<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES ACT OF 1934
For the transition period from _____ to _______
Commission file number 000-23740
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INNOTRAC CORPORATION
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(Exact name of registrant as specified in its charter)
Georgia 58-1592285
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
6655 Sugarloaf Parkway Duluth, Georgia 30097
-------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (678) 584-4000
---------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes / X / No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Outstanding at October 24, 1998
-------------------------------
Common Stock at $.10 par value 8,999,995 Shares
<PAGE>
Part I Financial Information
- ------------------------------
Item 1 Financial Statements
- -----------------------------
INNOTRAC CORPORATION
BALANCE SHEETS
As of September 30, 1998 and December 31, 1997
(in 000's)
<TABLE>
<CAPTION>
ASSETS September 30, 1998 December 31, 1997
------ ------------------ -----------------
(Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................... $ 4,056 $ 554
Accounts Receivable, net.................................... 40,943 20,081
Inventories................................................. 5,318 2,936
Deferred tax assets......................................... 3,089 386
Prepaid expenses and other current assets................... 1,186 373
------------ ------------
Total current assets 54,592 24,330
------------ ------------
Property and equipment:
Rental equipment............................................ 8,013 10,433
Computer, machinery and transportation equipment............ 4,190 1,558
Furniture, fixtures and leasehold improvements.............. 810 720
------------ ------------
13,013 12,711
Less accumulated depreciation and amortization.............. 6,132 5,102
------------ ------------
6,881 7,609
------------ ------------
Other assets, net............................................... 127 558
------------ ------------
$ 61,600 $ 32,497
============ ============
LIABILITIES AND PARTNERS', MEMBERS',
------------------------------------
AND SHAREHOLDERS' EQUITY September 30, 1998 December 31, 1997
------------------------ ------------------ -----------------
(Unaudited)
Current liabilities:
Current portion of long-term debt........................... $ 67 $ 738
Line of credit.............................................. 8,401 8,545
Accounts payable............................................ 9,838 4,766
Distributions payable....................................... 70 1,007
Accrued expenses............................................ 9,039 7,435
Other....................................................... 986 318
------------ ------------
Total current liabilities......................... 28,401 22,809
------------ ------------
Noncurrent liabilities:
Subordinated debt........................................... 0 3,500
Long-term debt.............................................. 9 404
Deferred tax liability...................................... 295 40
------------ ------------
Total noncurrent liabilities...................... 304 3,944
------------ ------------
Total liabilities................................. 28,705 26,753
------------ ------------
Commitment and contingencies....................................
Redeemable capital stock........................................ 577 917
------------ ------------
Partners', members' and shareholders' equity:
Partners' capital........................................... 0 1,759
Members' deficit............................................ 0 (490)
Common stock................................................ 900 5
Additional paid-in capital.................................. 24,840 14
Retained earnings........................................... 6,578 3,539
------------ ------------
Total partners', members and shareholders' equity 32,318 4,827
------------ ------------
Total liabilities and partners', members' and
shareholders' equity............................ $ 61,600 $ 32,497
============ ============
The accompanying condensed notes to financial statements are
an integral part of these balance sheets
</TABLE>
<PAGE>
Financial Statements-Continued
<TABLE>
<CAPTION>
INNOTRAC CORPORATION
INCOME STATEMENTS
Three Months and Nine Months Ended September 30, 1998 and 1997
(Unaudited)
(In 000's except per share data)
Three Months Ended September 30, Nine Months Ended September 30,
1998 1997 1998 1997
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Revenues, net................................. $ 35,233 $ 20,226 $ 94,143 $ 67,313
Cost of revenues.............................. 27,533 15,009 70,460 51,799
-------- -------- -------- --------
Gross Profit........................ 7,700 5,217 23,683 15,514
-------- -------- -------- --------
Operating expenses:
Selling, general and
administrative expenses................ 3,801 3,209 12,332 9,072
Depreciation and amortization............. 230 112 603 454
-------- -------- -------- --------
Total operating expenses............ 4,031 3,321 12,935 9,526
-------- -------- -------- --------
Operating income.............................. 3,669 1,896 10,748 5,988
-------- -------- -------- --------
Other (income) expense:
Interest expense.......................... 119 441 692 1,422
Other..................................... (30) 14 (9) (2)
-------- -------- -------- --------
Total other expenses................ 89 455 683 1,420
-------- -------- -------- --------
Income before income taxes.................... 3,580 1,441 10,065 4,568
