10-K 1 t75828_10k.htm FORM 10-K t75828_10k.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-K
 
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2012
 
o
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 incorporation or organization)   (I.R.S. Employer Identification No.)
 
6465 East Johns Crossing, Johns Creek, 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: Common Stock, Par Value $.10 Per Share.
 
Name of each exchange on which registered:  The NASDAQ Capital Market.
 
Securities registered pursuant to Section 12(g) of the Act:  None
 
Indicate by a check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes    o             No    x
 
Indicate by a check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.
Yes    o             No    x
 
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    o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  
Yes    x             No   o
 
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.  x
 
Indicate by a check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
  Large accelerated filer  o Accelerated filer  o
  Non-accelerated filer  o (Do not check if a smaller reporting company) Smaller reporting company  x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes    o             No    x
 
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, and their affiliates) of the Registrant as of June 30, 2012, the last business day of the Registrant’s most recently completed second fiscal quarter was $3,321,751 based on the closing sale price of the Common Stock as reported by the NASDAQ Capital Market on such date.  See Item 12.
 
At March 22, 2013, there were 13,070,440 shares of Common Stock, par value $0.10 per share, outstanding, which includes 735,637 restricted shares.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the Registrant’s Proxy Statement for the 2013 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 Annual Report on Form 10-K for the year ended December 31, 2012.
 
 
 

 
 
INNOTRAC CORPORATION
 TABLE OF CONTENTS
       
     
Page
       
PART I
   
2
ITEM 1.
BUSINESS
 
2
 
CERTAIN FACTORS AFFECTING FORWARD-LOOKING STATEMENTS
 
7
 
EXECUTIVE OFFICERS OF THE REGISTRANT
 
7
ITEM 1A.
RISK FACTORS
 
8
ITEM 1B.
UNRESOLVED STAFF COMMENTS
 
10
ITEM 2.
PROPERTIES
 
11
ITEM 3.
LEGAL PROCEEDINGS
 
12
       
PART II
   
13
ITEM 5.
MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
13
ITEM 6.
SELECTED FINANCIAL DATA
 
13
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
13
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
23
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
24
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
43
ITEM 9A.
CONTROLS AND PROCEDURES
 
43
ITEM 9B.
OTHER INFORMATION
 
43
       
PART III
   
44
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
 
44
ITEM 11.
EXECUTIVE COMPENSATION
 
44
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 
44
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
 
44
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
 
44
       
PART IV
   
45
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
 
45

 
 

 
 
PART I
 
ITEM 1.   BUSINESS
 
Innotrac Corporation (“Innotrac” or the “Company”), founded in 1984 and headquartered in Atlanta, Georgia, is an e-commerce provider integrating digital technology, order processing, fulfillment and customer support “contact” center services to support global brands of large corporations that outsource these functions.  In order to perform these functions in-house, a company may be required to develop expensive, labor-intensive infrastructures, which may divert its resources and management’s focus from its 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 our clients’ orders either through inbound contact center services, electronic data interchange (“EDI”) or the internet.  On a same day basis, depending on product availability, the Company picks, packs, verifies and ships the item, tracks inventory levels through an automated, integrated perpetual inventory system, warehouses data and handles customer support inquiries.  Our fulfillment and customer support services interrelate and are sold as a package, however they are individually priced.  Our clients may utilize our fulfillment services, our customer support services, or both, depending on their individual needs.
 
Innotrac’s core competencies include:
 
      Fulfillment Services:
 
 
sophisticated warehouse management technology
 
automated shipping solutions
 
real-time inventory tracking and order status
 
purchasing and inventory management
 
channel development
 
zone skipping and freight optimization modeling for shipment cost reduction
 
product sourcing and procurement
 
packaging solutions
 
back-order management
 
returns management
 
eCommerce consulting and integration
 
      Contact Center Services:
 
 
inbound customer support services
 
technical support and order status
 
returns and refunds processing
 
call center integrated into fulfillment platform
 
cross-sell/up-sell services
 
collaborative chat
 
intuitive e-mail response
 
The Company provides a variety of services for a significant number of eCommerce, retail, and direct marketing companies such as Target.com, a division of Target Corporation, Ann Taylor Retail, Inc.,  Microsoft, AT&T, Qwest, Beachbody, LLC and Thane International.  We take orders for our eCommerce, retail and direct marketing clients via the internet, through customer service representatives at our Pueblo, Colorado call center or through direct electronic transmissions from our clients.  The orders are processed through one of our order management systems and then transmitted to one of our eight fulfillment centers located across the country, and are shipped to the end consumer or retail store locations, as applicable, typically within 24 hours of when the order is received.  Inventory is held on a consignment basis, with certain exceptions, and includes items such as clothing, brand name promotional accessories, books, electronics, small appliances, home accessories, sporting goods and toys.
 
 
2

 
 
The following table sets forth the percentage of service revenues generated by the Company’s various customer business verticals during 2012 and 2011:
 
   
2012
   
2011
 
eCommerce/Direct to Consumer
    76.6 %     67.2 %
Direct Marketing
    13.7       18.1  
B2B & Telecommunications
    9.7       14.7  
      100.0 %     100.0 %
 
Note: 
The above table is compiled by presenting the total of any individual client in a single Business Line/Vertical consistently in the years 2012 and 2011 based on the predominant category of the client’s revenues for the year ended 2012.
 
 
The Company is a major provider of fulfillment and customer support services to eCommerce/Direct to Consumer and Direct Marketing industries.  For eCommerce and Direct to Consumer businesses, we provide complete integration capabilities between a client’s order entry systems, internet shopping carts, PCI Level 1 compliant credit card processors and product supply sources.  Our warehouse management systems provide real time reporting on order fulfillment, stock availability and freight carrier shipment tracking to the end consumer. Our technology integration strategy provides the ability to quickly develop client specific gateways between the major providers of website design hosting services while providing EDI reporting to client based management systems.
 
Since 2011, Innotrac Europe GmbH, a joint venture with PVS Fulfillment-Services GmbH, has offered end to end fulfillment services in Europe.  Innotrac Europe provides a fast to market solution to our United States based clients who want to enter the European market.  Additionally, eCommerce and retailers in Europe have easy visibility to Innotrac’s capabilities through on the ground marketing and business development efforts employed by Innotrac Europe.
 
The Company also provides services, including customer and distributor communication programs, retailer product rework/finishing services and supplier/retailer compliance reporting for business-to-business (“B2B”) clients including NAPA, The Walt Disney Company, and Spanx.  The Company has historically been a major provider of fulfillment and customer support services to the telecommunications industry.  Consolidation in the industry at the product supply level and changes in the technology of delivery mediums used by the telecommunications industry since 2000 has resulted in a lesser concentration of our service revenues from this industry.  Accordingly, we now present our service revenue by customer vertical information with B2B services and telecommunications as a single segment.
 
With facilities in Atlanta, Georgia, Pueblo, Colorado, Reno, Nevada, Bolingbrook, Illinois, Columbus, Ohio, two facilities in Hebron, Kentucky and a facility in Groveport, Ohio, we offer a national footprint to our customers.  We are committed to deeper penetration within our existing business lines and continued diversification of our client base.  Our long-term goal is to focus on current market growth trends while spreading our business across a higher number of clients in diverse industries to provide stability during difficult economic periods and avoid the risks associated with high individual account concentration and seasonality. We will continue to seek new clients and may open additional facilities as needed to service our customers’ business needs.
 
 
3

 
 
Fulfillment Services
 
Providing effective turnkey order 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, shoes, clothing, electronic equipment, accessories, books, small appliances, home accessories, sporting goods and toys for our clients.  We use several custom-designed, semi-automated packaging and labeling lines to pack and ship products as well as highly automated and conveyorized systems utilizing radio frequency (“RF”) scanning. 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.  Recognizing the importance of the total eCommerce buying experience to our customers, our SmartHub market surveys capture the competitive differences between eCommerce transactions tracking the start of order entry by the end consumer through speed and quality of shipment and ultimately the return process.  Innotrac’s accuracy and speed of order processing is compared against same product category performance for our customers on an ongoing basis.
 
Our operating locations have earned ISO 9001:2000 certification as follows: Atlanta in 2002 and again in 2010 after moving our fulfillment operations to a different facility, our first Hebron, Kentucky location in 2003, Pueblo in 2004, Chicago in 2005, Reno in 2006, our second Hebron, Kentucky location in 2008, and our Columbus location in 2009.   All of our facilities other than Groveport, which was recently opened and scheduled for certification in -September of 2013, were re-certified to the ISO 9001-2008 revision of the standard in 2011.  It is our intention to renew our current certificate upon its renewal date of December 20, 2014.  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 verify 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 2012 order accuracy rate was 99.25%.
 
Inventory Management.  An integral part of our fulfillment services is the monitoring and control of our clients’ inventories.  We provide automated inventory management and reporting to assure real-time stock counts of our 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.
 
 
4

 
 
Contact Center Services
 
Another of our core competencies is providing customer order and inquiry support services – Contact Center Services.  We believe these services are critical to a comprehensive order processing and order fulfillment solution.  Our Contact Center Services are described below.
 
Inbound Customer Support 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 various products for our clients when end consumers call our customer service representatives.  Depending on our client’s requirements, our customer service representatives use our internally developed customer relationship management system or through integrated technology portals, access client directed customer relationship information systems.  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 or an Innotrac customer service representative.  If the caller is placing an order, the caller is 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 answers the call using our client’s name and is specially trained in the applicable client’s business and products.  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 based on a Webmethods core written in Java over an Oracle database, which contains a complete web interface using XML-based Advanced Programming Interface tools that allows clients to transact with us electronically.  We deploy the solution running on HP enterprise class servers in a virtualized configuration running behind F-5 load balancers. Virtualization provides systems redundancy as well as rapid scalability.  Oracle RAC (Redundant Application Cluster) is used for OLTP (Online Transaction Procession) and business intelligence databases.  NetApp SAN (Storage Area Network) provides rapid access to data and the ability to scale data storage quickly depending on business demands.  Network topology is a meshed MPLS (Multi Protocol Label Switching) architecture for primary data connectivity and DIA internet circuits utilizing VPN tunnels for secondary data access.  Our burstable bandwidth allows us to quickly increase network bandwidth capacity.
 
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 real-time XML, direct system integration, EDI, secure FTP and internet access.  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 based on the clients preferred technology.  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 primarily utilize the WMOS system from Manhattan Associates as our warehouse management system.  We use an internally-developed customized order management system (“OMS”) for clients at our various facilities.  WMOS is an advanced fulfillment warehouse management system designed to support large volumes of transactions and users, which enables the effective management of high levels of throughput, from receiving through shipping.  WMOS provides efficiencies in inventory management, outbound distribution and task management. Innotrac also offers a fully integrated direct marketing solution with a customized warehouse management system, front-end customer relationship management capabilities and a robust integration layer.  Innotrac is also integrated with all the major ecommerce platforms such as Micros Retail, DemandWare, ATG and Magento.  All of Innotrac’s solutions are PCI / DSS Level 1 compliant.
 
 
5

 
 
We believe that our use of different systems for different types of clients and products allows us to effectively and efficiently manage our warehouse operations to secure a competitive advantage in the fulfillment industry.
 
Our Pueblo call center utilizes the Aspect Rockwell Spectrum Automatic Call Distributor, or ACD, switch to handle call management functions.  The ACD system has the capacity to handle 1,200 call center representatives and as of December 31, 2012 was supporting a capacity ranging from 200 to 450 representatives depending on our clients requirements.  Additionally, the ACD system is integrated with workforce management software designed to enable management to staff and supervise the call center based on call length and call volume.  Aspect’s AQM application is used for call monitoring and quality management.  Customer service representatives enter orders received via telephone into our proprietary CRM application which is integrated with our order management and warehouse management systems.  These orders are processed “real time” into one of our eight distribution centers.
 
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 contact center operations is critical to our ability to provide high quality fulfillment and customer support services.  Contact 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, 2013, we had approximately 1,450 full-time employees supported by temporary 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 we do 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
 
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 we do 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.
 
We work closely with our clients, companies we outsource outbound teleservices to and their respective advisors to ensure that we and our clients are in compliance with these regulations.  We cannot predict whether the status of the regulation of outbound telephone services or e-commerce will change and what effect, if any, this change would have on us or our industry.
 
 
6

 
 
As part of our fulfillment services, we maintain custody of, pack and manifest products, some of which are subject to Hazardous Material Handling regulations.  Our employees are trained and tested using our internal quality control systems in order to comply with regulations of the Department of Transportation and Federal Aviation Administration.
 
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.  In late 2011 we received a registration certificate from the United States Patent and Trademark Office for the service mark “SmartHub” which we use to promote our freight optimization services for our clients.  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, whether Innotrac will succeed in growing its existing client base and developing new business while achieving our revenue and margin forecasts and effectively managing capacity in our facilities.  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 under Item 1A “Risk Factors.”  Those are representative of factors that could affect the outcome of the forward-looking statements.  These and the other factors discussed elsewhere in this document are not necessarily all of the important factors that could cause our results to differ materially from those expressed in our forward-looking statements.  Forward-looking statements speak only as of the date they are made and we undertake no obligation to update them.
 
