses in the Corporation's consolidated statements of operations to the Corporation's underlying records obtained from management, and (ii) on a test basis, comparing the underlying records obtained from management to independent supporting documentation, and (iii) testing the mathematical accuracy of the underlying analysis; 13 (b) As described in Note 2 under the heading "Goodwill and Other Intangible Assets," transitional disclosures required by SFAS No. 142, which was adopted by the Corporation as of January 1, 2002, have been added. Our audit procedures with respect to the disclosures in Note 2 discussed above with respect to 2001 included (i) comparing the previously reported net income to the previously issued financial statements and the adjustment to reported net income representing amortization expense (including any related tax effects) recognized in that period to the Corporation's underlying analysis obtained from management, and (ii) testing the mathematical accuracy of the reconciliation of adjusted net income to reported net income, and the related earnings-per-share amount; (c) As described in Note 16, certain note disclosures have been added. Our audit procedures with respect to the note disclosures described in Note 16 included comparing added disclosure amounts to the Corporation's underlying records obtained from management. In our opinion, the reclassifications and disclosures for 2001 described in Notes 2 and 16 are appropriate. However, we were not engaged to audit, review, or apply any procedures to the 2001 financial statements of the Corporation other than with respect to such reclassification and disclosures and, accordingly, we do not express an opinion or any other form of assurance on the 2001 financial statements taken as a whole. DELOITTE & TOUCHE LLP Atlanta, Georgia March 30, 2004 14 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS PURSUANT TO SECURITIES AND EXCHANGE COMMISSION RULE 2-02 OF REGULATION S-X, THE FOLLOWING REPORT IS A COPY OF A REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP, WHICH HAS CEASED OPERATIONS, AND HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP. ARTHUR ANDERSEN LLP REPORTED ON SUCH FINANCIAL STATEMENTS PRIOR TO THE RECLASSIFICATIONS AND REVISIONS DISCUSSED IN NOTE 2 AND NOTE 16 OF THE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. To Innotrac Corporation: We have audited the accompanying consolidated balance sheets of INNOTRAC CORPORATION (a Georgia corporation) AND SUBSIDIARIES as of December 31, 2001 and 2000 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Innotrac Corporation and its subsidiaries as of December 31, 2001 and 2000 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting standards generally accepted in the United States. ARTHUR ANDERSEN LLP Atlanta, Georgia February 8, 2002 15 INNOTRAC CORPORATION CONSOLIDATED BALANCE SHEETS (IN 000'S)
DECEMBER 31, ASSETS 2003 2002 -------- -------- CURRENT ASSETS: Cash and cash equivalents $ 2,228 $ 961 Accounts receivable, net of allowance of $1,696 (2003) and $959 (2002) 15,682 14,203 Inventories, net 10,896 24,098 Prepaid expenses and other 915 2,357 Deferred income taxes, net -- 552 -------- -------- TOTAL CURRENT ASSETS 29,721 42,171 -------- -------- PROPERTY AND EQUIPMENT: Rental equipment 895 1,372 Computer, machinery and equipment 27,320 26,315 Furniture, fixtures and leasehold improvements 4,682 4,585 -------- -------- 32,897 32,272 Less accumulated depreciation and amortization (18,147) (13,357) -------- -------- 14,750 18,915 -------- -------- Goodwill, net 25,169 24,988 Deferred income taxes, net -- 7,940 Other assets, net 1,322 1,485 -------- -------- TOTAL ASSETS $ 70,962 $ 95,499 ======== ========
DECEMBER 31, LIABILITIES AND SHAREHOLDERS' EQUITY 2003 2002 -------- -------- CURRENT LIABILITIES: Accounts payable $ 5,738 $ 13,517 Line of credit 11,802 -- Accrued salaries and commissions 443 1,570 Accrued expenses and other 2,134 5,056 -------- -------- TOTAL CURRENT LIABILITIES 20,117 20,143 -------- -------- NONCURRENT LIABILITIES: Line of credit -- 14,372 Other noncurrent liabilities 1,083 1,125 -------- -------- TOTAL NONCURRENT LIABILITIES 1,083 15,497 -------- -------- Commitments and contingencies (see Note 7) -- -- SHAREHOLDERS' EQUITY: Preferred stock: 10,000,000 shares authorized, $0.10 par value, no shares outstanding -- -- Common stock: 50,000,000 shares authorized, $0.10 par value, 11,715,280 (2003) and 11,674,595 (2002) shares issued, 11,715,280 (2003) and 11,417,780 (2002) shares outstanding 1,171 1,167 Additional paid-in capital 63,791 62,614 Accumulated deficit (15,200) (3,219) Treasury stock: 0 (2003) and 256,815 (2002) shares -- (703) -------- -------- TOTAL SHAREHOLDERS' EQUITY 49,762 59,859 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 70,962 $ 95,499 ======== ========
The accompanying notes are an integral part of these consolidated balance sheets. 16 INNOTRAC CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (IN 000'S, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, -------------------------------- 2003 2002 2001 -------- -------- -------- Revenues, net $ 74,740 $ 82,420 $121,859 Cost of revenues 35,157 46,444 68,153 Special (credits), net -- (293) -- -------- -------- -------- TOTAL COST OF REVENUES 35,157 46,151 68,153 -------- -------- -------- GROSS PROFIT 39,583 36,269 53,706 -------- -------- -------- OPERATING EXPENSES: Selling, general and administrative 36,444 37,332 43,329 Special (credits) charges, net (30) 404 -- Depreciation and amortization 5,622 5,336 4,864 -------- -------- -------- Total operating expenses 42,036 43,072 48,193 -------- -------- -------- OPERATING (LOSS) INCOME (2,453) (6,803) 5,513 -------- -------- -------- OTHER EXPENSE (INCOME): Interest expense (income), net 741 318 (532) Other 15 (124) (20) -------- -------- -------- TOTAL OTHER EXPENSE (INCOME) 756 194 (552) -------- -------- -------- (LOSS) INCOME BEFORE INCOME TAXES AND MINORITY INTEREST (3,209) (6,997) 6,065 INCOME TAX (PROVISION) BENEFIT (8,772) 2,578 (2,573) -------- -------- -------- NET (LOSS) INCOME BEFORE MINORITY INTEREST (11,981) (4,419) 3,492 MINORITY INTEREST, NET OF INCOME TAXES -- -- (893) -------- -------- -------- NET (LOSS) INCOME $(11,981) $ (4,419) $ 4,385 ======== ======== ======== EARNINGS PER SHARE: Basic $ (1.04) $ (0.38) $ 0.39 ======== ======== ======== Diluted $ (1.04) $ (0.38) $ 0.38 ======== ======== ======== WEIGHTED AVERAGE SHARES OUTSTANDING: Basic 11,542 11,516 11,318 ======== ======== ======== Diluted 11,542 11,516 11,690 ======== ======== ========
The accompanying notes are an integral part of these consolidated statements. 17 INNOTRAC CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN 000'S)
Retained Accumulated Common Stock Earnings Other --------------- Paid-in (Accumulated Comprehensive Treasury Shares Amount Capital Deficit) Income Stock Total ------ ------ ------- ------------- ------------- -------- -------- BALANCE AT DECEMBER 31, 2000 11,365 $1,136 $60,889 $ (3,184) $ -- $(206) $58,635 Restricted stock grant, net -- -- 134 -- -- -- 134 Purchase of treasury stock -- -- -- -- -- (49) (49) Comprehensive income: Net income -- -- -- 4,385 -- -- 4,385 Unrealized gain on available-for- sale securities -- -- -- -- 178 -- 178 ------ ------ ------- -------- ----- ----- ------- BALANCE AT DECEMBER 31, 2001 11,365 $1,136 $61,023 $1,201 $ 178 $(255) $63,283 Issuance of common stock 310 31 1,519 -- -- -- 1,550 Restricted stock grant, net -- -- 72 -- -- -- 72 Purchase of treasury stock -- -- -- -- -- (448) (448) Comprehensive income: Net loss -- -- -- (4,419) -- -- (4,419) Reclassification adjustment for realized gain included in Consolidated Statement of Operations -- -- -- -- (178) -- (178) ------ ------ ------- -------- ----- ----- ------- BALANCE AT DECEMBER 31, 2002 11,675 $1,167 $62,614 $(3,219) $ -- $(703) $59,859 Issuance of common stock 40 4 264 -- -- -- 268 Restricted stock grant, net -- -- 328 -- -- -- 328 Issuance of treasury stock -- -- 304 -- -- 703 1,007 Tax benefit for stock options exercised -- -- 281 -- -- -- 281 Net loss -- -- -- (11,981) -- -- (11,981) ------ ------ ------- -------- ----- ----- ------- BALANCE AT DECEMBER 31, 2003 11,715 $1,171 $63,791 $(15,200) $ -- $ -- $49,762 ====== ====== ======= ======== ===== ===== =======
The accompanying notes are an integral part of these consolidated statements. 18 INNOTRAC CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (IN 000'S)
YEAR ENDED DECEMBER 31, -------------------------------- 2003 2002 2001 -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income $(11,981) $ (4,419) $ 4,385 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Depreciation and amortization 5,622 5,336 4,864 Impairment and/or loss on disposal of fixed assets 22 3,638 3,385 Deferred income taxes 8,492 (5,317) 3,389 Minority interest in subsidiary -- -- (893) Amortization of deferred compensation 72 72 134 Changes in working capital, net of effect of businesses acquired: (Increase) decrease in accounts receivable (1,479) (541) 17,659 Decrease (increase) in inventories 13,202 3,165 (12,208) Decrease (increase) in prepaid expenses and other assets 1,338 1,248 (180) (Decrease) increase in accounts payable (7,780) 4,936 (13,562) (Decrease) in accrued expenses and other (3,714) (4,248) (2,491) -------- -------- -------- Net cash provided by operating activities 3,794 3,870 4,482 -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (1,182) (12,830) (6,914) Acquisition of businesses, net of cash acquired (181) (13,502) (5,859) Sale (purchase) of available-for-sale securities -- 436 (436) -------- -------- -------- Net cash (used in) investing activities (1,363) (25,896) (13,209) -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net (repayments) borrowings under line of credit (2,570) 14,372 -- Repayment of capital lease and other obligations (119) (250) (145) Exercise of employee stock options 1,556 -- -- Purchase of treasury stock -- (448) (49) Loan fees paid (31) (100) -- -------- -------- -------- Net cash (used in) provided by financing activities (1,164) 13,574 (194) -------- -------- -------- Net increase (decrease) in cash and cash equivalents 1,267 (8,452) (8,921) Cash and cash equivalents, beginning of period 961 9,413 18,334 -------- -------- -------- Cash and cash equivalents, end of period $ 2,228 $ 961 $ 9,413 ======== ======== ======== Supplemental cash flow disclosures: Cash paid for interest $ 794 $ 355 $ 110 ======== ======== ======== Cash income tax refunds received, net of taxes paid $ (1,565) $ (18) $ (80) ======== ======== ========