Income tax provision.......................... (1,411) (110) (2,493) (75)
-------- -------- -------- --------
Net income.......................... $ 2,169 $ 1,331 $ 7,572 $ 4,493
======== ======== ======== ========
Proforma net income................. $ 2,169 $ 873 $ 6,098 $ 2,768
======== ======== ======== ========
Proforma net income per share:
Basic..................................... $ 0.24 $ 0.13 $ 0.78 $ 0.43
======== ======== ======== ========
Diluted................................... $ 0.24 $ 0.13 $ 0.78 $ 0.43
======== ======== ======== ========
Shares used for computing net income per share:
Basic..................................... 9,000 6,500 7,800 6,500
======== ======== ======== ========
Diluted................................... 9,011 6,500 7,816 6,500
======== ======== ======== ========
</TABLE>
The accompanying condensed notes to financial statements
are an integral part of these statements
<PAGE>
Financial Statements-Continued
<TABLE>
<CAPTION>
INNOTRAC CORPORATION
STATEMENT OF CASH FLOWS
For the nine months ended September 30, 1998 and 1997
(In 000's)
1998 1997
----------- -----------
(Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net income..................................................................... $ 7,572 $ 4,493
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization............................................. 603 454
Depreciation-rental equipment............................................. 2,300 2,861
Loss on disposal of rental equipment...................................... 1,560 3,175
Deferred income taxes..................................................... 568 (466)
(Increase) decrease in accounts receivable................................ (20,862) 3,787
(Increase) decrease in inventories........................................ (2,382) 4,712
(Increase) decrease in prepaid expenses and other assets.................. (483) 119
Increase (decrease) in accounts payable................................... 5,072 (9,688)
Increase in accrued expenses.............................................. 1,605 2,065
Other..................................................................... 668 126
---------- ----------
Net cash (used in) provided by operating activities................... (3,779) 11,638
---------- ----------
Cash flows from investing activities:
Accrued equipment purchases.................................................... 0 (1,362)
Purchase of property and equipment............................................. (3,635) (3,677)
---------- ----------
Net cash used in investing activities................................. (3,635) (5,039)
---------- ----------
Cash flows from financing activities:
Net repayment under lines of credit............................................ (144) (6,785)
Repayment of long-term debt.................................................... (1,066) (556)
Repayment of subordinated debt................................................. (3,500) 0
Proceeds from initial public offering, net..................................... 26,743 0
Redemption of redeemable capital stock......................................... (388) 0
Distributions to shareholders, members and partners............................ (10,729) (837)
---------- ----------
Net cash provided by (used in) financing activities................... 10,916 (8,178)
---------- ----------
Net increase (decrease) in cash and cash equivalents............................... 3,502 (1,579)
Cash and cash equivalents, beginning of period..................................... 554 2,005
---------- ----------
Cash and cash equivalents, end of period........................................... $ 4,056 $ 426
========== ==========
Supplemental cash flow disclosures:
Cash paid for interest......................................................... $ 774 $ 1,440
========== ==========
Cash paid for income taxes, net of refunds received............................ $ 1,257 $ 252
========== ==========
Non cash transactions:
Accreted dividends on redeemable capital stock................................. $ 48 $ 64
========== ==========
</TABLE>
The accompanying condensed notes to financial statements
are an integral part of these statements
<PAGE>
Financial Statements-Continued
INNOTRAC CORPORATION
CONDENSED NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1998 AND 1997
1. Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to Article 10 of
Regulation S-X of the Securities and Exchange Commission. The
accompanying unaudited condensed financial statements reflect, in the
opinion of management, all adjustments necessary to achieve a fair
statement of financial position and results for the interim periods
presented. All such adjustments are of a normal and recurring nature.
It is suggested that these condensed financial statements be read in
conjunction with the financial statements and notes thereto included in
the Company's Registration Statement on Form S-1 relating to the
Company's initial public offering, which was declared effective by the
Securities and Exchange Commission on May 6, 1998.
2. In May 1998, the Company completed an initial public offering of its Common
Stock. The Company issued 2,500,000 shares at an initial public
offering price of $12.00 per share. The total proceeds of the
offering, net of underwriting discounts and offering expenses, were
approximately $26,928,000.
3. The pro forma net income and earnings per share reflect the Company's
results on a fully taxed basis to reflect consolidation of the various
affiliated pass-through entities into a C corporation in conjunction
with the initial public offering.