EXECUTIVE OFFICERS OF THE REGISTRANT
 
The executive officers of Innotrac are as follows:
 
Name
 
Age
 
Position
         
Scott D. Dorfman
 
55
 
Chairman of the Board, President and Chief Executive Officer
         
Larry C. Hanger 
 
58
 
Senior Vice President—Client Services
         
    Robert J. Toner
 
49
 
Senior Vice President—Chief Operating Officer
         
    Stephen G. Keaveney 
 
48
 
Chief Financial Officer and Corporate Secretary
         
    Edgar L. Ringer 
 
57
 
Senior Vice President—Chief Information Officer
         
    Christine A. Herren 
 
41
 
Chief Accounting Officer, Senior Director and Corporate Controller
 
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.
 
 
7

 
 
Mr. Hanger joined Innotrac in 1994 and currently serves as Senior Vice President-Client Services.  He served as a Director from December 1997 through February 2004.  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 and currently serves as Senior Vice PresidentChief Operating Officer. He held the position of Senior Vice President—Logistics from June 2001 until February 2010.  Prior to joining Innotrac, Mr. Toner developed 16 years of distribution, logistics, and transportation experience; 14 of those years were with McMaster-Carr Supply Company, a distributor of industrial supplies. Subsequent to McMaster-Carr, Mr. Toner was the General Manager for East Coast Operations for Webvan Group Inc., an Internet retailer.
 
 
Mr. Keaveney joined Innotrac in March 2013 and currently serves as Chief Financial Officer and Corporate Secretary.  Prior to joining Innotrac, Mr. Keaveney served as the Chief Financial Officer of BeavEx, a national logistics company, a position he had held since September 2010. From January through December 2010, Mr. Keaveney served as Chief Financial Officer of Dutch Gold Resources, a publicly traded gold exploration business. From 2006 through 2009 Mr. Keaveney served as the Chief Financial Officer of Redquartz Developments/Flint Telecom, a private family fund with a diverse portfolio of investments in the real estate, technology and health care industries.
 
 
Mr. Ringer joined Innotrac in 2012 and currently serves as Chief Information Officer. Mr. Ringer most recently served as Chief Information Officer at Metadigm Services and prior to that he served as Vice President of IT at National Envelope Company, Division President at National Linen and Uniform Service, and CIO of National Service Industries.
 
Ms. Herren has been with Innotrac since 1991 and currently serves as the Chief Accounting Officer and Corporate Controller.  She also served as the company’s interim Chief Accounting Officer from January, 2005 through May, 2007.  Prior to being promoted to the Corporate Controller position in November 2002, she held the Assistant Corporate Controller position from March 2000 to November 2002 and the General Accounting Manager position from March 1998 to March 2000. Ms. Herren is a certified public accountant.
 
ITEM 1A.  RISK FACTORS
 
We have a large investment in fulfillment and computer technology equipment as well as long term building leases.  A severe or prolonged economic downturn affecting our customers’ unit volume sales could negatively impact our operating results.
 
Innotrac provides sufficient capacity in its fulfillment operations and electronic data processing systems to allow new clients to be developed, support growth in our existing customers’ business and service all customers during seasonal volume increases.  The investment in that capacity can result in an underutilization in our invested assets during a significant or prolonged economic downturn.  We lease our buildings with lease terms long enough to secure competitive lease rates, but which expose us to the term of the real property leases limiting our flexibility to reduce fixed capacity for periods of economic downturns.  We service varied client business lines and industry verticals which provide some level of protection for such downturns.  Our ability to maintain or achieve improved operating results could be partially effected by a significant multi-vertical economic downtown or the speed and strength of recovery from an economic downturn.
 
 
8

 
 
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, or if we experience unanticipated costs implementing systems and ramping up our services for new clients, 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.  Our ten largest clients accounted for 76.9% of our revenue in 2012.  If we lose one or more of our largest clients, or if revenues from our largest clients decline, 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 guarantee that we will be able to replace or supplement that client with others that generate comparable revenues or profits.  Although we believe growth of our existing client base, improvement in the economic climate and continued productivity improvement would partially offset the impact of losing a large client, our future operating results would rely heavily on our ability to sell new business.  Such projected new business may not develop and the future loss of any other large account could adversely affect our future results.
 
Noncompliance with any of the covenants under our revolving Credit Facility would allow our lender to declare any outstanding amounts to be immediately due and payable.
 
Our Credit Facility contains financial, change of ownership control and other restrictive covenants.  Noncompliance with any of the covenants would allow the lender to declare any outstanding borrowed amounts to be immediately due and payable.  From time to time in the past, we have violated various restrictive covenants, and have been obligated to obtain waivers or amendments from the lender.  We were in compliance with all financial covenants and other reporting requirements of the Credit Facility as of December 31, 2012 and February 28, 2013.  If our operating results in the future result in our inability to comply with the existing covenants and we were unable to obtain an amendment, our credit ratings could be negatively affected impairing our ability to finance our operations which could have a material adverse effect on our financial performance and condition.  The term of our Credit Facility matures on June 30, 2013.  We are in discussions with several banks including our existing bank to renew the line.  We are confident that a renewal of the facility will occur, but if we are unable to negotiate a renewal, our ability to finance our operations would be impaired which could have a material adverse effect on our financial performance and condition.
 
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.  Furthermore, we are contractually bound to our facility leases until their terms expire.  If a client terminates its contract suddenly, we may still have obligations under our leases.
 
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.
 
 
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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 future in order to meet our clients’ needs and maintain competitiveness.  Our Reno system, which provides service to several of our clients, is completely customized and therefore not supported by third party providers.  We are heavily reliant on a small number of developers.  If these developers leave, it could materially adversely affect our business.  We provide details about our technology in “Business - Technology” in Item 1.
 
Our industry is extremely competitive resulting in downward pressure on our pricing.  If we cannot continue to improve our operating efficiencies, our business could be materially adversely affected.
 
Although we continually work to improve our operating efficiencies and control selling general and administrative costs, there continue to be competitive pressures on pricing in the industry.  These pressures could affect our ability to retain current customers and attract new business.  If we fail to offset pricing pressures with reductions in operating costs, our business could be materially adversely affected.
 
Our common stock lacks liquidity and is held by a small number of investors, one of which is in receivership where its creditors would like to sell our shares as soon as possible.
 
As of December 31, 2012, Innotrac officers and directors owned approximately 48.2% of the outstanding common stock and an institutional shareholder, IPOF Fund, L.P., and its affiliates held approximately 32.9%.  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 or their position, our common stock price would likely decline materially.
 
The United States District Court in Cleveland, Ohio has appointed a receiver to identify and administer the assets of the IPOF Fund, L.P. and its general partner, Mr. David Dadante.  Based on information from the receiver, the Company understands that the Fund and Mr. Dadante own 4,321,777 shares of common stock of the Company, representing approximately 32.9% of the total shares outstanding, all of which are held as collateral in margin accounts maintained at several financial institutions.  The Federal Court has indefinitely restricted the financial institutions holding Company stock owned by the IPOF Fund and Mr. Dadante in margin accounts from selling any of these shares.  The court has permitted open market sales by the receiver as he may in his sole discretion determine to be consistent with his duty to maximize the value of the assets of IPOF Fund, and as warranted by market conditions.  The receiver has indicated to the Company that he does not intend to direct any open market sales except in circumstances in which he believes that there would be no material adverse impact on the market price for the Company’s shares.  Nevertheless, as long as these shares are held in margin accounts where the lenders desire to liquidate the positions, there will be significant downward pressure on the market price of our common stock because the market is concerned that these shares may be sold in a manner that causes the price of our common stock to decline precipitously.  This concern is ameliorated to some degree by the prohibition by the Federal Court for an indefinite period on sales of our shares by financial institutions that hold the shares in margin accounts.  The Company has engaged in discussions from time to time with the receiver in an effort to cause the shares to be sold in a manner that causes as little disruption to the market for Company stock as possible.  If the Federal Court were to not continue this prohibition before the shares have been sold in such a transaction, then the financial institutions might foreclose on some or all of these shares and sell them into the market, which could have an extremely negative impact on the market price for our common stock.
 
ITEM 1B.  UNRESOLVED STAFF COMMENTS
 
As a smaller reporting company, as defined in Rule 12b-2 of the Securities Exchange Act of 1934 (the “Exchange Act”), we are not required to provide the information required by this item.
 
 
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ITEM 2. PROPERTIES
 
Currently, the Company leases all of its facilities.  The Company’s corporate headquarters is located in Johns Creek, Georgia, a suburb of Atlanta.  The office lease includes 25,000 square feet and expires on March 31, 2015.
 
Innotrac leases a warehouse and fulfillment center located in Lawrenceville, Georgia consisting of 200,000 square feet.  The Lawrenceville facility lease expires on January 31, 2016.
 
Our Pueblo, Colorado facility consists of approximately 87,000 square feet of floor space with a lease term expiring on November 30, 2014 with a right to renew until November 30, 2019.  Approximately 45,000 square feet are used as a contact center, as well as quality assurance, administrative, training and management space.  This call center can support 450 workstations of which we utilized over 200 during seasonal activity in November and December 2012.  It currently operates from 6:00 am MT to 10:00 pm MT seven days per week.  The remaining 40,000 square feet are used for fulfillment services.
 
We operate a facility in Reno, Nevada that consists of over 280,000 square feet including a 250,000 square foot fulfillment center, 15,000 square feet of administrative office space and an additional 15,000 square feet of space which previously supported a 200 workstation contact center.  The existing lease expires on February 29, 2016 with a right to renew for an additional 3 years through February 28, 2019.
 
We operate a 354,000 square foot facility in Bolingbrook, Illinois.  This facility is used exclusively for fulfillment services and contains approximately 40,000 square feet of administrative office space with a lease expiration date of December 31, 2013 and a right to renew until December 31, 2016.
 
We operate a facility in Hebron, Kentucky that currently consists of approximately 396,000 square feet of fulfillment and warehouse space.  Approximately 40,000 square feet of this facility are used for multiple clients with the remainder used for a single large client.  The current lease for this building expires in February 2015 with a right to renew for 3 additional years.
 
In December 2005, we entered into a multiple year lease of a new building with an expiration date of June 30, 2011 for a second facility in Hebron, Kentucky.  This facility provides approximately 650,000 square feet of fulfillment and warehouse space for our Target.com operations, which began in the second quarter of 2006. In March 2011, we signed an amendment extending the lease term through December 31, 2016 at a reduced rate.
 
We operate a 394,000 square foot facility in Columbus, Ohio which provides 377,000 square feet of fulfillment and warehouse space for multiple customers and 17,000 square feet of office space.  In June 2011, we signed an amendment extending the lease term through September 30, 2014 at a reduced rate.
 
On February 29, 2012, we entered into a seven year lease with two five year renewal options for a 434,120 square foot facility in Groveport, Ohio which will be used for fulfillment services.  The building was leased in portions with 200,000 square feet leased through April 30, 2013, 317,060 square feet leased from May 1, 2013 to October 31, 2013 and the entire 434,120 square feet leased from November 1, 2013 through expiration.  The Company leased the building to provide space for recently signed fulfillment customers and to add capacity for future business.
 
 
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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.    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.
 
In 2006 and 2007, certain investors in the IPOF Fund asserted claims against the Company and/or certain of its officers and directors in separate litigation actions.  These actions are captioned Small, et al. v. Regalbuto, et al., which asserts claims against the Company, and Amantea, et al. v. Innotrac, Inc., et al. (the court docket in the Amantea action misidentifies the Company as “Innotrac, Inc.”), which asserts claims against the Company and certain current and former officers and directors of the Company, both in the United States District Court for the Northern District of Ohio.  The matters were stayed by that court shortly after they were filed.  In an order entered October 6, 2010, the Court dismissed the Small, et al. v Regalbuto, et al. action, without prejudice, subject to being reopened upon written motion to the Court.  In an order entered November 4, 2010, the Court dismissed the Amantea, et al. v. Innotrac, Inc., et al. action, without prejudice, subject to being reopened upon written motion to the Court.  The Court took this action because the case had been stayed for nearly three years.  The Company believes the claims are without merit and would vigorously defend against these claims if they were re-filed.
 
 
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PART II
 
ITEM 5.
MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
The Company’s Common Stock trades on the NASDAQ Capital Market under the symbol “INOC”.  On June 15, 2010, the Company began trading on the NASDAQ Capital Market following a listing change from the NASDAQ Global Market.  This change in the specific market of NASDAQ was achieved with no interruption in active listing of the Company’s common stock.  The following table sets forth for the periods indicated the high and low sales prices of the Common Stock on the NASDAQ Global and Capital Markets.
 