The accompanying notes are an integral part of these consolidated statements. 19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION Innotrac Corporation ("Innotrac" or the "Company") and its wholly-owned subsidiary, iFulfillment, Inc., a Georgia corporation, provide order processing, order fulfillment and call center services. The Company offers inventory management, inbound call center, pick/pack/ship services, order tracking, transaction processing and returns handling from its leased facilities in Atlanta, Georgia, Pueblo, Colorado, Reno, Nevada, Bolingbrook, Illinois and Hebron, Kentucky. The Company's facilities represent over 1.6 million square feet of warehouse space and 520 dedicated call center seats. 2. SIGNIFICANT ACCOUNTING POLICIES Basis of Financial Statement Presentation. The consolidated financial statements include the accounts of the Company and its subsidiary. The financial statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States of America. All significant intercompany transactions and balances have been eliminated in consolidation. 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. Concentration of Revenues. Revenues earned under the Company's contracts with its telecommunication clients to provide fulfillment of telecommunications equipment and related order processing and call center support services, including DSL modems and wireless pagers, accounted for approximately 42%, 46% and 60% of total revenues for the years ended December 31, 2003, 2002 and 2001, respectively. Revenues generated from the fulfillment of DSL and cable modem equipment accounted for 19%, 19%, and 18% of the aforementioned totals. The following table sets forth the percentage of total revenues derived from each of the Company's largest clients for the years ended December 31, 2003, 2002 and 2001. Except for the major clients noted in the following table, no other single customer provided more than 10% of consolidated revenues during these years.
YEAR ENDED DECEMBER 31, 2003 2002 2001 ---- ---- ---- BELLSOUTH - TELECOM EQUIPMENT 18.5% 18.7% 12.2% - DSL EQUIPMENT 13.0 9.7 10.8 SMITH & HAWKEN 13.2 5.6 -- TACTICA 10.2 16.8 9.9 THANE INTERNATIONAL 3.9 8.7 15.3 SBC COMMUNICATIONS -- -- 12.6
20 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Cash and Cash Equivalents. The Company considers all short-term, highly liquid investments with an original maturity of three months or less to be cash equivalents. Short-Term Investments. Current available-for-sale marketable securities are carried at their estimated fair value based on current market quotes. Any unrealized gains or losses are reported in shareholders' equity as a component of other accumulated comprehensive income (loss). At December 31, 2003 and 2002, the Company had no available-for-sale securities. Fair Value of Financial Instruments. The carrying value of the Company's revolving credit facility approximates fair value given that interest rates under the facility are based on prevailing market rates. Inventories. Inventories, consisting primarily of telephones and interactive wireless pagers are stated at the lower of cost or market, with cost determined by the first-in, first-out method. Substantially all inventory at December 31, 2003 and 2002 is for the account of one client who has indemnified the Company from substantially all risk associated with such inventory. Property and Equipment. Property and equipment are stated at cost. Depreciation is determined using straight-line methods over the following estimated useful lives: Rental equipment 3 years Computers and software 3-5 years Machinery and equipment 5-7 years Furniture and fixtures 7 years
Leasehold improvements are amortized using the straight-line method over the shorter of the service lives of the improvements or the remaining term of the lease. Maintenance and repairs are expensed as incurred. Goodwill and Other Acquired Intangibles. Goodwill represents the cost of an acquired enterprise in excess of the fair market value of the net tangible and identifiable intangible assets acquired. Goodwill and other acquired intangibles related to business combinations prior to July 1, 2001 were being amortized over 5 to 20 years on a straight-line basis, which represented management's estimation of the related benefit to be derived from the acquired business. However, goodwill and other acquired intangibles from business combinations occurring after June 30, 2001 are accounted for under the transition provisions for business combinations of Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets" which includes the iFulfillment acquisition. The Company adopted SFAS No. 142 effective January 1, 2002, which changed the accounting for goodwill and other indefinite life intangibles from an amortization method to an impairment only approach. The Company tests goodwill annually for impairment at 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 as of January 1, 2004 in accordance with SFAS No. 142, no impairment was determined to exist at that time. Innotrac's goodwill carrying amount as of December 31, 2003 was $25.2 million. This asset relates to the goodwill associated with the Company's acquisition of Universal Distribution Services ("UDS") in December 2000, including the earnout payment made to the former UDS shareholders in February 2002, and the acquisition of iFulfillment, Inc. in July 2001. 21 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) In accordance with the adoption of SFAS No. 142, no amortization of goodwill was recorded in 2003 or 2002. During the year ended December 31, 2001 amortization expense associated with goodwill was approximately $239,800. The Company's pro-forma consolidated net income and earnings per share for the year ended December 31, 2001, excluding goodwill amortization, would have been net income of $4.5 million ($0.40 per share basic and $0.39 diluted). The Company has intangible assets that continue to be subject to amortization under the provisions of SFAS No. 142. The intangible assets consist of acquired customer contracts, which are included in other assets in the Company's Consolidated Balance Sheets and which are amortized over a period of 1 to 5 years on a straight-line basis. At December 31, 2003 and 2002, the Company had intangible assets, consisting primarily of customer contracts, of approximately $387,000 and $589,000, net of accumulated amortization of approximately $873,000 and $671,000, respectively. Amortization expense of these intangible assets amounted to approximately $202,000, $369,000 and $258,000 during the years ended December 31, 2003, 2002 and 2001, respectively. Impairment of Long-Lived Assets. The Company reviews long-lived assets and certain intangible assets for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment would be measured based on a projected cash flow model. If the projected undiscounted cash flows for the asset are not in excess of the carrying value of the related asset, the impairment would be determined based upon the excess of the carrying value of the asset over the projected discounted cash flows for the asset. Deferred Tax Asset. Innotrac utilizes the liability method of accounting for income taxes. Under the liability method, deferred taxes are determined based on the difference between the financial and tax 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. A valuation allowance has been recorded against deferred tax assets at December 31, 2003 (see Note 8). Revenue Recognition. Innotrac derives its revenue primarily from two sources: (1) fulfillment operations and (2) the delivery of business services. Innotrac's fulfillment services operations record revenue at the conclusion of the material selection, packaging and shipping process. Innotrac's call center services business recognizes revenue according to written pricing agreements based on number of calls, minutes or hourly rate basis. All other revenues are recognized as services are rendered. As required by the consensus reached in Emerging Issue Task Force ("EITF") Issue No. 99-19, revenues have been recorded net of the cost of the equipment for all fee-for-service clients. During 2001, the Emerging Issues Task Force ("EITF") issued EITF No. 01-14, "Income Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses Incurred," which was adopted by the Company as of January 1, 2002. EITF No 01-14 states that reimbursements received from customers for out-of-pocket expenses incurred on their behalf should be characterized as revenue in the Company's statement of operations. Prior to the adoption of this standard, the Company netted reimbursements from customers, primarily for freight and postage fees, against the related expenses within revenues. With the adoption of this standard, the Company has reclassified reimbursements from customers for these expenses as cost of revenues, and has conformed this presentation for all periods presented. The adoption of EITF 01-14 increased the revenues, net and cost of revenues line items within the Consolidated Statements of Operations from amounts previously reported in 2001 by $27.1 million. 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"). 22 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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 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 (loss) income and net (loss) income per share would have been the following pro forma amounts (in 000's, except per share data):
YEAR ENDED DECEMBER 31, -------------------------------- 2003 2002 2001 -------- -------- -------- Net (loss) income $(11,981) $(4,419) $4,385 Pro forma net (loss) income $(12,699) $(5,074) $3,350 Diluted net (loss) income per share $(1.04) $(0.38) $0.38 Pro forma net (loss) income per share $(1.10) $(0.44) $0.29
Under the fair value based method, compensation cost, net of tax is $718,000, $655,000 and $1,035,000 for the years ended December 31, 2003, 2002 and 2001, respectively. The Company has computed for pro forma disclosure purposes the value of all options granted using the Black-Scholes option-pricing model as prescribed by SFAS No. 123 using the following weighted average assumptions:
2003 2002 2001 --------- --------- --------- Risk-free interest rate 4.27% 4.05% 5.45% Expected dividend yield 0% 0% 0% Expected lives 2.6 Years 3.1 Years 2.7 Years Expected volatility 80.4% 86.6% 84.3%