4. Basic earnings per share is computed by dividing pro forma net income by
the weighted average number of common shares outstanding. Diluted earnings
per share includes the effect of the Company's stock options (using the
treasury stock method). The following table shows the computation of
the number of shares outstanding (in thousands):
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
Basic Shares 9,000 6,500 7,800 6,500
Stock Options 11 0 16 0
----- ----- ----- -----
Diluted Shares 9,011 6,500 7,816 6,500
===== ===== ===== =====
</TABLE>
<PAGE>
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Since its formation in 1984, the Company has expanded its business and
facilities to offer distribution and management services, and inbound
teleservices in response to the needs of clients in a variety of industries
and to capitalize on market opportunities. In 1987, the Company began
providing marketing support services to BellSouth. In 1991, the Company
initiated a fulfillment program to sell or rent to BellSouth customers
Caller ID hardware, phone sets and other equipment, and in 1993, began
billing the charges on customers' telephone bills. As part of this program,
Innotrac acquires the Caller ID and other telecommunications equipment from
third party manufacturers, thereby assuming inventory and credit risk. Upon
receipt of an order, the Company ships the product, tracks inventory levels
and sales and marketing data and maintains teleservicing operations to
handle customer service and technical support. From time to time, rather
than acquiring units and selling or leasing them to BellSouth customers, the
Company distributes, for a fee, Caller ID hardware that BellSouth has
purchased from various third-party manufacturers.
At a customer's option, the Company sells one of its various models of
Caller ID units generally in four to six installments or rents certain
models for an open-ended term (which the Company estimates has averaged 1.5
years). If a rental customer chooses to purchase a Caller ID unit, the
customer must return the old unit (approximately 93% of the returned units
are refurbished and rented again by the Company) and purchase a new one.
The Company writes off the remaining net book value of rental units that are
not returned and includes such amounts in its cost of revenues. The
Company's margins on installment sales and rentals of Caller ID units are
similar. Rentals of Caller ID units accounted for approximately 11% and 19%
of the Company's net revenues for the nine months ended September 30, 1998
and 1997, respectively, while sales of Caller ID units accounted for
approximately 82% and 78% of the Company's net revenues for the nine months
ended September 30, 1998 and 1997, respectively.
To leverage its experience and infrastructure investment related to the
BellSouth marketing support program, the Company entered into an agreement
with Pacific Bell in June 1996 to sell Pacific Bell's Caller ID equipment.
The Company also provides marketing support services to US West and seeks
other telecommunications companies for whom it can provide similar marketing
support services. In June 1998, the Company entered into an agreement with
SBC Communications, Inc. to become an approved fulfillment partner for
Caller ID related telecommunications equipment. Under the terms of this
agreement, the Company exchanged its exclusive arrangement with Pacific Bell
in California to become an approved fulfillment partner for Southwestern
Bell, Pacific Bell and Nevada Bell, al1 of which are subsidiaries of SBC
Communications, Inc. Under the Company's programs with Southwestern Bell
and Pacific Bell, the Company bills either Southwestern Bell or Pacific Bell
directly for the Caller ID units that are sold to their end users.
Southwestern Bell or Pacific Bell, as the case may be, are then responsible
for billing and collecting from the consumer. As a result, the Company's
unit prices and top line margin are lower than in prior periods which is
offset by lower bad debt expenses (included in general and administrative
expenses).
The Company has experienced significant growth in revenues in recent years
primarily due to the growth in Caller ID market penetration and service
improvements by the Company with respect to product-based marketing support
services. Industry sources indicate that at the end of 1995, BellSouth's
Caller ID penetration was approximately 13%. BellSouth indicates that
<PAGE>
through the end of December 1997 its Caller ID penetration had increased to
approximately 29%. In 1993, the Company began billing on the telephone bill
and, in mid-1995, changed the method of selling BellSouth equipment from
taking referrals in the Company's call center from BellSouth representatives
to having a BellSouth representative negotiate sales on behalf of the
Company and send order information to the Company by electronic data
interchange ("EDI"). This change in process increased sales and decreased
order-processing time. Also, in January 1997, the Company implemented an
interactive voice response ("IVR") system to handle some of the BellSouth
customer service calls, which generally reduced response time and lowered
operating costs. Services provided to BellSouth and its customers accounted
for 67%, 85%, 82% and 82% of the Company's net revenues for the nine months
ended September 30, 1998 and for the years ended December 31, 1997, 1996 and
1995, respectively.