   
High
   
Low
 
2012
           
   First Quarter
  $ 1.35     $ 0.95  
   Second Quarter
  $ 1.43     $ 1.18  
   Third Quarter
  $ 2.60     $ 1.38  
   Fourth Quarter
  $ 3.60     $ 1.75  
   Fiscal Year Ended December 31, 2012
  $ 3.60     $ 0.95  
2011
               
   First Quarter
  $ 1.62     $ 1.28  
   Second Quarter
  $ 1.93     $ 1.27  
   Third Quarter
  $ 1.59     $ 1.02  
   Fourth Quarter
  $ 1.40     $ 0.92  
   Fiscal Year Ended December 31, 2011
  $ 1.93     $ 0.92  
 
The approximate number of holders of record of Common Stock as of March 23, 2013 was 65. The approximate number of beneficial holders of our Common Stock as of that date was approximately 800.
 
The Company has never declared cash dividends on the Common Stock.  The Company 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 6. SELECTED FINANCIAL DATA
 
As a smaller reporting company, as defined in Rule 12b-2 of the Securities Exchange Act of 1934 (the “Exchange Act”), we are not required to provide the information required by this item.
 
ITEM 7.
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 recent 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 in “Item 1A – Risk Factors” of this Annual Report on Form 10-K.
 
 
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Overview
 
Innotrac, founded in 1984 and headquartered in Atlanta, Georgia, is an e-commerce provider integrating digital technology, order processing, fulfillment and customer support contact center services to support global brands of large corporations that outsource these functions. The Company employs sophisticated order processing and warehouse management technology and operates eight fulfillment centers and one call center in seven cities spanning all time zones across the continental United States.
 
Prior to 2000, the Company was primarily focused on the telecommunications industry, with over 90% of its revenues being derived through this vertical.  Today, the Company primarily serves three 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 past several years.  We classify those industry verticals as i) eCommerce/Direct to Consumer, ii) Direct Marketing, and iii) Business to Business and telecommunications.
 
During 2012, the company’s new business development accelerated with the addition of 10 new clients actively serviced during the year.  We have expected launch dates in 2013 for serveral clients committed to using Innotrac, and we are actively pursuing other prospects.  Additionally, some of our larger clients experienced an increase in volume in 2012 compared to 2011 and have indicated an expectation of continued volume growth in 2013.
 
Our business has a long selling cycle.  As a result of this selling cycle, new customers who committed to use Innotrac in late 2012 and early 2013 project service to begin in the late 2nd and 3rd quarter of 2013.  We experienced a growth of 25% in service revenues in 2012 compared to 2011.  
 
Innotrac has more than twenty-seven years of experience as a provider of fulfillment services and recognizes the importance of maintaining sufficient capacity to support our clients’ seasonal needs as well as allow us to grow with new clients.  With no outstanding advances on our Credit Facility at December 31, 2012, we have the liquidity to increase our capacity as needed and to continue to invest in our business development activities in 2013.
 
Macro-Economic Factors
 
During 2012, the United States economy stabilized and grew slightly following a three year negative cycle.  eCommerce activity increased at a greater rate than the general economy and is expected to continue to grow in 2013, providing the potential opportunity for growth in our core business in the coming year.
 
We are continuing to monitor the economic trends and business experience of our customers and closely manage our operating costs which vary with volume.  Additionally, we believe our mix of multiple customer industries provides some protection from the impact of the downturn as the economy recovers.  However, as discussed in Item 1A “Risk Factors” of this Annual Report on Form 10-K our results can be negatively affected depending on the severity or concentration by industry of a renewed downturn.
 
Business Mix
 
The following table sets forth the percentage of revenues generated by the Company’s various business lines during 2012 and 2011:
 
Business Line/Vertical (1)
 
2012
   
2011
 
eCommerce/Direct to Consumer
    76.6 %     67.2 %
Direct Marketing
    13.7       18.1  
B2B & Telecommunications
    9.7       14.7  
      100.0 %     100.0 %
 
 
(1)
The above table is compiled by presenting the total of any individual client in a single Business Line/Vertical consistently in the years 2012 and 2011 based on the predominant category of the client’s revenues for the year ended 2012.
 
 
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eCommerce/Direct-to-Consumer and Direct Marketing.  The Company provides a variety of services for a significant number of eCommerce, retail, and direct marketing clients which include such companies as Target.com, a division of Target Corporation, Ann Taylor Retail, Inc., Microsoft, Inc., Beachbody, LLC and Thane International.  Our revenues are a result of the number of orders and customer service calls received. Our client contracts generally do not guarantee volumes.  The percentage of our revenues attributable to our eCommerce and retail clients increased during 2012 as compared to 2011 as a result of the growth in their reported revenue during the same period having increased greater than our other client categories.  We expect this trend to continue as we anticipate more opportunities for new business in this line and expect a higher level of organic growth than our other consumer categories.
 
Business to Business (B2B) and Telecomunications.  The Company also provides services including customer and distributor communication programs, retailer product rework/finishing services and supplier/retailer compliance reporting for business-to-business (“B2B”) clients including NAPA, The Walt Disney Company, and Spanx.  The Company has historically been a major provider of fulfillment and customer support services to the telecommunications industry.  Consolidation in the industry at the product supply level and changes in the technology of delivery mediums used by the telecommunications industry since 2000 has resulted in a lesser concentration of our service revenues from this industry.  Accordingly, we now present our service revenue by customer vertical information with B2B services and telecommunications as a single segment.
 
Results of Operations
 
The following tables set forth summary operating data, expressed as dollars and a percentage of revenues, for the years ended December 31, 2012 and 2011.  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.
 
   
Thousands of Dollars
Year Ended December 31,
 
    2012     2011  
Service revenues
  $ 94,006     $ 74,943  
Freight revenues
    13,688       9,741  
   Total revenues
    107,694       84,684  
Cost of service revenues
    47,113       36,211  
Freight expense
    13,150       9,642  
Selling, general and administrative
    39,966       36,802  
Depreciation and amortization
    3,699       3,380  
   Operating income (loss)
    3,766       (1,381 )
Other expense
    291       189  
   Income (loss) before taxes and noncontrolling interest in net loss
    3,475       (1,540 )
Income tax  (provision) benefit
    -       -  
Noncontrolling interest in net loss
    1       2  
   Net income (loss) attributable to Innotrac
  $ 3,476     $ (1,538 )
 
 
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Percent of Total Revenues
 
   
Year Ended December 31,
 
   
2012
   
2011
 
Service revenues
    87.3 %     88.5 %
Freight revenues
    12.7       11.5  
   Total revenues
    100.0       100.0  
Cost of service revenues
    43.8       42.7  
Freight expense
    12.2       11.4  
Selling, general and administrative
    37.1       43.5  
Depreciation and amortization
    3.4       4.0  
   Operating income (loss)
    3.5       (1.6 )
Other expense
    0.3       0.2  
   Income (loss) before taxes and noncontrolling interest in net loss
    3.2       (1.8 )
Income tax  (provision) benefit
    -       -  
Noncontrolling interest in net loss
    -       -  
   Net income (loss) attributable to Innotrac
    3.2 %     (1.8 )%
 
Service revenues. The Company’s service revenues increased 25.4% to $94.0 million for the year ended December 31, 2012 from $74.9 million for the year ended December 31, 2011. The $19.1 million increase in service revenues is primarily attributable to:
 
(i)
a $21.0 million increase in our eCommerce vertical primarily due to the addition of several new clients and increased volumes from existing clients,
 
(ii)
a $200,000 increase in revenues from our direct marketing vertical due to the addition of a new clients, offset by
 
(iii)
a $2.1 million decrease in revenues from our B2B and telecommunications clients due to a decrease in volumes.
 
Freight Revenues. The Company’s freight revenues increased $3.9 million or 40.5% to $13.7 million for the year ended December 31, 2012 from $9.7 million for the year ended December 31, 2011. The increase in freight revenues is primarily attributable to the addition of new eCommerce clients.  Changes between reporting periods in freight revenue do not have a material impact on our operating profitability due to pricing practices for direct freight costs.
 
Cost of Service Revenues.  The Company’s cost of service revenues, which include labor costs for the fulfillment and contact centers, telephone minute fees and packaging material costs, increased $10.9 million or 30.1% to $47.1 million for the year ended December 31, 2012 compared to $36.2 million for the year ended December 31, 2011.  Cost of service revenues as a percent of service revenues increased to 50.1% from 48.3% for the years ended December 31, 2012 and 2011, respectively.  The $10.9 million increase in cost of service revenues was primarily due to the combined effect of a change in the mix of revenues by client and new customer activity using a higher percentage of temporary labor.
 
Freight Expense.  The Company’s freight expense increased $3.5 million or 36.4% to $13.2 million for the year ended December 31, 2012 compared to $9.6 million for the year ended December 31, 2011 due to the increase in corresponding freight revenue as discussed above.
 
Selling, General and Administrative Expenses.  S, G & A expenses, which include facility and equipment costs, sales and marketing expenses, account services and information technology costs, management salaries and legal and accounting fees, increased $3.2 million or 8.6% to $40.0 million or 37.1% of revenues for the year ended December 31, 2012 compared to $36.8 million or 43.5 % of revenues for the year ended December 31, 2011.  The $3.2 million increase in expenses in 2012 as compared to 2011 was primarily attributable to a i) a $1.1 million increase in facility and facility management costs due to the addition of a new facility in Ohio and facility management to support several new clients; ii.) a $379,000 increase in information technology costs due to costs related to new client implementations; and iii) a net increase in all other SG&A costs of $1.7 million which includes increased sales commissions related to new clients and adjustments to the Company’s worker’s compensation claims reserve.   SG&A expenses as a percentage of total revenue decreased due to the growth in service revenue outpacing the increases in supporting SG&A expenses.
 
 
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Depreciation and Amortization Expenses.   Depreciation and amortization expense increased to $3.7 million for the year ended December 31, 2012 from $3.4 million for the year ended December 31, 2011.  The increase in depreciation was due to $3.3 million expenditures supporting the opening of our Groveport, Ohio facility in May 2012 and $2.0 million in other asset additions across all facilities.
 
Income Taxes.  The Company’s effective tax rate for the years ended 2012 and 2011 was 0%.  A valuation allowance continues to be recorded against the Company’s net deferred tax assets as historical losses have created uncertainty about the realization of tax benefits in future years.  Income taxes associated with the income in the year ended December 31, 2012 and the loss from the year ended December 31, 2011 were offset by a corresponding decrease or increase respectively of the valuation allowance resulting in an effective tax rate of 0% for the years ended December 31, 2012 and December 31, 2011.  The existence of a net operating loss carryforward at December 31, 2012 means that income taxes associated with any potential taxable earnings for the year ended December 31, 2013 will be offset by a corresponding decrease of this valuation allowance, resulting in an expected effective tax rate of 0% for the year ended December 31, 2013 as well.
 
Liquidity and Capital Resources
 
Liquidity.  The Company funds its operations and capital expenditures primarily through cash flow from operations and borrowings under a revolving credit facility (the “Credit Facility”) with Wells Fargo Bank, N.A. (the “Bank”).
 
The Company had cash and cash equivalents of approximately $4.0 million at December 31, 2012 and $3.3 million at December 31, 2011.  Additionally, at both December 31, 2012 and 2011, the Company had no borrowings under its Credit Facility.
 
During the year ended December 31, 2012, the Company generated $4.9 million in cash flow from operating activities compared to generating $5.7 million cash from operating activities in the year ended December 31, 2011.  The $881,000 decrease was primarily the result of the net change in all operating assets and liabilities using $2.5 million of cash for the year ended December 31, 2012 compared to providing $3.8 million during the same period in 2011, offset by the Company generating a net income of $3.5 million for the year ended December 31, 2012 compared to generating a net loss of $1.5 million in the same period in 2011.  The $6.3 million decrease in cash provided by operating assets and liabilities for the year ended December 31, 2012 compared to 2011 resulted mainly from the combined effect of i) $4.5 million decrease in cash provided by accounts receivable for the year ended December 31, 2012 compared to the same period in 2011 due to higher growth in revenue during 2012 compared to revenue growth in 2011, ii) $2.9 million greater decreases in inventory occurring in 2011 than in 2012 as a result of the end of an inventory buyback program in 2011 for a single client discussed below, and iii.) $710,000 greater decrease in long-term liabilities related to the impact of straight lining rent expense for our facilities and prepaid maintenance items, offset by a $2.0 million decrease in cash used in accounts payable and accrued expenses in 2012 compared to 2011.  The $2.0 million decrease in cash used for accounts payable and accrued expenses was primarily due to an overall increase in vendor payables balance outstanding as of December 31, 2012 due to an increase in temporary employees and amounts due other suppliers to support the increased volume in 2012.
 