Minority Interests. Minority interest arises from Mail Boxes Etc.'s ("MBE") 40% (14% prior to December 29, 2000) ownership of Return.com Online, LLC ("Return.com"), a subsidiary of the Company. In March 2001, United Parcel Service, Inc. ("UPS") announced a definitive agreement to purchase MBE. As a result of this agreement, the Company reacquired MBE's 40% ownership interest in Return.com in April 2001. A note receivable of $3.4 million due from MBE, at that time, was forgiven by the Company in exchange for MBE's ownership interest in Return.com, resulting in 100% ownership by the Company. 23 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) As a result of the Company's controlling ownership interest in Return.com, the Company consolidated the results of operations and financial position of Return.com in the accompanying 2001 consolidated financial statements. During the year ended December 31, 2001, the Company wrote off its $2.8 million investment in Return.com against an impairment reserve the Company recorded in the first quarter of 2001. At December 31, 2001, Return.com was no longer in operation. Earnings Per Share. Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding. In the computation of diluted earnings per share, the weighted average number of common shares outstanding is adjusted for the effect of all potential common stock equivalent shares. Recent Accounting Pronouncements. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This Statement requires recording costs associated with exit or disposal activities at their fair values when a liability has been incurred. Under previous guidance, certain exit costs were accrued upon management's commitment to an exit plan, which is generally before an actual liability has been incurred. The Company adopted SFAS No. 146 on January 1, 2003. Adoption of SFAS No. 146 did not have a material impact on the Company's consolidated financial position, results of operations or cash flows. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment to FASB Statement No. 123," which is effective for fiscal years beginning after December 15, 2002. SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company accounts for stock-based compensation under Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." The Company intends to continue to account for stock-based employee compensation under APB No. 25. Note 2 (above) includes the additional disclosure requirements of SFAS No. 148 as required by entities which continue to account for stock-based employee compensation under APB No. 25. In November 2002, the FASB issued Interpretation ("FIN") No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN No. 45 requires footnote disclosure of the guarantees or indemnification agreements a company issues. With certain exceptions, these agreements will also require a company to prospectively recognize an initial liability for the fair value, or market value, of the obligations it assumes under the guarantee. The initial recognition and initial measurement provisions of this Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The Company adopted FIN No. 45 on January 1, 2003. Adoption of FIN No. 45 did not have a material impact on the Company's consolidated financial position, results of operations, or cash flows. 24 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. ACQUISITIONS In July 2001, the Company acquired the assets and assumed specified liabilities of iFulfillment, Inc. ("iFulfillment") for approximately $5.8 million. iFulfillment specializes in fully integrated, automated order fulfillment services for multi-channel retailers and catalogers. The transaction was accounted for under the purchase method of accounting and, accordingly, the operating results of iFulfillment have been included since the date of acquisition in the Company's consolidated results of operations. The Company has accounted for this transaction in accordance with the provisions of SFAS No. 141 and SFAS No. 142. In 2003, net purchase price adjustments of $181,000 were recorded which increased the amount of recorded goodwill for the iFulfillment acquisition. The following table summarizes the assets purchased and liabilities assumed as well as the allocation of the purchase price to various intangibles and goodwill (in 000's): Current assets $ 207 Current liabilities (2,050) Property 1,417 Other liabilities (632) Customer contract 250 Goodwill 6,621 ------- Purchase price $ 5,813 =======
In December 2000, the Company acquired UDS for approximately $4.3 million in total consideration which was accounted for under the purchase method of accounting. Operating results for UDS have been included in the Company's results since December 2000. At December 31, 2001, the Company recorded an accrual for approximately $15.3 million for payment to the sellers of UDS under the terms of an earn-out provision contained in the merger agreement. The earn-out accrual was recorded as additional goodwill. In February 2002, the payment was made consisting of $13.7 million of cash and 310,000 shares of the Company's common stock valued at $1.6 million. No additional earn-out amounts were due or payable at December 31, 2003 or 2002. Goodwill related to UDS at December 31, 2003 amounted to $18.5 million, net of accumulated amortization of $0.3 million. Pro forma results have not been presented as these acquisitions were not considered material. 4. SPECIAL CHARGES AND SPECIAL CREDITS During 2000, the Company substantially completed its migration towards a fee-for-service business model, which eliminates inventory ownership risk and also elected to discontinue its front-end web site development, maintenance and hosting services to its e-commerce clients. As a result of these significant changes in the Company's business, a special pre-tax charge of $34.3 million was recognized. The special charges of $34.3 million for the year ended December 31, 2000 included the following: $24.4 million for inventory, accounts receivable and other items primarily related to the Company's shift to a fee-for-service business model; $6.2 million for the impairment of long-lived assets primarily due to the abandonment of specified software development projects; and $3.7 million in costs to exit the e-commerce business related to web development, maintenance and hosting services. At December 31, 2003 and 2002, the Company had approximately $0 and $277,000, respectively, in accruals related to the special charges recorded during the year ended December 31, 2000. Cash payments relating to the special charge accruals for the years ended December 31, 2003 and 2002 were approximately $277,000 and $716,000, respectively. 25 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company recognized approximately $3.0 million of special credits during the year ended December 31, 2002, related to gains realized on sales of inventory items which were written off as special charges in previous periods, cash collected for accounts receivable that were written off as special charges in previous periods, redeployment of leased computer hardware for which the leases were fully accrued for as special charges in previous periods, and client contract amendments which resulted in reduced liabilities. These amounts were recorded as a reduction in the special charge line item in the consolidated statements of operations. During 2002, the Company also recognized an additional $3.1 million in special charges. Approximately $2.4 million of these charges were related to capitalized hardware and software costs for systems purchased specifically for a potential new client which were subsequently not utilized as originally planned. The loss of the potential customer indicated that the carrying value of the asset group was potentially not recoverable, and therefore, an impairment test under the provisions of SFAS No. 144 was performed. As fair market value of the asset group was not readily determinable, a discounted, probability weighted cash flow model was utilized as a basis to determine fair value. As a result of the cash flow analysis, a $2.4 million impairment charge was recorded. Of the remaining charges, approximately $500,000 related to the write-down to net realizable value of specified fixed assets obtained as part of the December 2000 acquisition of UDS which were being utilized for one specific customer who ceased conducting business with UDS. The balance of approximately $200,000 was related to severance costs for positions which were eliminated. 5. ACCOUNTS RECEIVABLE Accounts receivable were composed of the following at December 31, 2003 and 2002 (in 000's):
2003 2002 -------- -------- Billed receivables $ 17,231 $ 13,606 Unbilled receivables 147 1,556 -------- -------- 17,378 15,162 Less: Allowance for doubtful accounts (1,696) (959) -------- -------- $ 15,682 $ 14,203 ======== ========
6. FINANCING OBLIGATIONS The Company currently has a revolving credit agreement with a bank for borrowings up to $40.0 million (subject to borrowing base limitations). The Company is currently negotiating to reduce the size of the facility to $25.0 million as the Company does not anticipate a need for the larger amount. The credit facility expires in June 2005. The Company and its subsidiary have granted a security interest in all of their assets and the subsidiary has provided a guarantee to the lender as collateral under this revolving credit agreement. The revolving credit agreement contains various restrictive financial and change of ownership control covenants. Noncompliance with any of the covenants allows the lender to declare any outstanding borrowing amounts to be immediately due and payable. The credit facility limits borrowings to a specified percentage of eligible accounts receivable and inventory, as defined, which totaled $18.5 million at December 31, 2003. At December 31, 2003 the Company had $6.7 million available under the revolving credit agreement. The financial covenants required the Company to maintain a fixed charge ratio of 1.75 to 1.00 by December 31, 2003. The Company was not in compliance with this covenant at December 31, 2003. However, the Company has received a waiver from the bank and that covenant was amended and reduced to a lower ratio of 1.30 to 1.00 for the balance of the term. The Company's fixed charge ratio at December 31, 2003 was 1.40 to 1.00. 