Management believes that growth in revenues from Caller ID marketing support
services will remain constant for the next several years as market
penetration increases and new Caller ID services that require enhanced
equipment are introduced. Sales are expected to level off as the market
matures. According to industry sources, market penetration of Caller ID
services in the U.S. as of December 1, 1997 was approximately 18% and is
expected to peak at approximately 75% by 2007. Management intends to offset
the eventual maturity of its Caller ID business by diversifying its client
base and expand the scope of marketing support services it renders to its
clients by cross-selling its other services to existing clients.
Additionally, the Company intends to contact previous purchasers of Caller
ID products to promote newer enhanced Caller ID products.
Revenues are recognized on the accrual basis as services are provided to
customers or as units are shipped (including installment sales) or rentals
are provided. Revenues are reduced for an estimate of product returns and
allowances. This provision is calculated based on the Company's historical
experience applied to current sales.
The largest component of the Company's expenses is its cost of revenues,
which includes the product costs of telecommunications equipment,
depreciation on Caller ID rental equipment, the costs of labor associated
with marketing support services for a particular client, telecommunications
services costs, materials and freight charges, and directly allocable
facilities costs. Most of these costs are variable in nature. A second
component of the Company's expenses includes selling, general and
administrative ("SG&A") expenses. This expense item is comprised of labor
and other costs associated with marketing, financial, information technology
support, human resources and administrative functions that are not allocable
to specific client services, as well as bad debt expense. Bad debt expense
represents a provision for installments and rentals that will be deemed to
be uncollectible based on the Company's historical experience as well as
billing adjustments from telecommunications providers. SG&A expenses tend
to be fixed in nature, with the exception of bad debt, which is related to
revenues.
This discussion may contain certain forward-looking statements 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 reliance on a small number of major clients; risk associated with
product-based marketing support services; reliance on the telecommunications
industry; ability to continue and manage growth; the impact of the trend
toward outsourcing; dependence on labor force; risks of business
interruption and the effects of the Company's new facility; risks associated
with rapidly changing technology and the Company's conversion to new
software; risks associated with competition; dependence on key personnel;
risks associated with Year 2000 compliance; compliance with government
<PAGE>
regulation; control by management; difficulties of completing and
integrating acquisitions and other factors discussed in more detail under
"Risk Factors" in the Company's final prospectus dated May 6, 1998.
RESULTS OF OPERATIONS
The following table sets forth summary operating data, expressed as a
percentage of revenues, for the three months and nine months ended September
30, 1998 and 1997, respectively. The information below is unaudited, has
been prepared on the same basis as the annual financial statements and, in
the opinion of the Company's management, reflects all adjustments
(consisting only of normal and recurring adjustments) necessary for a fair
presentation of the information for the periods presented. Operating
results for any period are not necessarily indicative of results for any
future period.
The financial information provided below has been rounded in order to
simplify its presentation. However, the percentages below are calculated
using the detailed information contained in the financial statements.
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues, net ........................................ 100.0% 100.0% 100.0% 100.0%
Cost of revenues...................................... 78.1 74.2 74.8 77.0
Gross profit.......................................... 21.9 25.8 25.2 23.0
Selling, general and administrative expenses.......... 10.8 15.9 13.1 13.5
Operating income...................................... 10.4 9.4 11.4 8.9
Interest expense...................................... 0.3 2.2 0.7 2.1
Income before income taxes............................ 10.2% 7.1% 10.7% 6.8%
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1997
REVENUES. The Company's net revenues increased 74.2% to $35.2 million
for the three months ended September 30, 1998 from $20.2 million for
the three months ended September 30, 1997. The increase in revenue was
primarily due to a 33.4% increase in Caller ID units sold and
fulfilled to 610,000 units along with an increase in the percentage of
units sold to 62.2% of total unit volume versus 39.9% for the three
months ended September 30, 1997. This was offset by a decrease in
average per unit prices of Caller ID units. The Company's reserve for
returns and allowances increased from $1.1 million (5.6% of net
revenues) for the three months ended September 30, 1997 to $3.1
million (8.8% of net revenues) for the three months ended September 30,
1998.
COST OF REVENUES. The Company's cost of revenues increased 83.4% to
$27.5 million for the three months ended September 30, 1998 compared
to $15.0 million for the three months ended September 30, 1997. This
was primarily due to an increase in cost of equipment associated with
the increase in units sold by the Company as described above.
