| INNOTRAC CORP ITEM 1A RISK FACTORS |
| 10 ITEM 1A RISK FACTORS WE RELY ON A SMALL NUMBER OF LARGE CLIENTS IF WE LOSE ONE OR MORE OF OUR LARGEST CLIENTS, OR IF REVENUES FROM OUR LARGEST CLIENTS DECLINE, OUR BUSINESS COULD BE ADVERSELY AFFECTED Innotrac focuses on developing long-term contractual relationships with large corporations |
| A relatively small number of our clients account for a significant portion of our revenues |
| Our ten largest clients accounted for 81dtta4prca of our revenue in 2005 |
| 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 assure you that we will be able to replace or supplement that client with others that generate comparable revenues or profits |
| One of our largest clients, BellSouth, recently announced that it plans to merge with AT&T We cannot predict what impact, if any, this merger will have on our business, if consummated |
| OUR WRITTEN CONTRACTS GENERALLY DO NOT GUARANTEE SPECIFIC VOLUME LEVELS AND CAN USUALLY BE TERMINATED ON LITTLE NOTICE Although we have written agreements with most of our clients, our agreements generally do not assure specific volume or revenue levels |
| In addition, some agreements provide for termination for any reason on short notice |
| Our current agreement with BellSouth may be terminated by BellSouth for any reason upon 90 days notice |
| Furthermore, we are contractually bound to our facility leases until their terms expire |
| If a client terminates its contract suddenly, we will still have obligations under our leases |
| 10 A SIGNIFICANT PORTION OF OUR BUSINESS IS CONCENTRATED IN THE TELECOMMUNICATIONS INDUSTRY, INCLUDING DSL MODEMS Approximately 33prca of our revenues in 2005 and approximately 38prca of our revenues in 2004 were attributable to Telecommunications products and Modems clients |
| Consequently, we are particularly susceptible to negative changes affecting these industries in general |
| The telecommunications industry has suffered a material downturn since mid-2000, which has had a significant negative impact on our business |
| To ameliorate this risk, we have been diversifying our client base across more industries and clients, including through selective acquisitions |
| We cannot guarantee, however, that the telecommunications industry will strengthen in 2006 or not deteriorate further, or that our diversification strategy will be successful |
| A SIGNIFICANT PORTION OF OUR BUSINESS IS CONCENTRATED IN THE DIRECT RESPONSE INDUSTRY Approximately 23prca of our revenues in 2005 and approximately 21prca of our revenues in 2004 were attributable primarily to clients in the direct response industry |
| Consequently, we are particularly susceptible to negative changes that impact this industry and our clients in particular, including potential false advertising product claims and Federal Trade Commission regulation and enforcement |
| The direct response industry has suffered a material downturn since the third quarter of 2001, which has had a significant negative impact on our business |
| This general downturn has significantly weakened the financial strength and wherewithal of companies in this sector which increases our risk pertaining to future business, growth and the collectibility of accounts receivable from our existing clients |
| If any of our existing direct response clients were to default on their amounts due Innotrac, this would result in a material charge against earnings |
| A former client, Tactica, has a material past due balance for which a reserve has been recorded |
| COMPETITION MAY HURT OUR BUSINESS We operate in highly competitive and price sensitive markets and expect this environment to persist and intensify in the future |
| Because our services comprise marketing and product consultation, sales channel management, fulfillment and back-end support, including our call center operations and returns processing, we have many competitors who offer one or more of these services |
| Our competitors include: - in-house marketing support operations of our current and potential clients; - other firms offering specific services, like fulfillment and call center operations; and - large marketing support services firms |
| A number of our competitors have developed or may develop financial and other resources greater than ours |
| Additional competitors with greater name recognition and resources may enter our markets |
| Our existing or potential clients &apos in-house operations are also significant competitors |
| Our performance and growth could be negatively impacted if: - existing clients demand and receive pricing concessions; - existing clients decide to provide, in-house, services they currently outsource; - potential clients retain or increase their in-house capabilities; or - existing clients consolidate their outsourced services with other companies |