26 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Additionally, the revolving credit agreement contains a minimum tangible net worth requirement of $34 million. Tangible net worth is computed as shareholders' equity less goodwill, other intangible assets and certain deferred costs. Included in the bank's definition of tangible net worth is the carrying amount of the Company's deferred tax asset. Due to the fact that a valuation allowance was recorded at December 31, 2003 for the entire deferred tax asset balance of $9.9 million, the Company was no longer in compliance with the tangible net worth requirement of $34 million. However, the Company received a waiver from the bank and that covenant was amended and reduced to $24 million for the balance of the term. Compliance with the minimum tangible net worth covenant and other financial covenants is determined on a quarterly basis. The revolving credit agreement is classified as a noncurrent liability in the Consolidated Balance Sheets as of December 31, 2002. During the first quarter of 2003, the Company and the lender modified the terms of the revolving credit agreement. The result of these negotiations, which 1) requires that the Company maintain a lockbox arrangement with the lender, and 2) allows the lender to declare any outstanding borrowing amounts to be immediately due and payable as a result of noncompliance with any of the covenants resulted in the classification of this revolving credit agreement being included in current liabilities at December 31, 2003. Interest on borrowings is payable monthly at rates equal to the prime rate, or at the Company's option, LIBOR plus up to 225 basis points. On November 13, 2003, the Company fixed $6.0 million of its $11.8 million of borrowings at the 90-day LIBOR rate of 2.68%. During the years ended December 31, 2003, 2002 and 2001, the Company incurred interest expense related to the line of credit of approximately $704,000, $266,100 and $0, respectively, resulting in a weighted average interest rate of 3.80%, 3.75%, and 0%, respectively. The Company also incurred unused revolving credit facility fees of approximately $50,000 and $123,000 during the years ended December 31, 2003 and 2002, respectively. 7. COMMITMENTS AND CONTINGENCIES Operating Leases. Innotrac leases office and warehouse space and equipment under various operating leases. The primary office and warehouse operating leases provide for escalating payments over the lease term. Innotrac recognizes rent expense on a straight-line basis over the lease term. The Company also has capital lease obligations that expire over the next two years primarily for warehouse equipment and computer hardware. Aggregate future minimum lease payments under noncancellable operating and capital leases with original periods in excess of one year as of December 31, 2003 are as follows (in 000's):
CAPITAL OPERATING LEASES LEASES ------- --------- 2004 ........................ $ 95 $ 7,779 2005 ........................ 56 6,734 2006 ........................ -- 6,780 2007 ........................ -- 5,602 2008 ........................ -- 949 ------- --------- Total minimum lease payments $ 151 $ 27,844 ======= ========= Amount related to interest (10) ------- Capital lease obligations 141 Current portion .......... (93) ------- Long-term portion ........ $ 48 =======
Rent expense under all operating leases totaled approximately $8.1 million, $6.1 million and $4.2 million during the years ended December 31, 2003, 2002 and 2001, respectively. 27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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. Shareholder Rights Plan. In December of 1997, the Company's Board of Directors approved a Shareholder Rights Plan (the "Rights Plan"). The Rights Plan provides for the distribution of one Right for each outstanding share of the Company's Common Stock held of record as of the close of business on January 1, 1998 or that thereafter becomes outstanding prior to the earlier of the final expiration date of the Rights or the first date upon which the Rights become exercisable. Each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series A Participating Cumulative Preferred Stock, par value $.10 per share, at a price of $60.00 (the "Purchase Price"), subject to adjustment. The Rights are not exercisable until ten calendar days after a person or group (an "Acquiring Person") buys, or announces a tender offer for, 15% or more of the Company's Common Stock. Such ownership level has been increased to 40% for a particular shareholder that owned approximately 25.5% of the shares outstanding on December 31, 2003. 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. Employment Commitment. In June 1999, in conjunction with the opening of a new call center facility, the Company entered into an Employment Commitment Agreement with the City of Pueblo, Colorado, whereby the Company received cash incentives of $968,000. These funds were accounted for as a reduction in the basis of the assets acquired. In return for this consideration, the Company is obligated to employ a minimum number of full-time employees at its Pueblo facility, measured on a quarterly basis. This obligation, which became effective June 2002, will continue through June 2009. During 2002 and 2003, the Company had substantially met the minimum employee requirements of 359 full-time employees, as measured on a quarterly basis. In the event that the number of full-time employees fails to meet the minimum requirement, the Company will incur a quarterly penalty of $96.30 for each employee less than the minimum required amount. 8. INCOME TAXES Details of the income tax benefit (provision) for the years ended December 31, 2003, 2002 and 2001 are as follows (in 000's):
2003 2002 2001 -------- -------- -------- Current $ (232) $ 3,312 $ 815 Deferred (8,540) (734) (3,388) -------- -------- -------- $ (8,772) $ 2,578 $ (2,573) ======== ======== ========
28 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Deferred income taxes reflect the net effect of the temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The significant components of the Company's deferred tax assets and liabilities as of December 31, 2003 and 2002 are as follows (in 000's):
2003 2002 -------- -------- Deferred tax assets: Net operating loss carryforwards $ 11,541 $ 10,409 Allowance for doubtful accounts 604 364 Reserves 230 188 Other 451 47 -------- -------- Total deferred tax assets 12,826 11,008 Valuation allowance (9,882) -- -------- -------- Net deferred tax assets 2,944 11,008 Deferred tax liabilities: Depreciation (2,944) (2,516) -------- -------- Net deferred taxes -- $ 8,492 Net deferred taxes: Current deferred tax assets -- $ 552 Noncurrent deferred tax assets -- 7,940 -------- -------- $ -- $ 8,492 ======== ========
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 December 31, 2003 is approximately $12.8 million. This deferred tax asset was generated primarily by net operating loss carryforwards created primarily by the special charge of $34.3 million recorded in 2000 and the net losses generated in 2002 and 2003. Innotrac has a tax net operating loss carryforward of $31.5 million at December 31, 2003 that expires between 2020 and 2023. Innotrac's ability to generate the expected amounts of taxable income from future operations is dependent upon general economic conditions, collection of existing outstanding accounts receivable, competitive pressures on sales and margins and other factors beyond management's control. Due to these factors combined with losses in recent years creates uncertainty about the ultimate realization of the gross deferred tax asset in future years. Therefore a valuation allowance of approximately $9.9 million has been recorded in 2003. Income taxes associated with future earnings will be offset by a reduction in the 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. The difference between the provision for income taxes (benefit) and the amount computed by applying the U.S. federal income tax rate for the years ended December 31, 2003, 2002 and 2001 is as follows:
2003 2002 2001 -------- -------- -------- Statutory federal income tax (benefit) $ (1,091) $ (2,379) $ 2,062 State income taxes, net of federal effect (106) (280) 243 Items not deductible for tax purposes 109 77 261 Valuation allowance for deferred tax assets 9,882 -- -- Other (22) 4 7 -------- -------- -------- Income tax provision (benefit) $ 8,772 $ (2,578) $ 2,573 ======== ======== ========
29 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. EARNINGS PER SHARE The following table shows the shares used in computing diluted earnings per share ("EPS") in accordance with Statement of Financial Accounting Standards No. 128 (in 000's):
2003 2002 2001 ------ ------ ------ Diluted earnings per share: Weighted average shares outstanding 11,542 11,516 11,318 Employee and director stock options -- -- 372 ------ ------ ------ Weighted average shares assuming dilution 11,542 11,516 11,690 ====== ====== ======
Options and warrants outstanding to purchase shares of the Company's common stock aggregating 1.9 million, 2.2 million and 1.0 million were not included in the computation of diluted EPS for the years ended December 31, 2003, 2002 and 2001, respectively, because their effect was anti-dilutive. This includes a warrant with registration rights issued to Thane International in December 2000 to purchase 150,000 shares of Innotrac common stock at the exercise price of $6.50, which vests 20% annually. Additionally, restricted stock of 65,447 shares were also excluded because their effect was anti-dilutive and the shares were not vested at December 31, 2003. 10. OTHER COMPREHENSIVE INCOME SFAS No. 130, "Reporting Comprehensive Income," established standards for reporting and display of comprehensive income and its components in financial statements. For the years ended December 31, 2003, 2002 and 2001, the components of the Company's comprehensive (loss) income are as follows (in 000's):
Year Ended December 31, -------------------------------- 2003 2002 2001 -------- -------- -------- Other comprehensive income: Net (loss) income $(11,981) $(4,419) $4,385 Unrealized gain -- -- 177 Reclassification adjustment for realized gains included in consolidated statement of operations -- (76) -- -------- -------- -------- Comprehensive (loss) income $(11,981) $(4,495) $4,562 ======== ======== ========