GROSS PROFIT. For the three months ended September 30, 1998, the
Company's gross profit increased 47.6% to $7.7 million as compared to
$5.2 million for the three months ended September 30, 1997 and gross
margin decreased to 21.9% of revenues from 25.8% of revenues,<PAGE>
respectively. The increase in gross profit was primarily due to the
increase in revenue. The decrease in gross margin was due primarily to
the increasing percentage of business derived from Southwestern Bell
and Pacific Bell where the Company does not assume the bad debt risk,
as described above. Therefore it is able to charge lower unit prices
to Southwestern Bell and Pacific Bell and, as a result, the Company
experiences lower gross margins. This is offset by lower bad debt expenses.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. SG&A expenses for the
three months ended September 30, 1998 increased 18.4% to $3.8 million
or 10.8% of revenues compared to $3.2 million or 15.9% of revenues for
the three months ended September 30, 1997. The Company's bad debt
expense, most of which is associated with sales of Caller ID and other
telecommunications equipment to BellSouth and Pacific Bell, through
July 1998, customers, was $2.1 million (6.0% of net revenues) for the
three months ended September 30, 1998 as compared to $2.0 million
(9.9% of net revenues) for the three months ended September 30, 1997.
The decrease in bad debt expense as a percentage of revenue is due
primarily to the increasing percentage of business derived from
Southwestern Bell and Pacific Bell as described above. The allowance
for doubtful accounts (inclusive of the reserve for returns and
allowances) decreased from 16.1% of gross accounts receivable at June
30, 1998 to 11.3% of gross accounts receivable at September 30, 1998,
as write-offs for the three months ended September 30, 1998 were $5.4
million and the provision and reserve for returns and allowances was
$3.8 million combined. The increase in other S,G&A expenses is due to
increased sales and marketing efforts, increased insurance and
benefits expenses and increased administrative costs to support the
Company's growth.
INTEREST EXPENSE. Interest expense decreased to $119,000 for the
three months ended September 30, 1998 from $441,000 for the three
months ended September 30, 1997. This decrease was primarily due to
repayment of a term loan from a bank and a subordinated note payable
to a shareholder and lower borrowings under the Company's line of
credit due to the Company's receipt of proceeds from the initial
public offering on May 11, 1998.
INCOME TAXES. The Company's effective tax rates for the three months
ended September 30, 1998 and 1997 were 39% and 8%, respectively. The
effective tax rates are lower than statutory rates for the three
months ended September 30, 1997 due to the amount of income
attributable to the pass-through entities involved in the combination
of the Company and related pass-through entities (the "Consolidation")
at the same time as consummation of the initial public offering, prior
to the Consolidation. As a result of the Consolidation, the Company
expects its effective tax rate in future periods to increase to
statutory levels.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1997
REVENUES. The Company's net revenues increased 39.9% to $94.1 million
for the nine months ended September 30, 1998 from $67.3 million for
the nine months ended September 30,1997. Consistent with the
quarter's results, the increase in revenue was due primarily to
increased Caller ID volume. Total Caller ID units sold and fulfilled
during the first nine months of 1998 increased 39.6% to 2.1 million
units from 1.5 million units for the first nine months of 1997. The
percentage of units sold versus fulfilled was 56.1% versus 50.4% for
the nine months ended September 30, 1998 and 1997, respectively. The
increase in unit volume was partially offset by lower per unit sales<PAGE>
prices. The growth was also partially offset by an increase in the
Company's reserve for returns and allowances from $3.4 million (5.0%
of net revenues) for the nine months ended September 30, 1997 to $8.2
million (8.7% of net revenues) for the nine months ended September 30,
1998.
COST OF REVENUES. The Company's cost of revenues increased 36.0% to
$70.5 million for the nine months September 30, 1998 compared to $51.8
million for the nine months ended September 30, 1997. This increase
was due to increased revenue volume described above.