We purchase inventory for two customers under contract terms that provide that the risk of inventory obsolescence remain with our customers.  During 2010, one such customer discontinued a specific business program and liquidated the inventory supporting that program.  This resulted in the customer repurchasing inventory from the Company at cost.  Upon buyback, there was no resulting revenue recorded in our operating results, consistent with past reporting by the Company.  In the last week of March 2011, we shipped $2.9 million of inventory under normal payment terms and in mid May 2011, the resulting accounts receivable was collected from the customer.
 
 
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During the year ended December 31, 2012, net cash used in investing activities consisted mainly of capital expenditures of $5.3 million in 2012 compared to $2.4 million in 2011.  The $5.3 million of investing activities for year ended December 31, 2012 includes i) $3.3 million of purchased equipment for the build out of our new fulfillment center in Groveport, Ohio and ii) $2.0 million for all other capital expenditures.  The $2.4 million of investing activities for the year ended December 31, 2011 consisted mainly of capital expenditures for all facilities which is comparable to the $2.0 million spent in 2012 for capital expenditures excluding the Groveport facility.  As of December 31, 2012, the initial build out of the Groveport, Ohio facility was materially completed with the build out of the remaining 200,000 square feet of space planned for 2013 as new business needs dictate.
 
As of December 31, 2012 and December 31, 2011, there were no net borrowings under the line of credit and $1.6 million advanced under the Equipment Loan at December 31, 2012.  The average daily borrowings outstanding on the Credit Facility for the year ended December 31, 2012 and 2011 were $278,000 and $304,000, respectively.  The maximum borrowings outstanding on the Credit Facility for any one day during the year ended December 31, 2012 and 2011 were $2.4 million and $2.3 million, respectively.  During the year ended December 31, 2012 and 2011, the Company repaid $429,000 and $314,000 of principal outstanding on capital leases respectively.  Additionally, during the year ended December 31, 2012 and 2011, the Company incurred $37,000 and $34,000 of loan commitment fees as a result of the Third and Second Amendments to the Credit Agreement respectively.  In addition, during the year ended December 31, 2011, the Company received $17,000 from PVS related to their noncontrolling interest in Innotrac Europe.
 
The Company generated positive cash flows from operations in 2012 and 2011.  During the year ended December 31, 2012, the Company required advances followed by repayment of those advances from its Credit Facility with the Bank resulting in no amount outstanding on the Credit Facility by year end 2012 and 2011.  We experienced 25% growth in service revenues in 2012 compared to 2011 and expect continued growth in service revenues in 2013.  This past and anticipated growth will require us to increase our fulfillment capacity in 2013 by continuing to add equipment in the new Groveport facility and other capacity improvements in various facilities to meet our customer’s volume projections.  It is estimated that $2.5 million in capital purchases will be added during 2013 to support this growth.
 
The Company estimates that its cash and financing needs through 2013 will be met by its available cash at December 31, 2012, cash flows from operations, capital lease financing and availability from its Credit Facility.
 
Credit Facilities. On March 27, 2009, the Company entered into the Fourth Amended and Restated Loan and Security Agreement (the “Credit Facility”) with the Bank, which was subsequently amended several times.  The term of the Credit Facility has been extended through June 30, 2013 and the Bank maintains a security interest in all of the Company’s assets.
 
The Credit Facility had a maximum borrowing limit of $15.0 million at both December 31, 2012 and 2011(including the issuance of letters of credit up to $2.0 million in face value), but limits borrowings to a specified percentage of eligible accounts receivable and inventory.  The Credit Facility is used to fund the Company’s capital expenditures, operational working capital and seasonal working capital needs.  Although total advances under the Credit Facility cannot exceed the maximum borrowing limit of $15.0 million, the Credit Facility limits borrowings at any time to a specified percentage of eligible accounts receivable and inventory, together “Eligible Collateral”, which totaled $17.8 million at December 31, 2012.  The terms of the Credit Facility provide that the amount borrowed and outstanding at any time combined with certain reserves for letters of credit outstanding and general reserves be subtracted from the facility limit or the value of the total collateral to arrive at an amount of unused availability to borrow under the line of credit.  The total collateral under the Credit Facility at December 31, 2012 amounted to $17.8 million, however borrowings were limited to the maximum borrowing limit of $15.0 million.  There were no borrowings outstanding under the Credit Facility at December 31, 2012 and the total value of reserves and letters of credit outstanding at that date totaled $2.8 million.  As a result, the Company had $12.2 million of borrowing availability under the revolving credit line at December 31, 2012.
 
On March 29, 2012, the Company entered into the Third Amendment to the Credit Facility which increased the Capital Expenditure limit for 2012 to $6.0 million and provided for a $1.8 million Equipment Loan (the Equipment Loan) to partially fund the purchase of equipment for the Groveport, Ohio facility.  Advances under the Equipment Loan have a five year repayment term through 60 equal $30,000 monthly payments which began on July 1, 2012.   Advances under the Equipment Loan are collateralized by specifically identified fulfillment equipment as valued by an independent appraiser which is reduced by an amount equal to the monthly repayment of the Equipment.
 
 
18

 
 
The Company has granted a security interest in all of its assets to the lender as collateral under the Credit Facility.  The provisions of the Credit Facility 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.  The Company was in compliance with all terms of the Credit Facility at December 31, 2012 and March 30, 2013.
 
For the year ended December 31, 2012, we incurred interest expense of $7,000 on the Credit Facility at a weighted average interest rate of 3.33%.  For the year ended December 31, 2011, we paid interest expense of $7,000 on the Credit Facility at a weighted average interest rate of 3.17%.  At December 31, 2012, the rate of interest being charged on the Credit Facility was 3.21%.  The average daily borrowings outstanding on the Credit Facility for the years ended December 31, 2012 and 2011 were $218,000 and $228,000, respectively.  The maximum borrowing outstanding on the Credit Facility for any one day during the years ended December 31, 2012 and 2011 were $2.4 million and $2.3 million, respectively.   The Company also incurred unused revolving Credit Facility fees of approximately $97,000 and $92,000 for the years ended December 31, 2012 and 2011, respectively.
 
Interest on borrowings pursuant to the Credit Facility is payable monthly at specified rates ranging from either the Base Rate (as defined in the Credit Facility) plus between 2.00% and 2.50%, or, at the Company's option, the LIBOR Rate (as defined in the Credit Facility) plus between 3.00% and 3.50%, in each case with the applicable margin depending on the Company’s Average Excess Availability (as defined in the Credit Facility).  The Company will pay a specified fee on undrawn amounts under the Credit Facility.  After an event of default, all loans will bear interest at the otherwise applicable rate plus 2.00% per annum.
 
The Credit Facility contains such financial, affirmative and negative covenants by the Company as are usual and customary for financings of this kind which can result in the acceleration of the maturity of amounts borrowed under the Credit Facility, including, without limitation, a restriction on cash dividends, change in ownership control covenants, a subjective material adverse change covenant and financial covenants.  The Credit Facility includes such events of default (and, as appropriate, grace periods) and representations and warranties as are usual and customary for financings of this kind.  The Company paid a customary closing fee upon the closing of the Credit Facility and would pay a specified fee upon any early termination of the Credit Facility, which fees are customary for transactions of this type.
 
As a result of the First, Second and Third Amendments, the significant covenants and terms of the Credit Facility are presented below for the periods identified:
 
The First Amendment provided for the following specific changes to the terms of the Credit Facility:
 
 
a.
in the event the current Chief Financial Officer of the Company no longer holds that position, the Company is provided with 150 days to fill that position;
 
b.
the definition of collateral is amended to restrict amounts included as accounts receivable for the sale of product to $4.0 million as a sub limit under the unchanged maximum borrowing limit of $15.0 million; and
 
The Second Amendment provided for the following specific changes to the terms of the Credit Facility:
 
 
a.
the term of the Credit Facility was extended twelve months to June 30, 2013 from the original termination date of June 30, 2012;
 
b.
the fixed charge ratio defined in the First Amendment to the Credit Facility for the monthly periods following April 1, 2011 were i) waived through June 30, 2012, ii) replaced with maximum monthly and cumulative loss limits through March 31, 2012, and iii) the Bank made a commitment to develop in March 2012 specific financial covenants for the period of April 2012 through June 2013 that will be based on the financial projections of the Company; and
 
 
19

 
 
 
c.
the unused line fee charged by the Bank was increased from one-half of one percent, or 0.5%, to three quarters of one percent, or 0.75%, per annum of the amount by which the $15.0 million Credit Facility limit exceeds the total of loaned advances outstanding plus letters of credit outstanding calculated on a daily basis.
 
The Third Amendment provided for the following specific changes to the terms of the Credit Facility:
 
 
a.
the Credit Facility will provide for a $1.8 million 5 year term loan to be funded in the second quarter of 2012 (the “Term Loan”) proceeds of which would be used to partially pay for the equipment expansion in the Company’s new Groveport, Ohio facility.  The Term Loan will be included under the Credit Facility’s $15.0 million total borrowing limit;
 
b.
the capital expenditure limit for the year 2012 will be increased to $6.0 million to allow for the total expansion cost of the new Groveport, Ohio facility;
 
c.
the excess availability block (the Availability Block), representing the amount of collateral held by the Company before any advances can be made on the Credit Facility, will range from $4.0 million to $2.5 million depending upon the company obtaining specific fixed charge ratio values; and
 
d.
monthly and cumulative loss covenants for the months of January and February 2012 would remain as determined in the Second Amendment, however after February 2012, monthly and cumulative loss covenants would no longer be required.
 
As a result of the Third Amendment to the Credit Facility, effective March 29, 2012, the financial covenants and additional terms of the credit facility for periods after December 31, 2011 are as follows:
 
 
i)
an annual capital expenditure limit of $6.0 million for 2012.
 
ii)
an Availability Block of $3.0 million from January 1, 2012 to March 29, 2012 when the Third Amendment was signed,
 
iii)
after March 29, 2012 an Availability Block of $4.0 million, which block will be reduced to $3.0 million when the twelve month trailing fixed charge ratio exceeds 1.1, and further reduced to $2.5 million when both the trailing twelve month fixed charge ratio has a) exceeded 1.2 for three consecutive months and b) is projected to exceed 1.2 for the immediately upcoming three consecutive months.,
 
iv)
a $1.8 million 5 year equipment term loan, to be repaid in 60 equal monthly installments, included within the $15.0 million Credit Facility limit at an annual at an annual rate of interest charged on amounts outstanding of the LIBOR Rate (as defined in the Credit Facility) plus 4.0% was provided for and advanced on at the end of June, 2012,
 
v)
the assets of the Company included in the collateral supporting the Credit Facility was increased to include up to $1.8 million in value as determined by an independent appraisal of specific fulfillment equipment which amount of collateral is reduced by an amount equal to each of the monthly installments made on the Equipment Loan as those installments are paid; and
 
vi)
maximum monthly (loss) limits of ($382,000) for periods from January 1, 2012 to February 29, 2012, after which periods the maximum monthly (loss) covenant will be removed.
 
The terms of the Credit Facility provide that the amount borrowed and outstanding at any time combined with certain reserves for rental payments, letters of credit outstanding and general reserves be subtracted from the Credit Facility limit or the value of the total collateral to arrive at an amount of unused availability to borrow.  The amount available to borrow under the Credit Facility will increase and decrease  mainly as a result of changes in the value of accounts receivable and inventory caused by variations in revenue or the timing of collection of accounts receivable.  Our availability to borrow under the Credit Facility will change from quarter to quarter due to seasonality of our business and revenue fluctuations caused largely by our clients’ selling cycles which directly affect our accounts receivable and, therefore, our Eligible Collateral to be higher at the end of the calendar year than the other three calendar quarter periods.
 
 
20

 
 
We were in compliance with all financial covenants of the Credit Facility at December 31, 2012 and February 28, 2013. We expect the Company’s existing cash on-hand, projected cash flows from operations and availability under the Credit Facility and our expected terms of a new credit facility after June 30, 2013 will satisfy our cash and financing needs for at least the next twelve months.
 
Since the Credit Facility matures on June 30, 2013, the Company has entered into discussions with several banks including Wells Fargo NA to secure a bank facility beyond that date.  As a result of those discussions, the Company expects to be able to secure a new facility at terms at least as favorable as the existing Credit Facility.
 
Contractual Obligations.  The Company’s primary long-term contractual commitments consist of operating leases and capital leases.  As of December 31, 2012, 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, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.  In addition, as of December 31, 2012, the Company did not participate in any guarantees of other entities’ obligations, structured finance arrangements, synthetic leases, repurchase obligations or similar commercial or financing commitments.
 
The following table sets forth the Company’s contractual commitments by period. For additional information, see Notes 4 and 5 to the Financial Statements (in 000’s).
 