11. SHAREHOLDERS' EQUITY In June 2000, the Company's Board of Directors authorized the repurchase, at the direction of senior management, of up to $5.0 million of the Company's common stock. The stock repurchase program was extended for an additional twelve months by the Board of Directors in February 2002. During the years ended December 31, 2003, 2002 and 2001, the Company repurchased approximately 0, 205,400 and 6,400 shares at a total cost of $0, $448,000 and $49,000, respectively. At December 31, 2003, all treasury shares previously repurchased had been reissued for stock options exercised during 2003, and accordingly no treasury stock balance remains. 30 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 12. EMPLOYEE RETIREMENT PLANS Innotrac employees may participate in a 401(k) defined contribution plan. The plan covers all employees who have at least six months of service and are 18 years of age or older. Participants may elect to defer up to 15% of compensation up to a maximum amount determined annually pursuant to IRS regulations. Innotrac's policy is to provide matching employer contributions equal to 15% of contributions for less than five years of service, 25% of contributions for five to nine years of service, and 35% of contributions for over nine years of service. However, this match was suspended from January 1, 2002 through June 30, 2002, reinstituted from July 1, 2002 through December 31, 2002 and has been temporarily suspended thereafter. Total matching contributions made to the plan and charged to expense by Innotrac for the years ended December 31, 2003, 2002 and 2001 were approximately $0, $49,000 and $108,000, respectively. The Company has an executive deferred compensation plan for certain employees, as designated by the Company's Board of Directors. Participants may elect to defer up to 30% of compensation. Innotrac's policy is to provide matching employer contributions ranging from 20% to 100% of employee contributions based on years of service. However, this match was suspended for both 2003 and 2002. Matching contributions were $79,412 for the year ended December 31, 2001. The Company invests these contributions in employee-directed marketable equity securities which are recorded as trading securities at fair-market value on the accompanying consolidated balance sheet (in other assets) and aggregated $733,446 and $563,506 at December 31, 2003 and 2002, respectively. The monies held by the plan are subject to general creditors of the Company in the event of a Company bankruptcy filing. 13. STOCK BASED COMPENSATION The Company has adopted two stock option plans: the 1997 and 2000 Stock Option and Incentive Award Plans ("The Plans"). The Plans provide key employees, officers, directors, contractors and consultants an opportunity to own shares of common stock of the Company and to provide incentives for such persons to promote the financial success of the Company. Awards under The Plans may be structured in a variety of ways, including as "incentive stock options," as defined in Section 422 of the Internal Revenue Code, as amended, non-qualified stock options, restricted stock awards, and stock appreciation rights ("SARs"). Incentive stock options may be granted only to full-time employees (including officers) of the Company and its subsidiary. Non-qualified options, restricted stock awards, SARs, and other permitted forms of awards may be granted to any person employed by or performing services for the Company, including directors, contractors and consultants. The 1997 Stock Option Plan and 2000 Stock Option Plan, as amended, provide for the issuance of options to purchase up to an aggregate of 800,000 shares and 2,800,000 shares of common stock, respectively. At December 31, 2003, there were 1,651,650 shares available to be issued under The Plans. Incentive stock options are also subject to certain limitations prescribed by the Code, including the requirement that such options may not be granted to employees who own more than 10% of the combined voting power of all classes of voting stock of the Company, unless the option price is at least 110% of the fair market value of the common stock subject to the option. The Board of Directors of the Company (or a committee designated by the Board) otherwise generally has discretion to set the terms and conditions of options and other awards, including the term, exercise price and vesting conditions, if any; to select the persons who receive such grants and awards; and to interpret and administer The Plans. 31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) A summary of the options outstanding and exercisable by price range as of December 31, 2003 is as follows (shares in 000's):
Options Outstanding Options Exercisable ------------------------------------ ----------------------------------- Weighted Average Weighted Range of As of Remaining Weighted Average As of Average Exercise Prices December 31, 2003 Contractual Life Exercise Price December 31, 2003 Exercise Price - --------------- ----------------- ---------------- ---------------- ----------------- --------------- $1.77 - $3.54 624 7.8 $3.31 120 $3.13 $3.54 - $5.31 279 7.8 4.35 85 4.48 $5.31 - $7.07 228 6.8 6.44 137 6.31 $7.07 - $8.84 242 6.6 7.30 153 7.23 $8.84 - $10.61 224 3.9 9.10 224 9.10 $10.61 - $12.38 20 4.4 12.00 20 12.00 $12.38 - $14.15 5 5.8 12.63 5 12.63 $15.92 - $17.68 20 5.2 16.87 20 16.87 ----- --- ----- --- ----- 1,642 6.9 $5.59 764 $7.07 ===== === ===== === =====
A summary of activity in the Company's two stock option plans is as follows (shares in 000's):
Weighted Average Shares Price ------ ---------------- Outstanding at December 31, 2000 1,844 6.19 Granted 454 7.35 Forfeited (490) 7.07 ----- ----- Outstanding at December 31, 2001 1,808 6.23 Granted 559 3.41 Forfeited (330) 5.96 ----- ----- Outstanding at December 31, 2002 2,037 5.50 Granted 120 4.31 Exercised (306) 4.35 Forfeited (209) 5.79 ----- ----- Outstanding at December 31, 2003 1,642 $5.59 ===== ===== Options exercisable at December 31, 2003 764 $7.07 ===== =====
14. RELATED PARTY TRANSACTIONS The Company leases a single engine aircraft from a company wholly-owned by its Chairman and Chief Executive Officer, pursuant to an agreement that provides for Innotrac to pay for 86% of all expenses associated with this aircraft. This allocation is determined annually based on actual business usage. The Company paid approximately $133,656 during 2003. For the years ended December 31, 2002 and 2001, the Company paid $60,000 annually. The Company paid approximately $82,500, $63,000 and $51,224 during 2003, 2002 and 2001, respectively, in fees to an accounting firm for tax and consulting services. One of the directors of the Company is the Managing Partner and part owner of that firm. The Company paid approximately $863,000, $744,000 and $1,083,345 during 2003, 2002 and 2001, respectively, in fees to a print broker for services related to the printing of marketing, client, inter-company and other materials. The broker is owned by the brother of the Company's Chairman and Chief Executive Officer. 32 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) In 2003, the Company and the IPOF Group (consisting of IPOF Fund, LP and its general partner, David Dadante), which as of December 31, 2003 beneficially owned approximately 3.0 million shares of Common Stock, entered into an amended Agreement to permit the IPOF Group to acquire up to 40% of the Common Stock on the terms set forth in that Agreement without becoming an "Acquiring Person" under the Company's Rights Agreement with SunTrust Bank. The Agreement with the IPOF Group contains various restrictions on the IPOF's Group right to vote and take certain other shareholder actions. Among these restrictions, the IPOF Group agreed to vote all shares in excess of 15% proportionately with vote(s) cast by the other shareholders of the Company and not seek to place a representative on the Company's Board or seek to remove any member of the Board. The IPOF Group further acknowledged that it is an "affiliate," as defined under applicable federal securities law. The Company and its outside counsel have become aware of possible IPOF Group violations of the short-swing profit rules under Section 16(b) of the Securities and Exchange Act of 1934. Upon conclusion of the investigation of this matter, the Company and IPOF Group, on March 3, 2004, entered into a negotiated resolution of these potential violations. 15. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
(000's, except per share data) First Second Third Fourth(1) -------- -------- -------- --------- 2003 Quarters: Revenues, net $ 18,334 $ 17,631 $ 18,545 $ 20,230 Operating (loss) income (1,165) (472) (180) (636) Net (loss) income (892) (393) (249) (10,447) Net (loss) income per share-basic (0.08) (0.03) (0.02) (0.89) Net (loss) income per share-diluted $ (0.08) $ (0.03) $ (0.02) $ (0.89) 2002 Quarters: Revenues, net $ 21,048 $ 19,351 $ 20,064 $ 21,957 Operating income (loss) 1,584 588 (8,462) (513) Net income 966 313 (5,308) (390) Net income per share-basic 0.08 0.03 (0.46) (0.03) Net income per share-diluted $ 0.08 $ 0.03 $ (0.46) $ (0.03)
- ---------------- (1) Results for the fourth quarter of 2003 include valuation allowances for the deferred tax asset and for one specific account receivable. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 8 for further explanation. 16. ADDITIONAL PRIOR YEAR DISCLOSURES In order to maintain consistency and comparability between periods presented, certain revisions have been made to the accompanying consolidated financial statement notes as of December 31, 2001 and for the year then ended. Such additions to certain disclosures have been made to conform to the 2003 and 2002 financial statement presentation as follows: Notes to Consolidated Financial Statements: - -- Note 9, Earnings per Share: Options and restricted shares outstanding which were anti-dilutive and not included in the computation of EPS for 2001 have been disclosed. - -- Note 12, Employee Retirement Plans: Matching contribution for the executive deferred compensation plan for 2001 has been disclosed. - -- Note 14, Related Party Transactions: Payments for an aircraft lease, for accounting fees and for print services for 2001 have been disclosed. 