GROSS PROFIT. For the nine months ended September 30, 1998, the
Company's gross profit increased 52.7% to $23.7 million or 25.2% of
revenues as compared to $15.5 million or 23.0% of revenues for the
nine months ended September 30, 1997. The increase in gross margin
was due primarily to improved equipment margins and lower call center
costs per order due to efforts to control labor costs and the
efficiencies associated with the increased volume and $1.6 million
inventory writedown in 1997.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. SG&A expenses for the
nine months ended September 30, 1998 were $12.3 million or 13.1% of
revenues compared to $9.1 million or 13.5% of revenues for the nine
months ended September 30, 1997. The Company's bad debt expense, most
of which was associated with sales of Caller ID and other
telecommunications equipment to BellSouth and Pacific Bell customers,
was $7.0 million (7.4% of net revenues) for the nine months ended
September 30, 1998 as compared to $5.6 million (8.3% of net revenues)
for the nine months ended September 30, 1997. The decrease in bad debt
expense as a percentage of revenue was primarily due to the Company's
new sales approach on new business where the client assumes bad debt
risk in exchange for a lower sales price. Consistent with the results
for the quarter, the increase in other SG&A expenses is due to
increased sales and marketing efforts, increased insurance and
benefits expenses and administrative costs to support the Company's
growth.
INTEREST EXPENSE. Interest expense decreased from $1,422,000 for the
nine months ended September 30, 1997 to $692,000 for the nine months
ended September 30, 1998. The decrease was primarily due to repayment
of a note payable from a bank and subordinated note payable to a
shareholder from the proceeds received from the initial public
offering and lower bank borrowings under the Company's line of credit
from the previous period ended.
INCOME TAXES. The Company's effective tax rates for the nine months
ended September 30, 1998 and 1997 were 24.8% and 0.2%, respectively.
The change from 1997 to 1998 was primarily the result of a lower level
of income attributable to the pass-through entities involved in the
Consolidation prior to the consolidation. As a result of the
Consolidation, the Company expects its effective tax rate in future
periods to increase to statutory levels.
LIQUIDITY AND CAPITAL RESOURCES
Prior to its initial public offering, the Company had funded its
operations and capital expenditures primarily through cash flow from
operations and borrowings from banks and shareholders. The Company
had cash and cash equivalents of approximately $4.1 million at
September 30, 1998. The Company maintains a $25.0 million revolving
line of credit with a bank, maturing in November 1999, which was
increased from $18.0 million in December 1997. Borrowings under the
line of credit bear interest at the Company's option at the bank's
prime rate, as adjusted from time to time, or LIBOR plus up to 225<PAGE>
basis points. At September 30, 1998, the interest rate was 7.14%. In
May 1998, the Company repaid a term loan with a bank that would have
matured in July 1999 and bore interest at 8.95% per annum, along with
a subordinated note payable to a shareholder which would have matured
in April 1999 and bore interest at a particular bank's prime rate, as
adjusted from time to time, plus 8.0% per annum, with proceeds
received from the initial public offering on May 11, 1998. At
September 30, 1998, $8.4 million was outstanding under the line of
credit.
As of September 30, 1998, the Company had entered into various
operating leases in the ordinary course of business and an operating
lease for a new distribution facility and corporate office into which
the Company moved in October 1998. As a result of the new facility
lease, rental expense will increase approximately $400,000 per year
through 2008. In addition, the Company entered into an agreement
with a related party to acquire from him by the end of 1998 all of
his interest in a subsidiary of the Company and one entity involved
in the Consolidation for an aggregate of $980,000. As a part of
the agreement, during the nine months ended September 30, 1998, the
Company acquired the interest in the entity involved in the
Consolidation for $388,000. The Company will acquire the interest in
the subsidiary in December 1998.
During the nine months ended September 30, 1998, the Company used $3.8
million in cash flow from operating activities compared to the
generation of $11.6 million in cash flow from operating activities in
the same period in 1997. The decrease in cash flow from operating
activities in 1998 was due to higher working capital requirements
resulting from increases in accounts receivable (principally
installment receivables and receivables from Pacific Bell and
Southwestern Bell) due to the increased sales volume during the first
nine months of 1998 as compared to the same period in 1997.
During the nine months ended September 30, 1998, net cash used in
investing activities was $3.6 million in 1998 as compared to $5.0
million in 1997. This decrease was primarily due to a decrease in the
number of purchases of Caller ID units for rent, partially offset by
expenditures associated with the Company's software upgrade.
During the nine months ended September 30, 1998, the net cash provided
by financing activities was $10.9 million compared to $8.2 million
used in financing activities in the same period in 1997. During the
nine months ended September 30, 1998, the Company received $26.7
million in the initial public offering completed on May 11, 1998, net
of fees associated with the initial public offering. The Company used
a portion of the proceeds to repay $4.6 million of long-term debt,
$7.5 million in distributions of undistributed earnings to
shareholders of affiliated flow through entities that were merged into
the Company in conjunction with the initial public offering, and
reduced its borrowings under the line of credit by $13.8 million.