   
Payments Due by Period
 
   
Total
   
Less than
1 year
   
1-3 years
   
4-5 years
   
After 5 years
 
Operating leases
  $ 29,862     $ 10,010     $ 13,309     $ 4,882     $ 1,661  
Equipment Loan
  $ 1,620     $ 360     $ 1,080     $ 180       -  
Capital Leases
  $ 1,073     $ 493     $ 580     $ -     $ -  
Line of Credit (1)
  $ -     $ -     $ -     $ -     $ -  
 
(1)
The provisions of the Credit Facility require that the Company maintain a lockbox arrangement with the lender and allow 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. For additional information, including information regarding the interest related to the revolving line of credit, see Note 4 of the Consolidated Financial Statements.
 
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 forecast, 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 critical to an investor’s understanding of our financial results and condition and require complex management judgment are discussed below:
 
 
21

 
 
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 upon completion of the shipping process. The shipping is considered complete after transfer to an independent freight carrier and receipt of a bill of lading or shipping manifest from that carrier.  Innotrac's contact 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 ASC topic No. 605 – Revenue Recognition, 1)  revenues have been recorded net of the cost of the goods for all fee-for-service clients and 2)  the Company records reimbursements received from customers for out-of pocket expenses, primarily freight and postage fees, as revenue and the associated expense as cost of revenue.  For two clients we purchase their product from our client’s vendor under agreements that require our clients to buy the product back from us at original cost when we ship the product to our client’s end consumer or after a period of time if the product has not been shipped from our fulfillment centers.  The value of these products is repaid to us at the same amount as we paid for them and no service fees are generated on the products.  We net the value of the purchase against the reimbursement from our customer with a resulting zero value in our reported revenue and costs of revenue.
 
Reserve for Uncollectible Accounts.  The Company makes estimates each reporting period associated with its reserve for uncollectible accounts.  These estimates are based on the aging of the receivables and known specific facts and circumstances.
 
Accounting for Income Taxes.  Innotrac utilizes the liability method of accounting for income taxes in accordance with ASC topic No. 740.  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, 2012 is $22.3 million.  This deferred tax asset was generated primarily by net operating loss carryforwards created in prior years and the goodwill impairment charge of $25.2 million recorded in 2009.  Innotrac has a net operating loss carryforward of $52.1 million at December 31, 2012 that expires between 2021 and 2032.
 
Innotrac’s ability to generate 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.  These factors, combined with losses in recent years create uncertainty about the ultimate realization of the gross deferred tax asset in future years.  Therefore, a valuation allowance of approximately $20.3 million and $21.8 million has been recorded as of December 31, 2012 and 2011, respectively against net deferred tax assets. Income taxes associated with future earnings may be offset by a reduction in the valuation allowance in that future year.  For the year ended December 31, 2012, the deferred income tax provision of $1.5 million was offset by a corresponding decrease of the deferred tax asset valuation allowance.  When and if the Company can return to consistent profitability and management determines that it will be able to utilize the deferred tax assets prior to their expiration, the valuation allowance may be reduced or eliminated.
 
Accounting Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.
 
Recent Accounting Pronouncements
 
Recently adopted accounting pronouncements
 
In May 2011, the FASB issued ASU 2011-04 to Topic 820 - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements which provides guidance for required disclosure on fair value measurements, including a consistent meaning of the term “fair value”, thereby facilitating greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and International Financial Reporting Standards. The amendment was adopted prospectively in the quarter ended March 31, 2012 and did not have any impact on the Company’s consolidated financial statements.
 
 
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In June 2011, the FASB issued ASU 2011-05, (Topic 220) - Comprehensive Income:  Presentation of Comprehensive Income.  The amendments to the Codification in this ASU allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders' equity. The amendments to the Codification in the ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.  The Company adopted these provisions in the first quarter of 2012 but has not presented a separate statement of comprehensive income since the Company has only immaterial other comprehensive income amounts. Adoption of these provisions did not have a material impact on the Company’s consolidated financial statements.
 
In December 2011, the FASB issued ASU 2011-12 to Topic 220 - Presentation of Comprehensive Income: Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. The amendments to the Codification in this ASU defer the presentation of reclassification adjustments out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented.  This ASU supersedes certain presentation requirements in ASU No. 2011-05, Comprehensive Income, discussed above, so that entities have not been required to comply with the presentation requirements in ASU No. 2011-05 that ASU No. 2011-12 is deferring.  While this ASU is in effect, entities are required to continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU No. 2011-05.  The amendments to this ASU are effective at the same time as the amendments in ASU No. 2011-05.  The Company adopted these provisions in the first quarter of 2012. Adoption of these provisions did not have a material impact on the Company’s consolidated financial statements since the Company has only immaterial other comprehensive income amounts.
 
In February 2013, the FASB issued ASU 2013-02 to Topic 220 - Presentation of Comprehensive Income: Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. The amendments to the Codification in this ASU require additional disclosure on the face of financial statements or in the notes to the financial statements, depending on materiality, for amounts reclassified out of accumulated other comprehensive income by component.  This ASU supersedes certain presentation requirements of ASU No. 2011-05 and ASU 2011-12 to topic 220.  This amendment to this ASU was effective for reporting periods beginning after December 15, 2012 with early adoption permitted.  The Company adopted these provisions in the fourth quarter of 2012. Adoption of this provisions did not have a material impact on the Company’s consolidated financial statements since the Company has only immaterial other comprehensive income amounts.
 
ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Management believes the Company’s exposure to market risks (investments, interest rates and foreign currency) is immaterial.  Innotrac holds no market risk sensitive instruments for trading purposes. At present, the Company does not employ any derivative financial instruments and does not currently plan to employ them in the future. During the year ended December 31, 2011, the Company did not transact any sales in foreign currency.  The first revenues recorded for Innotrac Europe occurred in the first quarter ended March 31, 2012.  The total value of revenues recorded for Innotrac Europe were less than 1.5% of the total revenue for the Company for the year ended December 31, 2012.  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.  All of the Company’s lease obligations are fixed in nature as noted in Note 5 to the Consolidated Financial Statements, and the Company has no long-term purchase commitments.
 
 
23

 
 
ITEM 8. FINANCIAL STATEMENTS
 
Report of Independent Registered Public Accounting Firm
 
To the Board of Directors and Shareholders
Innotrac Corporation:
 
We have audited the accompanying consolidated balance sheets of Innotrac Corporation (a Georgia corporation) and subsidiary (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the years then ended.  These financial statements are the responsibility of 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 the standards of the Public Company Accounting Oversight Board (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. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Innotrac Corporation and subsidiary as of December 31, 2012 and 2011, 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.
 
/s/ GRANT THORNTON LLP
Atlanta, Georgia
March 28, 2013
 
 
24

 
 
INNOTRAC CORPORATION and SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(dollars in 000’s)
 
   
December 31,
 
Assets
 
2012
   
2011
 
Current assets:
           
  Cash and cash equivalents
  $ 4,005     $ 3,283  
  Accounts receivable, net of allowance of $136 (2012) and $97 (2011)
    23,216       16,977  
  Inventories, net
    740       743  
  Prepaid expenses and other
    1,107       1,066  
    Total current assets
    29,068       22,069  
                 
Property and equipment:
               
  Computers, machinery and equipment
    42,877       39,425  
  Furniture, fixtures and leasehold improvements
    10,055       8,557  
      52,932       47,982  
  Less accumulated depreciation and amortization
    (39,089 )     (36,809 )
      13,843       11,173  
                 
Other assets, net
    1,281       1,100  
    Total assets
  $ 44,192     $ 34,342  
                 
       
Liabilities and Shareholders’ Equity
           
Current liabilities:
               
  Accounts payable
  $ 10,409     $ 7,914  
  Line of credit
    -       -  
  Accrued salaries
    2,854       1,669  
  Equipment lease payable
    421       281  
  Accrued expenses and other
  Equipment loan
   
3,088
1,620
     
2,534
-
 
    Total current liabilities
    18,392       12,398  
                 
Noncurrent liabilities:
               
  Deferred compensation
    837       735  
  Equipment lease payable
    544       251  
  Other noncurrent liabilities
    963       1,142  
     Total noncurrent liabilities
    2,344       2,128  
                 
Commitments and contingencies (see Notes 5 and 6)
    -       -  
                 
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,
               
  13,155,440 shares issued and outstanding 2012
               
  13,035,440  shares issued and outstanding 2011
    1,316       1,304  
  Additional paid-in capital
    66,784       66,632  
  Accumulated other comprehensive loss
    (2 )     (3 )
  Accumulated deficit
    (44,656 )     (48,132 )
    Total Innotrac shareholders’ equity
    23,442       19,801  
     Noncontrolling interest
    14       15  
    Total equity
    23,456       19,816  
Total liabilities and equity
  $ 44,192     $ 34,342  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
 
25

 
 
INNOTRAC CORPORATION and SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in 000’s, except per share data)
 
   
Year Ended December 31,
 
   
2012
   
2011
 
             
Service revenues
  $ 94,006     $ 74,943  
Freight revenues
    13,688       9,741  
     Total revenues
    107,694       84,684  
                 
Cost of service revenues
    47,113       36,211  
Freight expense
    13,150       9,642  
Selling, general and administrative
    39,966       36,802  
Depreciation and amortization
    3,699       3,380  
     Total operating expenses
    103,928       86,035  
           Operating income (loss)
    3,766       (1,351 )
Other expense:
               
     Interest expense
    292       186  
     Other (income) expense
    (1 )     3  
     Total other expense
    291       189  
                 
Income (loss) before income taxes and noncontrolling interest in net loss
    3,475       (1,540 )
Income taxes
    -       -  
Net income (loss)
    3,475       (1,540 )
Noncontrolling interest in net loss
    1       2  
Net income (loss) attributable to Innotrac
  $ 3,476     $ (1,538 )
                 
Income (loss) per share:
               
   Basic
  $ 0.27     $ (0.12 )
   Diluted
  $ 0.27     $ (0.12 )
                 
Weighted average shares outstanding:
               
   Basic
    13,063       12,940  
   Diluted
    13,063       12,940  
                 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
 
26

 
 
INNOTRAC CORPORATION and SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(dollars and number of shares in 000's)
 
   
Common Stock
   
Additional
   
Accumulated Other
                         
   
Shares
   
Amount
   
Paid – in Capital
   
Comprehensive Loss
   
Accumulated Deficit
   
Total Equity of Innotrac
   
Noncontrolling Interest
   
Total
Equity
 
 
Balance at December 31, 2010
    12,861     $ 1,286     $ 66,609     $  -     $ ( 46,596 )   $ 21,299     $  -     $ 21,299  
Restricted stock compensation expense
    174       18       21       -       -       39       -       39  
Stock option compensation expense
    -       -       2       -       -       2       -       2  
Noncontrolling interest in subsidiary
    -       -       -       -       2       2       17       19  
Foreign currency translation adjustment in subsidiary
    -       -       -       (3 )     -       (3 )     -       (3 )
Net loss
    -       -       -       -       (1,538 )     (1,538 )     (2 )     (1,540 )
 
Balance at December 31, 2011
    13,035     $ 1,304     $  66,632     $  (3 )   $ (48,132 )   $ 19,801     $ 15     $ 19,816  
Restricted stock compensation expense
    120       12       152       -       -       164       -       164  
Foreign currency translation adjustment in subsidiary
    -       -       -       1       -       1       -       1  
Net income
    -       -       -       -       3,476       3,476       (1 )     3,475  
 
Balance at December 31, 2012
    13,155     $ 1,316     $  66,784     $  (2 )   $ (44,656 )   $ 23,442     $ 14     $ 23,456  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
27

 
 
INNOTRAC CORPORATION and SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in 000’s)
 
   
Year Ended December 31,
 
   
2012
   
2011
 
             
Cash flows from operating activities:
           
  Net income (loss)
  $ 3,475     $ (1,540 )
  Adjustments to reconcile net income (loss) to net
               
   cash provided by operating activities:
               
   Depreciation and amortization
    3,699       3,380  
   Provision for bad debts
    49       43  
   Loss (gain) on disposal of fixed assets
    4       (15 )
   Stock compensation expense-stock options
    -       2  
   Stock compensation expense-restricted stock
    164       39  
   Changes in operating assets and liabilities:
               
Accounts receivable, gross
    (6,288 )     (1,741 )
Inventory
    3       2,883  
Prepaid expenses and other assets
    (7 )     116  
Long-term assets
    (68 )     10  
Accounts payable
    2,275       1,649  
Accrued expenses, accrued salaries and other
    1,740       391  
Long-term liabilities
    (178 )     532  
Net cash provided by  operating activities
    4,868       5,749  
                 
Cash flows from investing activities:
               
  Capital expenditures
    (5,292 )     (2,389 )
  Proceeds from disposition of assets
    1       26  
  Net change in noncurrent assets and liabilities
    (9 )     (10 )
           Net cash used in investing activities
    (5,300 )     (2,373 )
                 
Cash flows from financing activities:
               
  Net activity under line of credit
    -       -  
  Borrowings on equipment loan
    1,800       -  
  Payments on equipment loan
    (180 )     -  
  Capital lease payments
    (429 )     (314 )
  Contribution from noncontrolling interest
    -       17  
  Loan commitment fees
    (37 )     (34 )
          Net cash provided by (used in) financing activities
    1,154       (331 )
  Net increase in cash and cash equivalents
    722       3,045  
                 
  Cash and cash equivalents, beginning of period
    3,283       238  
                 
  Cash and cash equivalents, end of period
  $ 4,005     $ 3,283  
                 
Supplemental cash flow disclosures:
               
  Cash paid for interest
  $ 207     $ 126  
  Cash paid for state income taxes
  $ 8     $ 29  
  Non-cash investing and financing activities:
  Capital lease obligation for computer and warehouse equipment purchased
  $ 862     $ 451  
  Capital expenditures in accounts payable
  $ 219     $ 345  
                 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
 
28

 

INNOTRAC CORPORATION and SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2012 AND 2011
 
1.  ORGANIZATION
 
Innotrac Corporation (“Innotrac” or the “Company”), a Georgia corporation, provides order processing, order fulfillment and customer support “contact” 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; Hebron, Kentucky; Columbus Ohio and Groveport, Ohio.
 