| In addition, competitive pressures from current or future competitors could result in significant price erosion, which could in turn materially adversely affect our business, financial condition and results of operations |
| For more information about our competition, see "e Business--Competition "e in Item 1 |
| 11 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 &apos needs; and - introduce new services and products to respond to technological developments |
| If we fail to maintain our technological capabilities or respond effectively to technological changes, our business, results of operations and financial condition could be materially adversely affected |
| We cannot assure you that we will select, invest in and develop new and enhanced technology on a timely basis in the future in order to meet our clients &apos needs and maintain competitiveness |
| Our Reno systems, which provide service to several of our largest clients, are 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 "e Business--Technology "e in Item 1 |
| OUR QUARTERLY RESULTS MAY FLUCTUATE, WHICH MAY CAUSE SIGNIFICANT SWINGS IN THE MARKET PRICE FOR OUR COMMON STOCK Our operating results may fluctuate in the future based on many factors |
| These factors include, among other things: - changes in the telecommunications industry; - changes in the retail industry; - changes in the fulfillment and call center services industries; - changes in the timing and level of client-specific marketing programs, including the timing and nature of promotions; - changes in our existing client base; - pricing pressure or concessions; - increased competition; and - changes in customer purchasing patterns for products we fulfill |
| Due to these and any other unforeseen factors, it is possible that in some future quarter our operating results may be below the expectations of public market analysts and investors |
| If that variance occurs, our common stock price would likely decline materially |
| OUR COMMON STOCK LACKS LIQUIDITY AND IS HELD BY A SMALL NUMBER OF INVESTORS, ONE OF WHICH IS IN RECEIVERSHIP WHERE ITS CREDITORS WOULD LIKE TO SELL OUR SHARES AS SOON AS POSSIBLE As of December 31, 2005, Innotrac officers and directors owned approximately 47dtta3prca of the outstanding common stock and an institutional shareholder, IPOF Fund, LP, and their affiliates held 34dtta0prca |
| These ownership positions have resulted in a lack of liquidity in our common stock |
| Additionally, if any of Innotracapstas 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, LP and its general partner, Mr |
| Based on information from the receiver, the Company understands that the Fund and Mr |
| Dadante own 4cmam176cmam725 shares of common stock of the Company, representing approximately 34dtta0prca of the total shares outstanding, all of which are held as collateral in margin accounts maintained at several financial institutions |
| The Company has been engaged in discussions 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 prohibited the financial 12 institutions holding Company stock owned by the IPOF Fund and Mr |
| Dadante in margin accounts from selling any of these shares through at least July 14, 2006 |
| 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 Companyapstas 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 continuing prohibition by the Federal Court on sales of our shares by financial institutions that hold the shares in margin accounts |
| The Federal Court has extended this prohibition on several occasions, most recently to July 14, 2006, while we and the receiver pursue the sale of these shares in a manner that would not disrupt the market for our common stock |
| If the Federal Court were to not extend 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 |
| IF OUR GOODWILL IS DEEMED IMPAIRED AS PART OF OUR ANNUAL (OR EARLIER) IMPAIRMENT TEST, THE IMPAIRMENT CHARGE WOULD RESULT IN A DECREASE IN OUR EARNINGS AND NET WORTH Current accounting rules require that goodwill no longer be amortized but be tested for impairment at least annually |
| We have a significant amount of goodwill which, based upon a negative outcome of any impairment test in the future, could result in the write-down of all or a portion of goodwill and a corresponding reduction in earnings and net worth |
| NONCOMPLIANCE WITH ANY OF THE COVENANTS UNDER OUR REVOLVING CREDIT AGREEMENT ALLOWS THE LENDER TO DECLARE ANY OUTSTANDING BORROWING AMOUNTS TO BE IMMEDIATELY DUE AND PAYABLE Our revolving line of credit agreement contains a financial, change of ownership control and other restrictive covenants |
| Noncompliance with any of the covenants allows 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 |
| Although we have been able to obtain waivers and amendments in the past, there is no guarantee that we will be able to do so for any future covenant breaches |