33 EX-14.1 7 g87947exv14w1.txt CODE OF BUSINESS CONDUCT AND ETHICS EXHIBIT 14.1 INTRODUCTION Innotrac Corporation is about Integrity, Respect and Excellence in everything we do. These key beliefs define who we are and represent our core values as individuals and as an organization. We demonstrate our commitment to these beliefs every day in our interactions with our employees, our clients, our shareholders, our suppliers, our competitors and our communities. This Code highlights important issues and identifies policies and procedures to help you make decisions that reflect and support these key beliefs. Innotrac expects all employees, officers and members of its Board of Directors, as well as individuals and entities with whom we do business, to act with the highest ethical standards and to comply with all applicable laws. The Code is a guide to the specific standards of business conduct and laws that apply to our everyday business dealings. In some instances, the Code goes beyond what the law requires to protect the integrity of the Company in all situations. This Code does not include all policies of the Company, however; the Company publishes various policies, procedures and rules from time to time, and all employees, officers and Board members are expected to comply with these policies, procedures and rules as well. APPLICATION OF THE CODE Our words and action reflect who we are. Each of us is responsible for making sure that our actions conform to this Code and all laws applicable to us. This responsibility extends from the very top and throughout all levels of our organization, including the Board of Directors, the executive officers (including the senior financial officers), and all employees. Failure to abide by this Code or the law will lead to disciplinary action appropriate to the violation, up to and including termination. DISTRIBUTION OF THE CODE Innotrac will distribute this Code to new employees, officers and Board members, and will distribute or publish updates as appropriate. The current version of this Code also is available on the Company's intranet site. You may request a free copy of this Code by sending your written request to the Company's corporate secretary at 6655 Sugarloaf Parkway, Duluth, Georgia 30097. Our business partners, including consultants and subcontractors, play vital roles in the work that we do. It is very important that these business partners share our high ethical standards and commitment to integrity. We will inform our business partners of their responsibilities to act on behalf of Innotrac consistently with this Code and other applicable Innotrac policies and procedures. Innotrac Code of Ethics and Business Conduct March 1,2004 CONDUCT STANDARDS I. COMPLY WITH THE LAW Innotrac is committed to conducting our businesses in accordance with the letter and the spirit of the laws of the United States and the states in which we do business. All employees, officers and Board members of the Company are responsible for fulfilling this commitment by being knowledgeable about applicable laws, rules and regulations and by steadfastly complying with their legal obligations in the performance of their Company responsibilities. For questions or clarification, you should consult the Company's General Counsel. II. ENSURE A POSITIVE WORK ENVIRONMENT EQUAL OPPORTUNITY FOR ALL EMPLOYEES One of Innotrac's most valuable assets is its employees. Our mission is to provide our employees with a rewarding work environment that allows for individual growth and development within the Company. We support honesty, dignity, respect, integrity, and accountability in the workplace. We value our employees' uniqueness and diversity, which bring different perspectives to our work and enhances our ability to serve our clients and their customers. Each of us must demonstrate sensitivity to and respect for all other employees. We are an equal employment opportunity employer and provide employment opportunities regardless of race, color, sex, religion, national origin, age, disability, veteran status, or other legally protected status. We will not retaliate against any employee who in good faith makes a complaint about Innotrac's employment practices. FREEDOM FROM HARASSMENT Innotrac is committed to providing a positive, productive work environment for all employees. We treat all employees fairly, with dignity and respect. Innotrac will not tolerate any harassment of employees by anyone, including any supervisor, co-worker, vendor, client, or customer of Innotrac. Harassment occurs when words or actions create an intimidating, hostile or offensive work environment and can take many forms. It can be verbal, written, physical or graphic. Even behavior that is not intended to be harassing may be perceived that way. Our policy against harassment includes harassment for any discriminatory reason, such as sex, race, national origin, disability, age or religion. All of us are responsible for helping to enforce this policy and ensuring that the work environment remains pleasant and professional for everyone at Innotrac. 2 Innotrac Code of Ethics and Business Conduct March 1,2004 SAFETY AND HEALTH Innotrac is committed to providing a drug-free, safe and healthy work environment. Each of us is responsible for following Innotrac's safety and health policies and procedures. We must ensure that this work environment is free from the effects of illegal drugs and alcohol which could prevent us from conducting work activities safely and effectively. No employee may engage in the illegal use, sale, distribution or manufacture of drugs or abuse prescription drugs while on the job or on Company premises. III. ENGAGE IN FAIR COMPETITION ANTITRUST AND COMPETITION We compete vigorously, independently and fairly in compliance with all applicable antitrust and competition laws. Innotrac will not enter into any anticompetitive agreements with our competitors, which include agreements or understandings with competitors concerning pricing, sales terms, market share or territory allocation or boycotts. Innotrac also does not condone activities that seek to gain an unfair competitive advantage. Nor does Innotrac compete by disparaging or criticizing a competitor to a client or potential client. We earn our clients' trust and loyalty based on the quality, features and pricing of our services. The antitrust and unfair competition laws impose severe penalties for unlawful behavior and are aggressively enforced. They also may impose sanctions on individuals. Any questions about whether an action may violate an antitrust or competition law should be referred to the General Counsel. COMPETITIVE INTELLIGENCE We rely on competitive intelligence to understand the marketplace and to develop and manage our services accordingly. Innotrac must gather this competitive information ethically and lawfully, however. Innotrac will not use any unlawful means to acquire competitive information, such as theft, blackmail, wiretapping, electronic eavesdropping, bribery, threats, extortion, or other improper methods. Nor do we use our competitor's employees or suppliers as improper sources of confidential competitive information. Some Innotrac employees may have signed agreements with previous employers that contain restrictions on their post-termination activities. Innotrac expects these employees to comply with all lawful restrictions. In addition, no individual acting on Innotrac's behalf should use or disclose, directly or indirectly, any confidential information or trade secrets of a third party that the individual obtained while employed by or associated with that third party. 3 Innotrac Code of Ethics and Business Conduct March 1,2004 IV. PROTECT THE COMPANY'S ASSETS COMPANY RECORDS We must maintain accurate and complete Company records. All transactions must be recorded so as to permit preparation of financial statements in conformity with generally accepted accounting principles. We will not make any false or misleading entries in the Company's books and records for any reason, nor will we establish any undisclosed or unrecorded fund or asset for any purpose. No employee may engage in any arrangement that results in such a prohibited act. No payment on behalf of the Company may be approved without adequate supporting documentation or made with the intention or understanding that any part of such payment is to be used for any purpose other than as described by the documents supporting the payment. FINANCIAL REPORTING We are committed to full, fair, accurate, timely, and understandable disclosures of Innotrac's financial results and condition in all reports and documents filed by the Company with the Securities and Exchange Commission and in other public communications made by the Company. Although this commitment applies to everyone, Innotrac's financial officers and personnel have a special responsibility to ensure that the Company's finance and accounting practices support this objective. CONFIDENTIAL INFORMATION Our confidential information is vital to the Company's ongoing success. Confidential information is any information that is non-public and that is identified or treated by Innotrac as confidential, proprietary or secret, or which under the circumstances would reasonably be understood to be confidential. Confidential information also includes information belonging to our clients and their customers, our suppliers, and the business partners with whom we do business. The following examples illustrate some of the types of confidential information that employees may encounter each day, but is not exhaustive: - Business plans, strategies, and budgets - Operational and sales information - Pricing and pricing strategies - Internal policies and manuals - Financial data and reports that are not public - Technical information, including research, development, procedures, 4 Innotrac Code of Ethics and Business Conduct March 1,2004 algorithms, data, designs, and know-how - Possible acquisitions, divestitures and mergers - Information about actual or potential clients and vendors - Personal information about our clients' customers - Information about existing or future services No employee, officer or Board member may use or disclose any confidential information regarding the Company or our clients, operations, finances or business dealings, except in connection with the individual's work for the Company or as required by legal process. We also must ensure that we enter into appropriate non-disclosure agreements to protect the confidentiality of information that is disclosed or received. These confidentiality obligations will continue throughout an individual's employment or a business partner's association with Innotrac and even afterwards. All confidential information should be marked appropriately and stored in a secure location. Care should be taken not to leave documents containing confidential information visible on desks, not to throw such documents away in a trash without shredding the documents, and not to discuss confidential information in public places. We especially must be cautious when responding to requests for information from the media, financial analysts, attorneys or similar outside entities. All requests for information from the media or financial community should be referred to the Company's Chief Financial Officer and all requests for information about lawsuits, subpoenas or legal claims should be referred to the Company's General Counsel. All employment-related inquiries should be directed to the Company's Human Resources Department. ELECTRONIC COMMUNICATIONS SYSTEMS Innotrac uses various electronic communications systems, such as e-mail, telephony, pagers, facsimiles, and Internet access, to make our businesses operate more effectively and efficiently and to provide better service to our clients. These electronic resources belong to the Company and must be used for the purpose of conducting the Company's business. All computer users are obligated to use these resources responsibly, professionally, ethically, and lawfully. The systems should not be used in any way that