2.  SIGNIFICANT ACCOUNTING POLICIES
 
Principles of Consolidation.  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.  The consolidated financial statements include the accounts of the Company and its majority owned subsidiary.  On April 11, 2011 the Company completed the formation of Innotrac Europe GmbH (“Innotrac Europe”), a joint venture between Innotrac and PVS Fulfillment-Service GmbH (“PVS”) in Neckarsulm, Germany.  Innotrac has a 50.1% ownership stake in the joint venture.  All significant intercompany transactions and balances have been eliminated in consolidation.
 
Foreign Currency Translation.  The financial statements of foreign subsidiaries have been translated into U.S. Dollars in accordance with Accounting Standards Codification (“ACS”) topic No. 830-30 -  Translation of Financial Statements.  The financial position and results of operations of the Company’s foreign subsidiary are measured using the foreign subsidiary’s local currency as the functional currency.  Revenue and expenses of the subsidiary have been translated into U.S. Dollars at the average exchange rate prevailing during the period.  Assets and liabilities have been translated at the rates of exchange on the balance sheet date.  The resulting translation gain and loss adjustments are recorded directly as a separate component of shareholders’ equity, unless there is a sale or complete liquidation of the underlying foreign investment.  Foreign currency translation adjustments were immaterial during the years ended December 31, 2012 and 2011.
 
Gains and losses that result from foreign currency transactions are included in the “other expense” line in the consolidated statements of operations.  For the years ended December 31, 2012 and 2011, we incurred an immaterial amount of net foreign currency transaction gains and losses.
 
Accounting Estimates.  The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.
 
Customer Concentration. Except for one major client, from whom 25% of total revenues were derived in 2012 and 26% of total revenues were derived in 2011, and two other smaller clients who represented 13% and 10% of total revenues in 2012 and 12% and 10% of total revenues in 2011, no other single customer provided more than 10% of revenues during these years.  As of December 31, 2012, these three clients represented approximately 20%, 8% and 10% of total accounts receivable. As of December 31, 2011 these three clients represented approximately 20%, 11% and 14% of total accounts receivable.  For both the years ended December 31, 2012 and 2011, our ten largest customers represented 77% of our total revenues.
 
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. The Company maintains its cash balances in financial institutions.  These balances may, at times, exceed federally insured limits.  The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash balances.
 
 
29

 
 
Reserve for Uncollectible Accounts.  The Company makes estimates each reporting period associated with its reserve for uncollectible accounts.  These estimates are based on the aging of the receivables and known specific facts and circumstances.
 
Fair Value Measurements. The Company accounts for fair value in accordance with ASC topic No. 820 – Fair Value Measurements and Disclosures for all financial and non-financial assets and liabilities accounted for at fair value on a recurring basis.  ASC topic No. 820 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States of America, and expands disclosures about fair value measurements.
 
The Company determined the fair values of certain financial instruments based on the fair value hierarchy established in ASC topic No. 820. ASC topic No. 820 requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value.
 
Level 1: Quoted market prices in active markets for identical assets or liabilities.
 
Level 2: Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
 
Level 3: Unobservable inputs developed using the Company’s estimates and assumptions which reflect those that the market participants would use.
 
ASC topic No. 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
 
The carrying value of our cash, accounts receivable, accounts payable and other debt instruments approximates fair value because of the short maturity of these instruments.  The interest rate on the debt instruments is equal to the market rate for such instruments of similar duration and credit quality.
 
 
   
As of December 31, 2012
 
   
Fair Value Measurements Using
(in 000’s)
 
Description
 
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
   
Significant
Other
Observable
Inputs (Level 2)
   
Significant
Unobservable
Inputs
 (Level 3)
   
Total
 
 
Deferred Compensation plan assets held in Rabbi Trust (1)
  $ 837     $ -     $ -     $ 837  
                                 
Total
  $ 837     $ -     $ -     $ 837  
 
 
30

 
 
 
As of December 31, 2011
 
 
Fair Value Measurements Using
(in 000’s)
 
Description
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
 
Significant
Other
Observable
Inputs (Level 2)
 
Significant
Unobservable
Inputs
 (Level 3)
 
Total
 
 
Deferred Compensation plan assets held in Rabbi Trust (1)
  $ 735     $ -     $ -     $ 735  
Total
  $ 735     $ -     $ -     $ 735  
                                 
 
 
(1)
This is an executive deferred compensation plan for certain employees, as designated by the Company’s Board of Directors.  The Company invests contributions to this plan in employee-directed marketable equity securities which are recorded in other assets on the accompanying consolidated balance sheets at quoted market prices.   The contributions are fully invested in five different mutual funds having various growth, industry and geographic characteristics.
 
There were no significant transfers into and out of each level of the fair value hierarchy for assets measured at fair value for the years ended December 31, 2012 and 2011.
 
All transfers, if any, are recognized by the Company at the end of each reporting period.
 
Transfers between Levels 1 and 2 generally relate to whether a market becomes active or inactive. Transfers between Levels 2 and 3 generally relate to whether significant relevant observable inputs are available for the fair value measurement in their entirety.
 
Inventories.  Inventories 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, 2012 and 2011 is for the account of a single 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:
 
  Computers and software 3-5 years  
  Machinery and equipment 5-7 years  
  Furniture and fixtures 7-10 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.  Depreciation and amortization expense for the years ended December 31, 2012 and 2011 for all property and equipment, including capital leases, was $3.7 million and $3.4 million respectively.  Computers, machinery and equipment include capital leases of $2.1 million and $1.3 million at December 31, 2012 and 2011, respectively.  Accumulated depreciation includes $798,000 at December 31, 2012 and $447,000 at December 31, 2011 related to capital leases.   Maintenance and repairs are expensed as incurred.
 
Impairment of Long-Lived Assets.  The Company reviews long-lived 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 future 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 future cash flows for the asset.  During the years ended December 31, 2012 and 2011, there was no impairment of long-lived assets.
 
 
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Accounting for Income Taxes.  Innotrac utilizes the liability method of accounting for income taxes in accordance with Accounting Standards Codification (“ASC”) topic No. 740 – Income Taxes.  Under the liability method, deferred taxes are determined based on the difference between the financial and tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. A valuation allowance is recorded against deferred tax assets if the Company considers it is more likely than not that deferred tax assets will not be realized.  A full valuation allowance has been recorded against deferred tax assets at December 31, 2012 and 2011 (see Note 7).
 
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 upon completion of the shipping process. The shipping is considered complete after transfer to an independent freight carrier and receipt of a bill of lading or shipping manifest from that carrier.  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 ASC topic No. 605 – Revenue Recognition, 1)  revenues have been recorded net of the cost of the goods for all fee-for-service clients and 2)  the Company records reimbursements received from customers for out-of pocket expenses, primarily freight and postage fees, as revenue and the associated expense as cost of revenue.  For two clients we purchase their product from our client’s vendor under agreements that require our clients to buy the product back from us at original cost when we ship the product to our client’s end consumer or after a period of time if the product has not been shipped from our fulfillment centers.  The value of these products is repaid to us at the same amount as we paid for them and no service fees are generated on the products.  We net the value of the purchase against the reimbursement from our customer with a resulting zero value in our reported revenue and costs of revenue.
 
Cost of Revenues.  The primary components of cost of revenues include labor costs, telephone minute fees, and packaging material costs.  Costs related to facilities, equipment, account services and information technology are included in selling, general and administrative expense along with other operating costs.  As a result of the Company’s policy to include facility, account services and information technology costs in selling, general and administrative expense, our gross margins may not be comparable to other fulfillment companies.
 
Stock-Based Compensation Plans. The Company accounts for stock based compensation according to the provisions of the Compensation – Stock Compensation topic of the ASC, which establishes accounting for stock-based awards exchanged for employee services.  Accordingly, stock-based compensation cost is measured at grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the employee’s requisite service period.
 
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 dilutive potential common stock equivalent shares.
 
Recent Accounting Pronouncements.
 
In May 2011, the FASB issued ASU 2011-04 to Topic 820 - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in US GAAP and IFRS which provides guidance for required disclosure on fair value measurements, including a consistent meaning of the term “fair value”, thereby facilitating greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and International Financial Reporting Standards. The amendment was adopted prospectively in the quarter ended March 31, 2012 and did not have any impact on the Company’s consolidated financial statements.
 
 
32

 
 
In June 2011, the FASB issued ASU 2011-05, (Topic 220) - Comprehensive Income:  Presentation of Comprehensive Income.  The amendments to the Codification in this ASU allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders' equity. The amendments to the Codification in the ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.  The Company adopted these provisions in the first quarter of 2012 but has not presented a separate statement of comprehensive income since the Company has only immaterial other comprehensive income amounts. Adoption of these provisions did not have a material impact on the Company’s consolidated financial statements.
 
In December 2011, the FASB issued ASU 2011-12 to Topic 220 - Presentation of Comprehensive Income: Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. The amendments to the Codification in this ASU defer the presentation of reclassification adjustments out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented.  This ASU supersedes certain presentation requirements in ASU No. 2011-05, Comprehensive Income, discussed above, so that entities have not been required to comply with the presentation requirements in ASU No. 2011-05 that ASU No. 2011-12 is deferring.  While this ASU amendment is in effect, entities are required to continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU No. 2011-05.  The amendments to this ASU are effective at the same time as the amendments in ASU No. 2011-05.  The Company adopted these provisions in the first quarter of 2012. Adoption of these provisions did not have a material impact on the Company’s consolidated financial statements since the Company has only immaterial other comprehensive income amounts.
 
In February 2013, the FASB issued ASU 2013-02 to Topic 220 - Presentation of Comprehensive Income: Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. The amendments to the Codification in this ASU require additional disclosure on the face of financial statements or in the notes to the financial statements, depending on materiality, for amounts reclassified out of accumulated other comprehensive income by component.  This ASU supersedes certain presentation requirements of ASU No. 2011-05 and ASU 2011-12 to topic 220.  This amendment to this ASU was effective for reporting periods beginning after December 15, 2012 with early adoption permitted.  The Company adopted these provisions in the fourth quarter of 2012. Adoption of this provisions did not have a material impact on the Company’s consolidated financial statements since the Company has only immaterial other comprehensive income amounts.
 
3.           ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
 
The Company grants credit to our customers without requiring collateral.  The amount of accounting loss for which we are at risk in these unsecured accounts receivable is limited to their carrying value.  Accounts receivable were composed of the following at December 31, 2012 and 2011 (in 000’s):
 
   
2012
   
2011
 
             
Billed receivables
  $ 22,292     $ 16,564  
Unbilled receivables
    1,060       510  
      23,352       17,074  
Less: Allowance for doubtful accounts
    (136 )     (97 )
    $ 23,216     $ 16,977  
 
 
33

 
 
Changes in the allowance for doubtful accounts were composed of the following during the twelve months ended December 31, 2012 and 2011 (in 000’s):
 
 
 
Description
 
Balance at
Beginning
of Period
   
Charged to
Expenses
   
Charged to
Other
Accounts
   
 
Deductions
   
Balance at
End of
Period
 
(in 000’s)
     
 
Allowance for doubtful accounts
                             
   Year ended December 31,
                             
              2012
  $ 97     $ 49     $ -     $ (10 )   $ 136  
              2011
  $ 242     $ 43     $ -     $ (188 )   $ 97  
 
4.           FINANCING OBLIGATIONS
 
The Company has a revolving credit facility with Wells Fargo, N.A., (the “Credit Facility”) which had a maximum borrowing limit of $15.0 million at December 31, 2012 and 2011.  The Credit Facility is used to fund the Company’s capital expenditures, operational working capital and seasonal working capital needs.  The Credit Facility was renewed on March 27, 2009 when the Company entered into a Fourth Amended and Restated Loan and Security Agreement (the “Credit Facility”) with the Bank, setting forth the new terms of the Credit Facility.  The Credit Facility has been further amended by the First, Second and Third Amendments on May 14, 2010, March 30, 2011 and March 29, 2012 respectively.  The amended Credit Facility includes a maturity date of June 30, 2013 and continues the Bank’s security interest in all of the Company’s assets.  There was no outstanding balance on December 31, 2012 or December 31, 2011 under the Credit Facility.
 