| If the lender does not waiver a future covenant violation, and accelerates the payment date for any amounts outstanding under the credit facility, we might not be able to pay these amounts |
| Failure to comply with the covenants, even if waived by our lenders, also could adversely affect our credit ratings, which could increase our costs of debt financings and impair our ability to obtain additional debt financing |
| DUE TO THE NATURE OF OUR BUSINESS WE HAVE A SIGNIFICANT AMOUNT OF UNSKILLED LABOR AND A HIGH TURNOVER RATE THEREBY INCREASING OUR EXPOSURE TO EMPLOYEE-RELATED LITIGATION Our fulfillment and call centers employ a sizable amount of unskilled labor and generate a high turnover rate |
| We may have to terminate employees from time to time as our business mix changes and labor demands shift among our eight facilities |
| High employee turnover could increase our exposure to employee-related litigation |
| IF WE ARE NOT ABLE TO CONTINUE TO MANAGE OUR INFRASTRUCTURE AND VOLUME GROWTH, OUR BUSINESS COULD BE ADVERSELY AFFECTED Our operations, number of facilities and volume of packages shipped have grown significantly in recent years |
| Our business, results of operations and financial condition could be materially adversely affected if we cannot effectively manage our growth |
| Our continued success depends upon our ability to: 13 - initiate, develop and maintain existing and new client relationships; - respond to competitive developments; - maintain pricing and margins; - continue to develop our sales infrastructure; - attract, train, motivate and retain management and other personnel; and - maintain the high quality of our services |
| IF THE TREND TOWARD OUTSOURCING DOES NOT CONTINUE, OUR BUSINESS WILL BE ADVERSELY AFFECTED Our business, results of operations and financial condition could be materially adversely affected if the trend of businesses outsourcing services not directly related to their principal business activities declines or reverses, or if corporations bring previously outsourced functions back in-house |
| Particularly during general economic downturns, businesses may bring in-house previously outsourced functions in order to avoid or delay layoffs |
| OUR BUSINESS IS SUBJECT TO GOVERNMENT REGULATION, WHICH MAY LIMIT OUR ACTIVITIES OR INCREASE OUR COSTS In connection with the limited amount of outbound telemarketing services that we provide, we must comply with federal and state regulations |
| These include the Federal Communications Commissionapstas rules under the Telephone Consumer Protection Act of 1991 and the Federal Trade Commissionapstas regulations under the Federal Telemarketing and Consumer Fraud and Abuse Prevention Act of 1994, both of which govern telephone solicitation |
| When we conduct outbound telemarketing services, these rules and regulations would apply to that portion of our business |
| Furthermore, there may be additional federal and state legislation or changes in regulatory implementation |
| These changes could include interpretations under the Telecommunications Act of 1996 restricting the ability of telecommunications companies to use consumer proprietary network information (CPNI) or imposing new requirements on telecommunications companies to better ensure security and privacy of CPNI New legislation or regulatory implementation in the future may significantly increase compliance costs or limit our activities, our clients &apos activities or the activities of companies to which we outsource outbound telemarketing functions |
| Additionally, we could be responsible for failing to comply with regulations applicable to our clients or companies to which we outsource telemarketing |
| If unfavorable federal or state legislation or regulations affecting Caller ID service, CPNI, internet service or other technology related to products we fulfill and provide customer support for are adopted, our business, financial condition and results of operations could be materially adversely affected |
| See "e Business -- Government Regulation "e in Item 1 for further information about government regulation of our business |
| IF WE ARE UNABLE TO INTEGRATE ACQUIRED BUSINESSES SUCCESSFULLY AND REALIZE ANTICIPATED ECONOMIC, OPERATIONAL AND OTHER BENEFITS IN A TIMELY MANNER, OUR PROFITABILITY MAY DECREASE If we are unable to integrate previous or potential business acquisitions successfully, we may incur substantial costs and delays in increasing our customer base |
| In addition, the failure to integrate acquisitions successfully may divert managementapstas attention from Innotracapstas existing business and may damage Innotracapstas relationship with its key customers and suppliers |
| Integration of an acquired business may be more difficult when we acquire a business in a market in which we have little or no expertise, or with a corporate culture different from Innotracapstas |