Subsequent to the initial public offering, the Company has made
periodic borrowings against the line of credit to fund short term
working capital needs, resulting in a net decrease in borrowings on
the line of credit of $144,000 for the nine months ended September 30,
1998.
The Company estimates that its cash and financing needs through 1998
will be met by cash flows from operations, its line of credit
facility, and the net proceeds from the Initial Public Offering.
However, any increase in the Company's growth rate, shortfalls in
anticipated revenues, increases in anticipated expenses, or
significant acquisitions could have a material adverse effect on the
Company's liquidity and capital resources and would require the
Company to raise additional capital from public or private equity or<PAGE>
debt sources in order to finance operating losses, anticipated growth
and contemplated capital expenditures. If such sources of financing
are insufficient or unavailable, the Company will be required to
modify its growth and operating plans in accordance with the extent of
available funding. The Company may need to raise additional funds in
order to take advantage of unanticipated opportunities, such as
acquisitions of complementary businesses or the development of new
products, or otherwise respond to unanticipated competitive pressures.
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.
YEAR 2000 COMPLIANCE
The efficient operation of the Company's business is dependent in part
on its computer software programs and operating systems. These
programs and systems are used in inventory management, pricing, sales,
shipping and financial reporting, as well as in various administrative
functions. Recognizing the importance and need for an integrated
information systems solution, the Company has developed an
implementation plan for upgrading its systems architecture. This plan
also addresses the functionality of its systems beyond December 31,
1999 ("Year 2000 compliance") as the majority of the internal
information systems are being replaced with new systems that the
systems vendor represents will be Year 2000 compliant the cost of
which is not considered to be Year 2000 related. The Company does not
anticipate additional material expenditures for Year 2000 compliance
issues. This new systems implementation is expected to be completed
by April 30, 1999. Management believes that the remaining Company
information technology ("IT") systems and other non IT systems are
either Year 2000 compliant or will be compliant by June 30, 1999 after
applying vendor supplied patches, or upgrades to these systems. The
cost of the upgrades are not considered to be material. The Company is
in the process of obtaining documentation from its suppliers, clients,
financial institutions and others as to the status of their Year 2000
compliance programs and the possibility of any interface difficulties
relating to Year 2000 compliance that may affect the Company. To
date, no significant concerns have been identified; however, there can
be no assurance that there will not be any Year 2000-related operating
problems or expenses that will arise with the Company's computer
systems and software or in connection with the Company's interface
with the computer systems and software of its suppliers, clients,
financial institutions and others. Because such third-party systems or
software may not be Year 2000 compliant, the Company is in the process
of developing contingency plans to address Year 2000 failures of these
entities with which the Company interfaces. The Company could be
required to incur unanticipated expenses to remedy any problems, which
could have a material adverse effect on the Company's business,
results of operations and financial conditions. The Company has
received verbal confirmation and expects to receive written confirmation
that the mechanical systems in its physical facilities (elevators and
HVAC) are Year 2000 compliant.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"),
which establishes standards for reporting and presentation of
comprehensive income and its components in a full set of general
purpose financial statements. This statement was effective for
periods beginning after December 15, 1997. SFAS 130 did not have a
material impact on the Company's financial statements for any periods
presented.
<PAGE>
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and
Related Information" ("SFAS 131"), which establishes standards for the
way that public business enterprises report information about
operating segments in annual financial statements and requires that
those enterprises report selected information about operating segments
in interim financial reports issued to stockholders. It also
establishes standards for related disclosures about products and
services, geographic areas and major customers. This Statement was
effective for year-end financial statements for periods beginning
after December 15, 1997. The adoption of SFAS 131 is not expected to
have a material impact on the Company's financial statements.
<PAGE>
ITEM 3- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------------------------------------------------------------------
Not applicable.
PART II
OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
(a) 27. Financial Data Schedule
Reports on Form 8-K - There were no Form 8-K filings.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
INNOTRAC CORPORATION
(Registrant)
Date: November 9, 1998 By: /s/ Scott D. Dorfman
Scott D. Dorfman
President and Chief Executive Officer
and Chairman of the Board
Date: November 9, 1998 By: /s/ John H. Nichols III
John H. Nichols III
Vice President and Chief Financial
Officer and Secretary (Principal
Financial Officer)
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