Since the Credit Facility matures on June 30, 2013.  The Company has entered into discussions with several banks including Wells Fargo NA to secure a bank facility beyond that date.  As a result of those discussions, the Company expects to be able to secure a new facility at terms at least as favorable as the existing Credit Facility.
 
Interest on borrowings pursuant to the Credit Facility is payable monthly at specified rates of either, at the Company’s option, the Base Rate (as defined in the Credit Facility) plus between 2.00% and 2.50%, or the LIBOR Rate (as defined in the Credit Facility) plus between 3.00% and 3.50%, in each case with the applicable margin depending on the Company’s Average Excess Availability (as defined in the Credit Facility).  The Company paid a specified fee of one-half of one percent, or 0.5%, until March 30, 2011, and after March 30, 2011 paid and will pay in the future three quarters of one percent, or 0.75% on undrawn amounts under the Credit Facility.  After an event of default, all loans will bear interest at the otherwise applicable rate plus 2.00% per annum.
 
The 2009 Credit Facility contains such financial, affirmative and negative covenants by the Company as are usual and customary for financings of this kind which can result in the acceleration of the maturity of amounts borrowed under the Credit Facility, including, without limitation, a restriction on cash dividends, a change in ownership control covenant, a subjective material adverse change covenant and financial covenants.  The financial covenants include an annual capital expenditure limit, a minimum excess availability limit, and as revised by the Second Amendment monthly and cumulative (loss) or profit limits for periods through the effective date of the Third Amendment.  The Second Amendment provided for a determination in March of 2012 of specific financial covenants based on the financial projections of the Company for the business periods following March 31, 2012.  The provisions of the Credit Facility require that the Company maintain a lockbox arrangement with the Bank, and allows the Bank to declare any outstanding borrowings to be immediately due and payable as a result of noncompliance with any of the covenants.  Accordingly, in the event of noncompliance, the Company’s payment obligations with respect to such borrowings could be accelerated.  Therefore, when the Company has a balance on its line of credit, it is classified as a current liability.  As of December 31, 2012, the Company was in compliance with all terms of the Credit Facility.
 
 
34

 
 
Although the maximum borrowing limit is $15.0 million, the Credit Facility limits borrowings to a specified percentage of eligible accounts receivable and inventory, together “Eligible Collateral”, which totaled $17.8 million at December 31, 2012.  Additionally, the terms of the Credit Facility provide that the amount borrowed and outstanding at any time combined with certain reserves for letters of credit outstanding and general reserves be subtracted from the Credit Facility limit or the value of the total collateral to arrive at an amount of unused availability to borrow.  The total collateral under the Credit Facility at December 31, 2012 amounted to $17.8 million, however borrowings were limited to the maximum borrowing limit of $15.0 million.  At December 31, 2012, there were no borrowings outstanding under the Credit Facility, however, the value of reserves and letters of credit outstanding totaled $2.8 million.  As a result, the Company had $12.2 million of borrowing availability under the Credit Facility at December 31, 2012.
 
As a result of the Third Amendment to the Credit Facility, effective March 29, 2012, the financial covenants and additional terms of the credit facility for periods after December 31, 2011 are as follows:
 
 
i)
an annual capital expenditure limit of $6.0 million for 2012,
 
ii)
an Availability Block of $3.0 million from January 1, 2012 to March 29, 2012 when the Third Amendment became effective,
 
iii)
after March 29, 2012 an Availability Block of $4.0 million, which block will be reduced to $3.0 million when the twelve month trailing fixed charge ratio exceeds 1.1, and further reduced to $2.5 million when both the trailing twelve month fixed charge ratio has a) exceeded 1.2 for three consecutive months and b) is projected to exceed 1.2 for the immediately upcoming three consecutive months,
 
iv)
a $1.8 million 5 year term loan, to be repaid in 60 equal monthly installments, included within the $15.0 million Credit Facility limit at an annual rate of interest charged on amounts outstanding of the LIBOR Rate (as defined in the Credit Facility) plus 4.0% was provided for and advanced on at the end of June, 2012,
 
v)
the assets of the Company included in the collateral supporting the Credit Facility was increased to include up to $1.8 million in value as determined by an independent appraisal of specific fulfillment equipment which amount of collateral is reduced by an amount equal to each of the monthly installments made on the Equipment Loan (Note 5) as those installments are paid; and
 
vi)
maximum monthly (loss) limits of ($382,000) for the months of January 2012 and February 2012, after which periods the maximum monthly (loss) covenant will be removed.
 
At December 31, 2012, the outstanding balance of the Equipment Loan and related collateral of fulfillment equipment was $1.6 million, and the Availability Block was $2.5 million.
 
The terms of the Credit Facility provide that the amount borrowed and outstanding at any time combined with certain reserves for rental payments, letters of credit outstanding and general reserves be subtracted from the Credit Facility limit or the value of the total collateral to arrive at an amount of unused availability to borrow.  The amount available to borrow under the Credit Facility will increase and decrease  mainly as a result of changes in the value of accounts receivable and inventory caused by variations in revenue or the timing of collection of accounts receivable.  Our availability to borrow under the Credit Facility will change from quarter to quarter due to the seasonality of our business and revenues which causes our accounts receivable and, therefore, our Eligible Collateral to be higher at the end of the calendar year than the other three calendar quarter periods.
 
For the year ended December 31, 2012, we recorded interest expense of $7,000 on the Credit Facility at a weighted average interest rate of 3.3%.  The rate of interest being charged on the Credit Facility at December 31, 2012 was 3.2%.  The average daily borrowings outstanding on the Credit Facility for the years ended December 31, 2012 and 2011 were $218,000 and $228,000 respectively.  The maximum borrowing outstanding on the Credit Facility for any one day during the years ended December 31, 2012 and 2011 were $2.4 million and $2.3 million respectively.  For the year ended December 31, 2011, we recorded interest expense of $7,000 on the Credit Facility at a weighted average interest rate of 3.17%.  The Company also incurred unused Credit Facility fees of approximately $97,000 and $92,000 for the years ended December 31, 2012 and 2011, respectively.  Additionally, the Company reported $80,000 and $62,000 of amortized loan costs as interest expense during the year ended December 31, 2012 and 2011, respectively.
 
 
35

 
 
5.           EQUIPMENT LOAN AND LEASES
 
Equipment Loan.  Innotrac entered into a five year $1.8 million dollar equipment loan in June 2012.  The equipment loan as described in Note 4 Financing Obligations to these consolidated financial statements is within the $15.0 million borrowing limit of the Credit Facility and is collaterized by specifically identified fulfillment equipment as valued by an independent appraiser.  The Equipment Loan has a five year repayment term and will be paid back in 60 equal $30,000 monthly payments with an equal offsetting monthly reduction in the value of the selected fulfillment equipment included as collateral under the Credit Facility. This loan is subject to renewal with the Credit Facility at June 30, 2013 and as a result is classified as a current liability in the accompanying consolidated balance sheets.  Future payments under the Equipment loan as of December 31, 2012 are as follows:
 
   
Equipment Loan
 
2013
  $ 360  
2014
    360  
2015
    360  
2016
    360  
2017
    180  
Total payments due after December 31, 2012
  $ 1,620  
 
Equipment Leases.  Innotrac has entered into various capital leases for warehouse and computer equipment.  The amortization of these assets is included in depreciation and amortization expense.  Aggregate future minimum lease payments under these noncancellable capital leases as of December 31, 2012 are as follows (in 000’s):
 
   
Capital Leases
 
2013
  $ 493  
2014
    436  
2015
    144  
      1,073  
Less amounts representing interest and taxes
    (108 )
Present value of future minimum lease payments
    965  
Less current portion
    (421 )
Capital lease obligations, net of current portion
  $ 544  
 
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.
 
Aggregate future minimum lease payments under noncancellable operating leases with original periods in excess of one year as of December 31, 2012 are as follows (in 000’s):
 
   
Operating
Leases
 
2013
  $ 10,010  
2014
    8,103  
2015
    5,206  
2016
    3.623  
2017
    1,259  
Thereafter
    1,661  
Total minimum lease payments
  $ 29,862  
 
Rent expense under all operating leases totaled approximately $9.5 million during both years ended December 31, 2012 and 2011.
 
 
36

 
 
6.           COMMITMENTS AND CONTINGENCIES
 
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.
 
7.           INCOME TAXES
 
Details of the income tax benefit (provision) for the years ended December 31, 2012 and 2011 are as follows (in 000’s):
 
   
2012
   
2011
 
Current tax expense
  $ -     $ -  
Deferred tax expense (benefit)
    1,519       (536 )
Change in valuation allowance
    (1,519 )     536  
Income tax benefit (provision)
  $ -     $ -  
                 
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, 2012 and 2011 are as follows (in 000’s):
 
   
2012
   
2011
 
             
Deferred tax assets:
           
     Net operating loss carryforwards and credits
  $ 18,955     $ 18,985  
     Allowance for doubtful accounts
    49       35  
     Accruals
    687       647  
     Goodwill
    2,339       3,045  
     Other
    295       241  
Gross deferred tax assets
    22,325       22,953  
       Less valuation allowance
    (20,319 )     (21,839 )
Gross deferred tax assets net of valuation allowance
    2,006       1,114  
                 
Deferred tax liabilities:
               
       Depreciation
    (2,006 )     (1,114 )
Gross deferred tax liabilities
    (2,006 )     (1,114 )
Net deferred taxes
  $ -     $ -  
 
Innotrac utilizes the liability method of accounting for income taxes in accordance with ASC topic No. 740 – Income Taxes.  Under the liability method, deferred taxes are determined based on the difference between the financial and tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse.  A valuation allowance is recorded against deferred tax assets if the Company considers it is more likely than not that deferred tax assets will not be realized.  Innotrac’s gross deferred tax asset as of December 31, 2012 is approximately $22.3 million. This deferred tax asset was generated primarily by net operating loss carryforwards created by net losses in prior years and the goodwill impairment charge of $25.2 million recorded in 2009.  Innotrac has a net operating loss carryforwards of $52.1 million at December 31, 2012 that expire between 2021 and 2032.
 
 
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Innotrac’s ability to generate 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.  These factors, combined with losses in recent years, create uncertainty about the ultimate realization of the gross deferred tax asset in future years.  Therefore, a valuation allowance of approximately $20.3 million and $21.8 million has been recorded as of December 31, 2012 and 2011, respectively. Income taxes associated with future earnings may be offset by a reduction in the valuation allowance.  For the year ended December 31, 2012, the income tax provision of $1.5 million was offset by a corresponding decrease in the deferred tax asset valuation allowance.  When and if the Company can return to consistent profitability and management determines that it is more likely than not that the Company will be able to utilize the deferred tax assets prior to their expiration, the valuation allowance may be reduced or eliminated.
 
ASC topic No. 740 requires that the Company determine whether it is more likely than not that a tax position will be sustained upon audit, based on the technical merits of the position.  A tax position that meets the more likely than not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements.  The tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement.  The tax years that are open for audit are 2001-2007, and 2009-2012.  There are no unrecognized tax benefits and no related ASC topic No. 740 tax liabilities at December 31, 2012 and 2011.
 
The Company generally recognizes interest and/or penalties related to income tax matters in general and administrative expenses.  As of December 31, 2012 and 2011, we have no accrued interest or penalties related to uncertain tax positions.
 
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, 2012 and 2011 is as follows:
 
   
2012
   
2011
 
             
Statutory federal income tax (benefit) expense
  $ 1,181     $ (531 )
Expired state tax credits
    31       -  
State income taxes, net of federal effect
    66       (42 )
Permanent book-tax differences
    48       28  
Rate adjustment for change in state rate     61       -  
State NOL true-up     136       -  
Other
    (4 )     9  
Valuation allowance for deferred tax assets
    (1,519 )     536  
Income tax provision (benefit)
  $ -     $ -  
 
8.           EARNINGS PER SHARE
 
The following table shows the shares used  in computing diluted earnings per share (“EPS”) in accordance with ASC topic No. 260 – Earnings per Share, (in 000’s):
 
   
2012
   
2011
 
Diluted earnings per share:
     Weighted average shares outstanding
    13,063       12,940  
     Employee and director stock options
    -       -  
     Weighted average shares
          assuming dilution
    13,063       12,940  
 
Options to purchase 351,000 shares of the Company’s common stock outstanding at December 31, 2012 and options to purchase 520,000 shares of the Company’s common stock at December 31, 2011 were not included in the computation of diluted EPS because their effect was anti-dilutive.
 