may be disruptive to Company operations or that violate Company policy or law. To protect the security of these resources, all user ids and passwords should be safeguarded carefully. While occasional personal use of the Company's system is permitted as long as such use does not interfere with the employee's job responsibilities, individuals should be aware that all electronic information (such as e-mail messages stored on the Company's systems) are the property of the Company, and the Company, at its discretion, reserves the right to access and disclose any electronic information for any 5 Innotrac Code of Ethics and Business Conduct March 1,2004 purposes, including computer files, messages sent over its e-mail system, or information accessed through its Internet connection. In addition, data, programs, documents, correspondence, and other files stored on or transmitted by these electronic systems are the property of the Company and must be safeguarded with the same diligence as traditional paper documents. COMPUTER SOFTWARE Innotrac's integrated network of computer systems utilizes many different software applications that work together to assist us in our jobs every day. We must protect these assets carefully from damage, destruction and improper use. Innotrac prohibits any unauthorized acquisition, copy, or use of computer software of the Company or any third party. All software used by or on behalf of the Company or on Company-owned computers must be purchased through the appropriate channels in the Company using approved procedures. Software may not be brought in from any unauthorized source, including downloading from the Internet. Software must be used only in accordance with the terms of its license agreement. No employee may make or distribute unauthorized copies of software or documentation for use within or on behalf of the Company or for personal use or for the use of others, including clients, customers and family members. COMPANY FACILITIES, PROPERTY AND SERVICES Company facilities, property and services (or those of third parties doing business with the Company) may not be used for personal use. Similarly, personal expenses may not be charged to the Company (including on Company credit cards) or otherwise paid by the Company, except as permitted under approved fringe benefit policies. All property of the Company, including materials produced by employees and proprietary information, must be returned to the Company immediately upon termination of employment. INSIDE INFORMATION AND SECURITIES TRADING Under federal and state securities laws, it is unlawful to buy or sell the stock of a public company like Innotrac while aware of "insider" information. To ensure that we comply with these securities laws, all Innotrac employees, officers and Board members must observe the following important standards: - Material non-public information must not be disclosed to (a) anyone within the Company except those people who need to know the information in the performance of their job responsibilities, or (b) anyone outside the Company except those people who are being requested to provide products or services to the Company which directly involve that information and agree to or are otherwise obligated to keep that information confidential. - No employee, officer or Board member of the Company may directly or 6 Innotrac Code of Ethics and Business Conduct March 1,2004 indirectly buy or sell securities of the Company while aware of material, non-public information about the Company, except as provided in stock sale or purchase plans permitted under applicable laws and approved by Innotrac's General Counsel. In addition, employees, officers and Board members of the Company may not directly or indirectly buy or sell securities of any other publicly traded corporation about which the individual has material, non-public information as a result of his or her position with the Company, including knowledge of business transactions or potential business transactions between the Company and such other corporation. - Additional restrictions apply to members of the Board and executive officers of the Company, who generally may only trade on the open market during the two-week window beginning 48 hours after the Company first publicly releases its earnings for the most recently completed fiscal period. V. AVOID CONFLICTS OF INTEREST Innotrac requires honest and ethical conduct from its employees, officers and Board members. Individuals are expected to act at all times in Innotrac's best interests and to exercise sound judgment unclouded by personal interests or divided loyalties. Actual or apparent conflicts of interest between personal and professional relationships must be handled ethically. In furtherance of these requirements, employees, officers and Board members must observe the following standards: RELATIONSHIPS WITH CLIENTS, SUPPLIERS AND COMPETITORS Employees, officers and Board members must disclose any ownership, control or beneficial interest they may have in any firm seeking to do business with the Company or any relationship with any person who might benefit from such a transaction. Business transactions where a material interest or relationship is or reasonably could be expected to be present may only be pursued if a written waiver is first granted in accordance with this Code. Employees, officers and Board members may not hold investments in firms competing directly with the Company. Ownership or beneficial interest of less than 1% of the outstanding stock of publicly held companies is excluded from these policies. Employees, officers and Board members may not borrow from or lend personal funds to clients, suppliers, competing companies, or their affiliates except for arms-length transactions that occur in the normal course of business. Employment (whether or not for remuneration), compensation, or other financial benefits from an actual or potential client, supplier, or competing company while employed by the Company is strictly prohibited. RELATED PARTY TRANSACTIONS 7 Innotrac Code of Ethics and Business Conduct March 1,2004 Any transaction between Innotrac and any officer, Board member, or principal shareholder or affiliate should be at "arms-length", which means that the terms must be no less favorable than those that Innotrac could obtain from an unaffiliated third party or the transaction should otherwise be in the best interests of the Company. To enable Innotrac to make this determination, all proposed related party transactions must first be approved by the Company's Audit Committee. The Company will disclose all approved related party transactions as required by the Securities and Exchange Commission and applicable law. [annually?] OTHER OUTSIDE EMPLOYMENT AND BOARD MEMBERSHIPS Innotrac does not permit officers or employees to hold other outside employment (whether or not for remuneration) or investments affecting efficiency or working hours unless a written waiver is first granted in accordance with this Code. An employee, officer or Board member may serve on the Board of Directors of another company or non-profit organization that is not an actual or potential client, supplier or competitor of Innotrac so long as the directorship does not affect the individual's efficiency or working hours and does not otherwise create an actual or potential conflict of interest. If in doubt, the individual should seek guidance from the Chief Financial Officer or General Counsel before accepting an outside directorship. ACCEPTANCE OF GIFTS FROM THIRD PARTIES Innotrac employees, officers and Board members must not accept anything that might make it appear that our judgment for Innotrac would be compromised, such as kickbacks, lavish gifts or entertainment, money in any amount, or gratuities. You may accept items of nominal value, such as advertising or promotional items bearing another company's logo. You also may accept occasional meals, refreshments and entertainment that is reasonable in the context of the business. Solicitation of gifts is strictly prohibited. You must report any offers from a third party that violate this policy to the Audit Committee for matters relating to Board members and executive officers of the Company or to the Company's chief executive officer for matters relating to all other employees. GIFTS TO THIRD PARTIES Some business situations call for gift giving and entertainment. These business courtesies must be reasonable in the business context and legal. All reimbursable items must be identified on expense reports and other documents and are subject to supervisory review, including a determination that expenditures conform to this policy. You may not offer any gift or entertainment that is lavish or that is prohibited by law or the policy of the recipient. It is each employee's obligation to ask about the recipient's policy before offering any business courtesy. If in doubt, check first. Some government agencies prohibit any entertaining of, or gifts to, their employees (including civilian employees), and in such cases no entertainment or gifts are permitted. To be safe, check with the General Counsel before offering any business 8 Innotrac Code of Ethics and Business Conduct March 1,2004 courtesy to a governmental official or employee. In addition, the Company complies fully with the Foreign Corrupt Practices Act, which generally prohibits any payment to foreign officials, including political parties or candidates, for the purpose of obtaining or retaining business for the Company or otherwise securing any improper advantage. VI. SUPPORT OUR COMMUNITIES COMMUNITY SERVICE We strive to build a sense of community within all of our locations throughout the United States. Each associate is valued and respected for their commitment to family, community and charity. SOUND ENVIRONMENTAL PRACTICES Innotrac respects the environment by conducting its operations in accordance with all applicable environmental laws and regulations in the places where we operate. Innotrac strives to protect the environment by minimizing any adverse environmental impact of our operations and utilizing recycling programs whenever feasible. POLITICAL CONTRIBUTIONS Innotrac encourages individuals to become involved in political affairs. Our officers, employees and Board members are free to make individual, personal contributions to causes and candidates of their choice, as long as they make it clear that their views and actions are not those of Innotrac. Company funds may not be used for political contributions, directly or indirectly, in support of any party or candidate except as permitted under applicable law. WAIVERS The Company in its discretion may grant a written waiver for certain activities, relationships or situations that otherwise would violate or could reasonably be expected to violate this Code. To obtain a waiver, the employee, officer or Board member must disclose all relevant facts and information concerning the matter either to (1) the Company's Audit Committee for matters involving a Board member, corporate officer or senior financial officer, or (2) the chief executive officer of the Company for matters relating to all other employees. Waivers that are not expressly approved in writing shall be deemed to be denied. 9 Innotrac Code of Ethics and Business Conduct March 1,2004 GETTING HELP AND REPORTING VIOLATIONS QUESTIONS If you have doubt or uncertainty about whether a situation may violate this Code, you should contact the Company's General Counsel using the contact information listed below. The Company will then determine whether a violation of the Code exists. REPORTING VIOLATIONS Each of us has a responsibility to report any violation of the Code promptly. You should report violations or suspected violations in writing or verbally to either of the following individuals: Chief Financial Officer General Counsel 6655 Sugarloaf Parkway 6655 Sugarloaf Parkway Duluth, Georgia 30097 Duluth, Georgia 30097 (678) 584-4020 (678) 584-4234 Any reports involving accounting, internal controls or auditing matters will be referred to the Company's Audit Committee. If you are not comfortable identifying yourself, you may send reports anonymously and/or request confidentiality. Employees will not be disciplined or retaliated against in any way for reporting violations in good faith. CONSEQUENCES FOR VIOLATIONS Innotrac will take prompt and appropriate remedial action in response to violations of the Code. Any employee, officer or Board member who engages in conduct prohibited by the Code as determined by the Company will be subject to discipline appropriate to the violation, up to and including termination or removal. Additionally, the Company may be required to report certain violations to appropriate government or legal authorities. 10 Innotrac Code of Ethics and Business Conduct March 1,2004 CERTIFICATION I have read and affirm my commitment to the principles and standards described in the Innotrac Corporation Code of Ethics and Business Conduct. I confirm that I am not in violation of any of the provisions of the Code and I have no knowledge of any unreported violations of any of such provisions by anyone else, whether for their own benefit or for the supposed benefit of the Company, except as I have noted below. Failure to read and/or sign this Certification in no way relieves employees, officers and Board members of the responsibility to comply with the standards set forth in the Innotrac Corporation Code of Ethics and Business Conduct or applicable laws, policies and procedures. ___________________ ___________________ Name Date 11 EX-21.1 8 g87947exv21w1.txt LIST OF SUBSIDIARIES EXHIBIT 21.1 LIST OF SUBSIDIARIES - - iFulfillment, Inc. EX-23.1 9 g87947exv23w1.txt CONSENT OF DELOITTE & TOUCHE LLP EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statements Nos. 333-66045 and 333-54970 of Innotrac Corporation on Form S-8 of our report dated March 30 2004, relating to the consolidated financial statements of Innotrac Corporation as of December 31, 2003 and December 31, 2002 and for the two fiscal year periods then ended (which report expresses an unqualified opinion and includes an explanatory paragraph relating to (1) the Company's change in its method of accounting for goodwill and other intangible assets to conform with Statement of Financial Accounting Standards No. 142 and (2) relating to the application of procedures relating to certain disclosures of financial statement amounts related to the 2001 financial statements that were audited by other auditors who have ceased operations and for which we have expressed no opinion or other form of assurance other than with respect to such disclosures) appearing in this Annual Report on Form 10-K of Innotrac Corporation for the year ended December 31, 2003. /s/ Deloitte and Touche LLP Atlanta, Georgia March 30, 2004 EX-23.2 10 g87947exv23w2.txt NOTICE REGARDING CONSENT OF ARTHUR ANDERSEN LLP EXHIBIT 23.2 NOTICE REGARDING CONSENT OF ARTHUR ANDERSEN LLP Section 11 (a) of the Securities Act of 1933, as amended (the "Securities Act"), provides that if any part of a registration statement at the time such part becomes effective contains an untrue statement of a material fact or an omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring a security pursuant to such registration statement (unless it is proved that at the time of such acquisition such person knew of such untruth or omission) may sue, among others, every accountant who has consented to be named as having prepared or certified any part of the registration statement, or as having prepared or certified any report or valuation which is used in connection with the registration statement, with respect to the statement in such registration statement, report or valuation which purports to have been prepared or certified by the accountant. This Annual Report on Form 10-K is incorporated by reference into Registration Statement File Nos. 333-54970 and 333-66045 on Form S-8 (collectively, the "Registration Statements") of the Company and, for purposes of determining any liability under the Securities Act, is deemed to be a new registration statement for each Registration Statement into which it is incorporated by reference. On April 22, 2002 the Board of Directors of the Company, upon the recommendation of its Audit committee, dismissed its independent accounts, Arthur Andersen LLP ("Andersen"). See the Company's Current Report on Form 8-K filed April 24, 2002 for more information. After reasonable efforts, the Company has been unable to obtain Andersen's written consent to the incorporation by reference into the Registration Statements of its audit reports with respect to the Company's financial statements as of and for the fiscal years ended December 31, 2001 and 2000. Under these circumstances, Rule 437a under the Securities Act permits the Company to file this Form 10-K without a written consent from Andersen. However, as a result, with respect to transactions in the Company's securities pursuant to the Registration Statements that occur subsequent to the date this Annual Report on Form 10-K is filed with the Securities and Exchange Commission, Andersen will not have any liability under Section 11 (a) of the Securities Act for any untrue statements of a material fact contained in the financial statements audited by Andersen or any omissions of a material fact required to be stated therein. Accordingly, you would be unable to assert a claim against Andersen under Section 11 (a) of the Securities Act because it has not consented to the incorporation by reference of its previously issued reports into the Registration Statements. To the extent provided in Section 11 (b) (3) (c) of the Securities Act, however, other persons who are liable under Section 11 (a) of the Securities Act, including the Company's officers and directors, may still rely on Andersen's original audit reports as being made by an expert for purposes of establishing a due diligence defense under Section 11 (b) of the Securities Act. EX-24.1 11 g87947exv24w1.txt POWER OF ATTORNEY Exhibit 24.1 POWER OF ATTORNEY Know all men by these presents, that each person whose signature appears below constitutes and appoints Scott D. Dorfman and David L. Gamsey and either of them, as attorneys-in-fact, with power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that said attorneys-in-fact may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant in the capacities indicated on the 30th day of March, 2004.
Signature Title --------- ------ /s/ Scott D. Dorfman Chairman of the Board, President and Chief Executive Officer (Principal - --------------------- Executive Officer) Scott D. Dorfman /s/ David L. Gamsey Senior Vice President, Chief Financial Officer and Secretary (Principal - -------------------- Financial and Accounting Officer) David L. Gamsey /s/ David L. Ellin Senior Vice President -- Sales and Director - ------------------- David L. Ellin /s/ Alston Gardner Director - ------------------- Alston Gardner /s/ Bruce V. Benator Director - -------------------- Bruce V. Benator /s/ Martin J. Blank Director - -------------------- Martin J. Blank /s/ Joel E. Marks Director - -------------------- Joel E. Marks
S-2 EX-31.1 12 g87947exv31w1.txt SECTION 302 CERTIFICATION OF THE CEO EXHIBIT 31.1 CERTIFICATION PURSUANT TO RULE 13a-14(a)/15d-14(a) I, Scott D. Dorfman, certify that: 1. I have reviewed this annual report on Form 10-K of Innotrac Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 30, 2004 /s/ Scott D. Dorfman ------------------------------ Scott D. Dorfman President, Chief Executive Officer and Chairman of the Board (Principal Executive Officer) EX-31.2 13 g87947exv31w2.txt SECTION 302 CERTIFICATION OF THE CFO EXHIBIT 31.2 CERTIFICATION PURSUANT TO RULE 13A-14(A)/15D-14(A) I, David L. Gamsey, certify that: 1. I have reviewed this annual report on Form 10-K of Innotrac Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 30, 2004 /s/ David L. Gamsey ------------------------------------ David L. Gamsey Senior Vice President , Chief Financial Officer and Secretary (Principal Financial Officer) EX-32.1 14 g87947exv32w1.txt SECTION 906 CERTIFICATION OF THE CEO EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 I, Scott D. Dorfman, Chief Executive Officer of Innotrac Corporation (the "Company"), certify, pursuant to 18 U.S.C. Section 1350 as adopted by Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) the Annual Report on Form 10-K of the Company for the year ended December 31, 2003 (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: March 30, 2004 /s/ Scott D. Dorfman -------------------------------------- Scott D. Dorfman President, Chief Executive Officer and Chairman of the Board EX-32.2 15 g87947exv32w2.txt SECTION 906 CERTIFICATION OF THE CFO EXHIBIT 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 I, David L. Gamsey, Chief Financial Officer of Innotrac Corporation (the "Company"), certify, pursuant to 18 U.S.C.Section 1350 as adopted by Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) the Annual Report on Form 10-K of the Company for the year ended December 31, 2003 (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: March 30, 2004 /s/ David L. Gamsey ------------------------- David L. Gamsey Senior Vice President, Chief Financial Officer and Secretary -----END PRIVACY-ENHANCED MESSAGE-----