 
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On January 1, 2009 the Company adopted an update to ASC topic No. 260, which requires the inclusion of all unvested stock awards which contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, in the number of shares outstanding in our basic and diluted EPS calculations.  As a result, we have included 820,637 restricted shares in our calculation of basic and diluted EPS for the year ended December 31, 2012.  For the year ended December 31, 2011, we included 700,637 of restricted shares in our calculation of basic and diluted EPS.    
 
9.           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 current policy is to provide matching employer contributions equal to 5% of contributions for less than four years of service and 10% of contributions for over four years of service.  Total matching contributions made to the plan and charged to expense by Innotrac for the years ended December 31, 2012 and 2011 were approximately $46,000 and $32,000, respectively.
 
The Company has an executive deferred compensation plan, a Rabbi Trust, 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 since 2008.  The Company invests all contributions in employee-directed marketable equity securities which are recorded at quoted market prices on the accompanying balance sheet (in other assets with an equal value in deferred compensation liability) and aggregated $837,000 and $735,000 at December 31, 2012 and 2011, respectively. The monies invested in the plan and held by the Rabbi Trust are subject to general creditors of the Company in the event of a Company bankruptcy filing.
 
10.           STOCK BASED COMPENSATION
 
Stock Options.  The Company has adopted three stock option plans: the 1997 Stock Option Plan (the “1997 Plan”), the 2000 Stock Option and Incentive Award Plan (the “2000 Plan”) and the 2010 Innotrac Stock Award Plan (the “2010 Plan” and the three plans together “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.  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.  In November 2007, the 1997 Plan expired and in March 2010, the 2000 Plan expired.  The 2010 Plan provides for the issuance of an aggregate 1,200,000 shares of the Company’s Common Stock, plus any shares that are subject to outstanding grants under the terminated Innotrac Corporation 2000 Stock Option and Incentive Award Plan, which expire, are forfeited or otherwise terminate without delivery of shares. At December 31, 2012, there were 1,149,750 shares available to be issued under the 2010 Plan.
 
 
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Incentive stock options are also subject to certain limitations prescribed by the Internal Revenue 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.
 
A summary of the options outstanding and exercisable by price range as of December 31, 2012 is as follows (shares in 000’s):
 
   
Options Outstanding
    Options Exercisable  
Range of
Exercise Prices
 
As of
December 31, 2012
   
Weighted Average
Remaining
Contractual
Life
   
Weighted Average
Exercise
Price
   
As of
December 31, 2012
   
Weighted Average
Exercise
Price
   
Weighted Average Remaining Contractual
Life
 
$1.77 - $3.54
    60       4.35     $ 2.70       60     $ 2.70       4.35  
$3.54 - $5.31
    291       2.53       4.56       291       4.56       2.53  
      351       2.84     $ 4.24       351     $ 4.24       2.84  
 
A summary of activity in the Company’s three stock option plans is as follows (shares in 000’s):
 
   
Shares
   
Weighted
Average Price
 
Outstanding at December 31, 2010
    761     $ 4.08  
Granted
    -       -  
Exercised
    -       -  
Expired
    241       4.33  
Forfeited
    -       -  
Outstanding at December 31, 2011
    520     $ 3.97  
Granted
    -       -  
Exercised
    -       -  
Expired
    169       3.40  
Forfeited
    -       -  
Outstanding and exercisable at December 31, 2012
    351     $ 4.24  
 
The Company did not issue any options during 2012 and 2011.  When the Company issues options, the Black-Sholes pricing model is used to value stock options at issuance date.  Stock option grants generally have a contractual term of 10 years.  No options vested during 2012, and the grant date fair value of options vesting in 2011 was $44,000.  The aggregate intrinsic value of stock options outstanding at December 31, 2012 was $21,000.  The Company recorded no expense related to stock options in 2012 due to all outstanding stock options having become fully vested in the second quarter of 2011.  We recognized approximately $2,000 of compensation expense relating to our stock option grants in 2011.  As of December 31, 2012, there was no amount of unrecognized compensation expense related to non-vested stock options.
 
Restricted Stock. Restricted shares were issued under the Innotrac Corporation 2000 Stock Option and Incentive Award Plan and the Innotrac Corporation 2010 Stock Award Plan. Both plans provide for immediate voting rights, forfeiture of unvested shares if a grantee’s employment or service with the Company ends for any reason (other than a change in control, as defined in the plan), and vesting of shares upon the earlier of a change in control or on specific vesting dates. On April 16, 2007, 265,956 shares of restricted stock were issued to certain executives under the terms provided in the 2000 Plan.  The grant date fair value of this award was $2.82 per share.  On March 29, 2010, 260,000 restricted shares were issued to certain executives and the Board of Directors under the terms provided in the 2010 Plan which plan was ratified on June 2, 2010 at the Company’s 2010 annual meeting.  The grant date fair value of this award was $1.64 per share.  On June 10, 2011, 310,000 shares of restricted stock were issued to certain executives and the Board of Directors under the terms provided in the 2010 Plan.  On August 31, 2012, 145,000 shares of restricted stock were issued to certain executive and the Board of Directors under the terms provided in the 2010 Plan.  The vesting period for all restricted shares issued prior to June 2012 is 25% on each of the 7th, 8th, 9th and 10th anniversary of the issuance date, or earlier upon a change in control.  Vesting for restricted shares issued to employees in June 2011 follow the same schedule of 25% on each of the 7th, 8th, 9th and 10th anniversary of the issuance date, or earlier upon a change in control.  The vesting period for restricted shares issued to Directors of the Company beginning in June 2012 follows the same schedule of 25% on each of the 7th, 8th, 9th, and 10th anniversary (or earlier upon a change in control), unless the Director’s service with the Company terminates other than for cause prior to all shares vesting, in which case shares vest one third on the date of issuance and one third on each of the 1st and 2nd anniversary of the issuance date.
 
 
40

 
 
A summary of restricted stock activity during the years ended December 31, 2012 and 2011 is as follows:
 
   
Shares
   
Weighted
Average Grant
Date Fair Value
 
Non-vested at December 31, 2010
    525,956     $ 2.24  
Granted
    310,000       1.70  
Vested
    (13,333 )     1.70  
Forfeited
    (135,319 )     2.54  
Non-vested at December 31, 2011
    687,304       2.09  
Granted
    145,000       1.50  
Vested
    (23,333 )     2.63  
Forfeited
    (25,000 )     1.70  
Non-vested at December 31, 2012
    783,971     $ 2.12  
 
We recognized approximately $164,000 and $39,000 of compensation expense relating to our restricted stock grants in 2012 and 2011, respectively.  As of December 31, 2012, there was approximately $1.0 million of unrecognized compensation expense related to non-vested restricted stock.  This cost is expected to be recognized over a weighted average period of 7.2 years.
 
11.           RELATED PARTY TRANSACTIONS
 
Policy on Related Party Transactions
 
The Company recognizes that transactions between the Company or its subsidiaries and any of its directors or executive officers can present potential or actual conflicts of interest.  Accordingly, as a general matter it is the Company’s preference to avoid such transactions.  Nevertheless, the Company recognizes that there are circumstances where such transactions may be in, or not inconsistent with, the best interests of the Company.  Therefore, the Company has adopted a formal policy that requires the Company’s Audit Committee to review and, if appropriate, approve or ratify any such transactions.  Pursuant to the policy, the Committee will review any transaction in which the Company is or will be a participant and the amount involved exceeds $120,000, and in which any of the Company’s directors, executive officers or 5% shareholders had, has or will have a direct or indirect material interest.  After its review, the Committee will only approve or ratify those transactions that are in, or are not inconsistent with, the best interests of the Company and its shareholders.
 
Certain Related Party Transactions
 
The Company leases a single engine aircraft from a company wholly-owned by the Chairman and Chief Executive Officer, pursuant to an agreement that provides for the Company to pay for approximately 86% of all expenses associated with this aircraft.  This allocation is determined annually based on actual business usage.  The Company paid approximately $224,000 and $201,000 for the years ended December 31, 2012 and 2011, respectively.  In August 2012, the Company made $367,000 in improvements to the aircraft which will be depreciated over the ten year term of the lease.  Under the terms of the airplane lease between the Company and the Chairman and Chief Executive Officer, i) should the airplane not be made available for use as required by the Company, the Chief Executive Officer will reimburse the Company for the undepreciated portion of the improvements, and ii) if the Company should cancel the lease of the aircraft before its contract term ending in August 2022, the Company would not require the Chief Executive to reimburse the Company for the undepreciated portion of the improvements.
 
In 2003, the Company and the IPOF Group (consisting of IPOF Fund, LP and its general partner, David Dadante), which as of December 31, 2012 beneficially owned approximately 4.3 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.
 
 
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During 2004, the Company became 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 Settlement Agreement regarding the potential Section 16(b) liability issues that provided for the Company’s recovery in 2006 of $301,957.  In December 2005, the United States District Court in Cleveland, Ohio appointed a receiver to identify and administer the assets of the IPOF Fund, L.P. and its general partner, David Dadante.  The Company informed the IPOF receiver of such agreement, but the likelihood of recovering such amount from the receiver is doubtful.  The Company has not recorded any estimated receivable from this settlement.
 
The United States District Court in Cleveland, Ohio has appointed a receiver to identify and administer the assets of the IPOF Fund, L.P. and its general partner, Mr. David Dadante.  Based on information from the receiver, the Company understands that the Fund and Mr. Dadante own 4,321,777 shares of common stock of the Company, representing approximately 33.1% of the total shares outstanding, all of which are held as collateral in margin accounts maintained at several financial institutions.  The Company continues to engage in discussions from time to time with the receiver in an effort to cause the shares to be sold in a manner that causes as little disruption to the market for Company stock as possible.  The Federal Court has indefinitely restricted the financial institutions holding Company stock owned by the IPOF Fund and Mr. Dadante in margin accounts from selling any of these shares.  The court has permitted open market sales by the receiver as he may in his sole discretion determine to be consistent with his duty to maximize the value of the assets of IPOF Fund, and as warranted by market conditions.  The receiver has indicated to the Company that he does not intend to direct any open market sales during this period except in circumstances in which he believes that there would be no material adverse impact on the market price for the Company’s shares.
 
12.           QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
 
(000’s, except per share data)
 
First
   
Second
   
Third
   
Fourth
 
                         
2012 Quarters:
                       
     Revenues, net
  $ 24,170     $ 22,946     $ 25,694     $ 34,884  
     Operating income (loss)
    497       512       1,194       1,563  
     Net income (loss)
    445       441       1,105       1,485  
     Net income (loss) per share-basic
    0.03       0.03       0.08       0.11  
     Net income (loss) per share-diluted
    0.03       0.03       0.08       0.11  
                                 
2011 Quarters:
                               
     Revenues, net
  $ 20,969     $ 18,614     $ 19.517     $ 25,584  
     Operating income (loss)
    (480 )     (768 )     (446 )     343  
     Net income (loss)
    (526 )     (816 )     (490 )     294  
     Net income (loss) per share-basic
    (0.04 )     (0.06 )     (0.04 )     0.02  
     Net income (loss) per share-diluted
  $ (0.04 )   $ (0.06 )   $ (0.04 )   $ 0.02  
                                 
 

 
42

 
 
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
None.
 
ITEM 9A.
CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures
 
The Company’s management, under the supervision and with the participation of the Company's Chief Executive Officer and Chief Accounting (and principal accounting) Officer, carried out an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) as of December 31, 2012.   Based upon that evaluation, the Chief Executive Officer and Chief Accounting Officer concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report.
 
Management’s Report on Internal Control over Financial Reporting
 
A company’s internal control over financial reporting is a process designed by, or under the supervision of, a public company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles (“GAAP”) including those policies and procedures that: (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company, (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures are being made only in accordance with authorizations of management and directors of the company, and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
 
Management is responsible for establishing and maintaining adequate internal control over financial reporting. Our management, with the participation of our Chief Executive Officer and Accounting Officer, has assessed the effectiveness of our internal control over financial reporting as of December 31, 2012. In making this assessment, our management used the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).  Based upon that assessment, the Chief Executive Officer and Accounting Officer concluded that the Company’s internal controls over financial reporting were effective as of the end of the period covered by this report.
 
This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting.  Management’s report is not subject to attestation by our independent registered public accounting firm pursuant to the rules of the SEC for small companies.
 
Changes in Internal Control over Financial Reporting
 
There were no changes in the Company’s internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during the quarter ended December 31, 2012 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
ITEM 9B.           OTHER INFORMATION
 
None.
 
 
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PART III
 
ITEM 10.  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
 
The information required by this Item 10 contained under the headings “Board Matters,” “Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the definitive Proxy Statement used in connection with the solicitation of proxies for the Company’s 2012 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.
 
ITEM 11.  EXECUTIVE COMPENSATION
 
The information required by this Item 11 contained under the heading “Compensation of Executive Officers and Directors” included in the definitive Proxy Statement used in connection with the solicitation of proxies for the Company’s 2012 Annual Meeting of Shareholders, to be filed with the Commission, is hereby incorporated herein by reference.
 
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS