UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C.  20549
 
 FORM
10-Q
 
 (X)  QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 SECURITIES
EXCHANGE ACT OF 1934
 
 For the
Quarterly Period Ended March 31, 2008
 
 OR
 
 (   )  TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 SECURITIES
ACT OF 1934
 
 For the
transition period from  _____________
to _____________
  Commission
file number  000-23740
 
 INNOTRAC CORPORATION
 (Exact
name of registrant as specified in its charter)
 
 
 Georgia
              58-1592285(State
      or other jurisdiction of
              (I.R.S.
      Employerincorporation
      or organization)
              Identification
      Number)6655 Sugarloaf Parkway Duluth,
      Georgia
              30097(Address
      of principal executive offices)
              (Zip
      Code)
 
 Registrant's
telephone number, including area code:(678)
584-4000
  Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.  Yes o  No 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  oNon-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
12-b-2 of the Act) Yes o  No x
 
 Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date.
 
 Outstanding at May 10,
      2008Common
      Stock $.10 par value per share
              12,319,803
      Shares
  
  INNOTRAC
CORPORATION
 
 INDEX
 
 
 PagePart
      I.  Financial InformationItem
      1.
              Financial
      Statements:
              2Condensed
      Balance Sheets at  March 31, 2008 (Unaudited) and December 31,
      2007
              3Condensed
      Statements of Operations for the Three Months Ended March 31, 2008 and
      2007 (Unaudited)
              4Condensed
      Statements of Cash Flows for the Three Months Ended March 31, 2008 and
      2007 (Unaudited)
              5Notes
      to Condensed Financial Statements (Unaudited)
              6Item
      2.
              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
              13Item
      3.
              Quantitative
      and Qualitative Disclosures About Market Risk
              22Item
      4.
              Controls
      and Procedures
              22Part
      II.  Other InformationItem
      6.
              Exhibits
              23Signatures
              
              
              24
 
 1
  Part I – Financial
Information
 
 Item 1 – Financial
Statements
 The
following condensed financial statements of Innotrac Corporation, a Georgia
corporation (“Innotrac” or the “Company”), have been prepared in accordance with
the instructions to Form 10-Q and, therefore, omit or condense certain footnotes
and other information normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America.  In the opinion of management, all adjustments are of a
normal and recurring nature, except those specified as otherwise, and include
those necessary for a fair presentation of the financial information for the
interim periods reported.  Results of operations for the three months
ended March 31, 2008 are not necessarily indicative of the results for the
entire year ending December 31, 2008.  These financial statements
should be read in conjunction with the statements and notes thereto included in
the Company’s 2007 Annual Report on Form 10-K, which is available on our website
at www.innotrac.com.
  2
  INNOTRAC
CORPORATION
 CONDENSED
BALANCE SHEETS
 (in
thousands, except share data)
 
 ASSETS
              
              March 31, 2008
              
              
              December 31, 2007(unaudited)Current
      assets:Cash
      and cash equivalents
              
              $
              51
              
              
              $
              1,079Accounts
      receivable (net of allowance for doubtful accounts of $303
    atMarch
      31, 2008 and $288 at December 31, 2007)
              
              
              24,811
              
              
              
              28,090Inventories,
      net
              
              
              1,073
              
              
              
              599Prepaid
      expenses and other
              
              
              1,592
              
              
              
              1,100Total
      current assets
              
              
              27,527
              
              
              
              30,868Property
      and equipment:Rental
      equipment
              
              
              259
              
              
              
              286Computer
      software and equipment
              
              
              40,596
              
              
              
              40,479Furniture,
      fixtures and leasehold improvements
              
              
              7,819
              
              
              
              7,81548,674
              
              
              
              48,580Less
      accumulated depreciation and amortization
              
              
              (31,901
              )
              
              
              (30,878
              )16,773
              
              
              
              17,702Goodwill
              
              
              25,169
              
              
              
              25,169Other
      assets, net
              
              
              1,112
              
              
              
              1,192Total
      assets
              
              $
              70,581
              
              
              $
              74,931LIABILITIES
      AND  SHAREHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
              
              $
              10,688
              
              
              $
              14,050Line
      of credit
              
              
              5,036
              
              
              
              6,168Term
      Loan
              
              
              5,000
              
              
              
              5,000Accrued
      expenses and other
              
              
              5,003
              
              
              
              5,708Total
      current liabilities
              
              
              25,727
              
              
              
              30,926Noncurrent
      liabilities:Other
      noncurrent liabilities
              
              
              940
              
              
              
              993Total
      noncurrent liabilities
              
              
              940
              
              
              
              993Commitments
      and contingencies (see Note 5)Shareholders’
      equity:Preferred
      stock:  10,000,000 shares authorized, $0.10 par
      value,no
      shares issued or outstanding
              
              
              -
              
              
              
              -Common
      stock:  50,000,000 shares authorized, $0.10 par
      value,12,585,759
      issued and 12,319,803 shares outstanding
              
              
              1,259
              
              
              
              1,259Additional
      paid-in capital
              
              
              66,291
              
              
              
              66,251Accumulated
      deficit
              
              
              (23,636
              )
              
              
              (24,498
              )Total
      shareholders’ equity
              
              
              43,914
              
              
              
              43,012Total
      liabilities and shareholders’ equity
              
              $
              70,581
              
              
              $
              74,931
 
  See notes
to condensed financial statements.
 3
 Financial
Statements-Continued
 
 INNOTRAC
CORPORATION
 CONDENSED
STATEMENTS OF OPERATIONS
 For
the Three Months Ended March 31, 2008 and 2007
 (in
thousands, except per share amounts)
 
  Three
      Months Ended March 31,2008
              
              
              2007(unaudited)
              
              
              (unaudited)Service
      revenues
              
              $
              25,471
              
              
              $
              22,115Freight
      revenues
              
              
              7,242
              
              
              
              5,660Total
      revenues
              
              
              32,713
              
              
              
              27,775Cost
      of service revenues
              
              
              12,099
              
              
              
              10,390Freight
      expense
              
              
              7,249
              
              
              
              5,562Selling,
      general and administrative expenses
              
              
              11,079
              
              
              
              11,164Depreciation
      and amortization
              
              
              1,155
              
              
              
              1,285Total
      operating expenses
              
              
              31,582
              
              
              
              28,401Operating
      income (loss)
              
              
              1,131
              
              
              
              (626
              )Other
      expense:Interest
      expense
              
              
              269
              
              
              
              167Total
      other expense
              
              
              269
              
              
              
              167Income
      (loss) before income taxes
              
              
              862
              
              
              
              (793
              )Income
      taxes
              
              
              -
              
              
              
              -Net
      income (loss)
              
              $
              862
              
              
              $
              (793
              )Income
      (loss) per share:Basic
              
              $
              0.07
              
              
              $
              (0.06
              )Diluted
              
              $
              0.07
              
              
              $
              (0.06
              )Weighted
      average shares outstanding:Basic
              
              
              12,320
              
              
              
              12,281Diluted
              
              
              12,605
              
              
              
              12,281
  See notes
to condensed financial statements.
 4
 Financial
Statements-Continued
 
 
 INNOTRAC
CORPORATION
 CONDENSED
STATEMENTS OF CASH FLOWS
 For
the Three Months Ended March 31, 2008 and 2007
 (in
thousands)
 
 Three
      Months Ended March 31,2008
              
              
              2007(unaudited)
              
              
              (unaudited)Cash
      flows from operating activities:Net
      income (loss)
              
              $
              862
              
              
              $
              (793
              )Adjustments
      to reconcile net loss to net income (loss) provided by (used
      in)operating
      activities:Depreciation
      and amortization
              
              
              1,155
              
              
              
              1,285Provision
      for bad debts
              
              
              22
              
              
              
              (46
              )Stock
      compensation expense-stock options
              
              
              21
              
              
              
              19Stock
      compensation expense-restricted stock
              
              
              19
              
              
              
              -Changes
      in operating assets and liabilities:Decrease  in
      accounts receivable, gross
              
              
              3,257
              
              
              
              4,440(Increase)
      decrease in inventory
              
              
              (474
              )
              
              
              144Increase
      in prepaid expenses and other
              
              
              (516
              )
              
              
              (440
              )Decrease
      in accounts payable
              
              
              (3,362
              )
              
              
              (4,398
              )Decrease
      in accrued expenses and other
              
              
              (760
              )
              
              
              (329
              )Net
      cash provided by (used in) operating activities
              
              
              224
              
              
              
              (118
              )Cash
      flows from investing activity:Capital
      expenditures
              
              
              (120
              )
              
              
              (691
              )Net
      cash used in investing activities
              
              
              (120
              )
              
              
              (691
              )Cash
      flows from financing activities:Net
      repayments under line of credit
              
              
              (1,132
              )
              
              
              (140
              )Net
      cash used in financing activities
              
              
              (1,132
              )
              
              
              (140
              )Net
      decrease in cash and cash equivalents
              
              
              (1,028
              )
              
              
              (949
              )Cash
      and cash equivalents, beginning of period
              
              
              1,079
              
              
              
              1,014Cash
      and cash equivalents, end of period
              
              $
              51
              
              
              $
              65Supplemental
      cash flow disclosures:Cash
      paid for interest
              
              $
              307
              
              
              $
              177
 
 See notes
to condensed financial statements.
 5
  INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 March
31, 2008 and 2007
 (Unaudited)
  1.            
SIGNIFICANT ACCOUNTING
POLICIES
 
 The
accounting policies followed for quarterly financial reporting are the same as
those disclosed in the Notes to Financial Statements included in the Company’s
Annual Report on Form 10-K filed with the Securities and Exchange Commission for
the year ended December 31, 2007.  Certain of the Company’s more
significant accounting policies are as follows:
 
 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.
 
 Goodwill and Other Acquired
Intangibles.   Goodwill represents the cost of an acquired
enterprise in excess of the fair market value of the net tangible and
identifiable intangible assets acquired.  The Company tests goodwill
annually for impairment as of January 1 or sooner if circumstances
indicate.
 
 Impairment of Long-Lived
Assets.  The Company reviews long-lived assets and certain
intangible assets for impairment when events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. Impairment
would be measured based on a projected cash flow model.  If the
projected undiscounted cash flows for the asset are not in excess of the
carrying value of the related asset, the impairment would be determined based
upon the excess of the carrying value of the asset over the projected discounted
cash flows for the asset.
 
 Accounting for Income
Taxes.Innotrac utilizes the liability method of accounting
for income taxes.  Under the liability method, deferred taxes are
determined based on the difference between the financial and tax basis of assets
and liabilities using enacted tax rates in effect in the years in which the
differences are expected to reverse. A valuation allowance was recorded against
the net deferred tax asset as of December 31, 2007 and March 31, 2008 (see Note
4).
  Revenue Recognition. Innotrac derives its
revenue primarily from two sources: (1) fulfillment operations and (2) the
delivery of call center services integrated with our fulfillment
operations. Innotrac's fulfillment services operations record revenue at
the conclusion of the material selection, packaging and shipping
process. The shipping process 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 service  revenue
is recognized according to written pricing agreements based on the number
of calls, minutes or hourly rates when those calls and time rated services
occur.  All other revenues are recognized as services are
rendered.
  Stock-Based Compensation
Plans.In December
2004, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standard (“SFAS”) No. 123(R), “Share-Based Payment,” which
revises SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123(R)
requires all share-based payments to employees, including grants of employee
stock options, to be recognized as compensation expense in the financial
statements based on their fair values.  That expense will be
recognized over the period during which an employee is required to provide
services in exchange for the award, known as the requisite service period
(usually the vesting period).  The Company adopted SFAS No. 123(R)
effective January 1, 2006 using the Modified Prospective Application
Method.  Under this method, SFAS 123(R) applies to new awards and to
awards modified, repurchased or cancelled after the effective
date.  Additionally, compensation expense for the portion of awards
for which the requisite service has not been rendered that are outstanding as of
the required effective date shall be recognized as the requisite service is
performed on or after the required effective date.  Under the
requirements of  SFAS No. 123(R) the Company recorded $21,000 and
$19,000 in compensation expense for the three months ended March 31, 2008 and
2007, respectively.  As of March 31, 2008, approximately $105,000 of
unrecognized compensation expense related to non-vested stock options is
expected to be recognized over the following 37 months.
  6
 INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 March
31, 2008 and 2007
 (Unaudited)
  The fair
value of each option was estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted average
assumptions:
 
 Three
      months endedMarch
      31, 2008
              
              
              March
      31, 2007Risk-free
      interest rate
              
              3.51%
              
              
              4.
      56%Expected
      dividend yield
              
              0%
              
              
              0%Expected
      lives
              
              2.0
      Years
              
              
              2.0
      YearsExpected
      volatility
              
              75.3%
              
              
              71.9%
 
 Fair Value
Measurements.  In September 2006, the FASB issued SFAS
No. 157, “Fair Value Measurements” (“SFAS No. 157”).
SFAS No. 157 defines fair value, establishes a framework for measuring
fair value in accordance with accounting principles generally accepted in the
United States, and expands disclosures about fair value measurements.
SFAS No. 157 was effective for fiscal years beginning after
November 15, 2007, with earlier application encouraged. Any amounts
recognized upon adoption as a cumulative effect adjustment will be recorded to
the opening balance of retained earnings (deficit) in the year of adoption.
There was no impact on the Company’s financial statements upon adoption on
January 1, 2008.
  Effective
January 1, 2008 on a prospective basis, we determined the fair values of certain
financial instruments based on the fair value hierarchy established in SFAS No.
157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 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 price (unadjusted) in active markets for identical assets
 
 Level 2:
inputs to the valuation methodology include quoted prices for similar assets and
liabilities in active markets, and inputs that are observable for the asset or
liability, either directly or indirectly, for substantially the full term of the
instrument
 
 Level 3:
inputs to the valuation methodology are unobservable for the asset or
liability
 
 SFAS No.
157 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.
 
 To
measure fair value, we obtain statements of amounts outstanding for our debt
instruments since our debt instruments consist of a revolving credit line and a
term note which mature within one year of March 31, 2008.
 
 Assets
and liabilities measured at fair value on a recurring basis are summarized
below:
 
 As
      of March 31, 2008Fair
      Value Measurements Using
                  (S
      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$
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -Total
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -
 
 As noted
in the above table, we did not have any assets or liabilities measured at fair
value on a recurring basis using quoted market prices in active markets (Level
1), significant other observable inputs (Level 2) or significant unobservable
inputs (Level 3) during the period.
 
 Assets
and Liabilities Recorded at Fair Value on a Non-recurring Basis
 
 As
allowed under FSP FAS 157-2, “Effective Date of FASB Statement No. 157”, as of
January 1, 2008, we have elected not to fully adopt SFAS No. 157 and are
deferring adoption for certain non-financial assets and liabilities until
January 1, 2009.  We are evaluating the effect, if any of the full
adoption of SFAS No. 157 for certain non-financial assets and
liabilities.
 
 2.             FINANCING
OBLIGATIONS
 
 The
Company has a revolving credit facility with Wachovia Bank, which has a maximum
borrowing limit of $15.0 million.  The revolving credit facility is
used to fund the Company’s capital expenditures, operational working capital and
seasonal working capital needs.  At March 31, 2008 the Company also
had a $5.0 million second lien loan outstanding to a credit management
company.  The specific terms of the $5.0 million second lien loan are
more fully described below.  The combined amount outstanding at March
31, 2008 under these two financing obligations was $10.0 million.
 
 The
revolving bank credit agreement matures in March 2009 and has a maximum
borrowing limit of $15.0 million.  Although the maximum borrowing
limit is $15.0 million, the credit facility limits borrowings to a specified
percentage of eligible accounts receivable and inventory, which totaled $17.9
million at March 31, 2008.  As provided for in the second waiver
agreement dated April 16, 2007, our Chairman and Chief Executive Officer, Scott
Dorfman, has granted to the bank a security interest in $2.0 million of his
personal securities, which after application of a 75% factor, results in $1.5
million of additional collateral to support the borrowing limit of $15.0 million
under the credit facility.  Additionally, the terms of the credit
facility provide that the amount borrowed and outstanding at any time combined
with certain reserves for rental payments, letters of credit outstanding and
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
March 31, 2008 amounted to $19.4 million.  The amount borrowed and
outstanding and the total value of reserves and letters of credit outstanding at
March 31, 2008 amounted to $5.0 million.  As a result, the Company had
$10.0 million of borrowing availability under the revolving credit line at March
31, 2008.
  7
  INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 March
31, 2008 and 2007
 (Unaudited)
   The
Company has granted a security interest in all of its assets to the lender as
collateral under this revolving credit agreement.  The revolving
credit agreement contains a restrictive fixed charge coverage
ratio.  The provisions of the revolving credit agreement require that
the Company maintain a lockbox arrangement with the lender, and allows the
lender to declare any outstanding borrowing amounts to be immediately due and
payable as a result of noncompliance with any of the
covenants.  Accordingly, in the event of noncompliance, these amounts
could be accelerated.  The fixed charge coverage ratio requires the
Company to maintain a minimum twelve month trailing fixed charge coverage ratio
of 0.9 to 1.0 from December 2007 through March 2008, 1.0 to 1.0 for the months
of April and May 2008, 1.05 to 1.0 from June through September 2008 and 1.1 to
1.0 from October 2008 through the maturity of the facility in March
2009.  The Company was  in compliance with the terms and
conditions of the revolving credit agreement, as amended, and the Second Lien
Credit Agreement as of March 31, 2008.
 
 On
September 28, 2007 the Company and the bank entered into the fifth amendment to
its revolving bank credit facility entitled “Fifth Amendment Agreement” (the
“Fifth Amendment”) whereby the bank agreed to the Company’s entering into a debt
obligation described as the “Second Lien Credit Agreement” which is subordinated
to the bank’s position as senior lender to the Company.  The Second
Lien Credit Agreement was entered into with Chatham Credit Management III, LLC,
as agent for Chatham Investment Fund III, LLC, Chatham Investment Fund QP III,
LLC, and certain other lenders party thereto from time to time, and Chatham
Credit Management III, LLC, as administrative agent (Chatham Credit Management
III, LLC, Chatham Investment Fund III, LLC, Chatham Investment Fund QP III, LLC,
and Chatham Credit Management III, LLC are collectively referred to as
“Chatham”).  The proceeds of the $5.0 million Second Lien Credit
Agreement were needed to fund fourth quarter 2007 capital expenditure projects
and provide seasonal working capital needs in the same quarter resulting from
high revenue growth through the nine months ended September 30,
2007.  We anticipate repaying the term loan, from cash generated from
operations, before September 28, 2008; the one year anniversary of its
inception.
 
 The
Second Lien Credit Facility has a one year term with the option to renew for
five months resulting in an ultimate maturity date of March 1, 2009, the same
date on which the revolving bank credit agreement, described above,
matures.  If the option to renew for five months is exercised, the
Company will be obligated to pay a $62,500 success fee which amount is five
twelfth’s of the success fee paid when the loan was entered into on September
28, 2007.  There are no scheduled principal payments before maturity
under the Second Lien Credit Facility.  Borrowings under the Second
Lien Credit Facility bear interest at an annual rate equal to the greater of (a)
LIBOR or (b) 5.75% plus 9.25% for a rate of 15%.  Interest on
borrowings under the Second Lien Credit Facility which accrued from inception to
December 31, 2007 was paid on January 2, 2008.  Interest accruing
during the period from January 1, 2008 through June 30, 2008 was, according to
the terms of the Second Lien Credit Facility paid on January 1, 2008 when the
Company signed an additional note for the value of the interest for that period
of $379,000.  Under the terms of the additional note, if the Company
repays any or all of the $5.0 million outstanding under the Second Lien Credit
Facility before June 30, 2008, the amount owed under the additional note would
not change.  The additional note will be repaid in accordance with the
terms of the Second Lien Credit Agreement.  In the event of default,
all obligations will bear interest at the otherwise applicable rate plus 2.00%
per annum until the event of default is cured.
 
 The
Company’s obligations under the Second Lien Credit Facility are secured by a
second priority security interest in, and a second priority lien on,
substantially all of the assets and property of the Company.  The
Company’s obligations under the Second Lien Credit Facility are partially
guaranteed by Scott Dorfman, the Company’s Chairman, President, and Chief
Executive Officer, pursuant to a Limited Guaranty Agreement between Mr. Dorfman
and Chatham Credit Management III, LLC.  Mr. Dorfman has also pledged
as partial collateral for the loans under the Second Lien Credit Facility,
pursuant to a Guarantor Pledge Agreement between Mr. Dorfman and Chatham Credit
Management III, LLC, the membership interests he owns in Chatham Investment Fund
II, LLC and Chatham Investment Fund III, LLC (collectively, the “Chatham
Funds”).  Mr. Dorfman’s guarantee is limited to the value of this
Chatham Funds collateral.  Chatham Investment Fund III, LLC is one of
the lenders under the Second Lien Credit Agreement, and both of the Chatham
Funds are affiliated with the other Chatham entities acting as agents and
lenders under the Second Lien Credit Agreement.  Mr. Dorfman
previously served on the advisory board of Chatham Investment Fund II,
LLC.
  8
  INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 March
31, 2008 and 2007
 (Unaudited)
 The
Second Lien Credit Agreement contains a fixed charge coverage ratio covenant
with the same ratio requirements as those included in the revolving credit
agreement with Wachovia.  The Second Lien Credit Agreement also limits
the amount of capital expenditures the Company may make in any fiscal year
beginning in the fiscal year 2008 to $4,500,000.  The Second Lien
Credit Agreement contains representations and warranties, affirmative and
negative covenants and events of default (and, as appropriate, grace
periods).  Simultaneous with the execution of the Fifth Amendment and
the Second Lien Credit Agreement on September 28, 2007, the bank and Chatham
entered into an intercreditor agreement defining the relative priority of
security interests and other subordination terms.
 
 Interest
on borrowings under the revolving credit agreement is payable monthly at rates
equal to the prime rate, or at the Company’s option, LIBOR plus up to 200 basis
points; however so long as the fixed charge ratio is less than 1.00 to 1.00, the
interest rate will be equal to the prime rate plus 1% or at the Company’s
option, LIBOR plus 285 basis points.  Interest on borrowings under the
Second Lien Credit Agreement is accrued on a monthly basis equal to the greater
of (a) LIBOR or (b) 5.75% plus 9.25% for a rate of 15% of the principal balance
plus accrued interest payable outstanding on the $5.0 million
loan.  For the three months ended March 31, 2008, we recorded interest
expense of $77,000 on the revolving credit agreement at a weighted average
interest rate of 5.42% and $190,000 of interest expense on the Second Lien
Credit Agreement.  Our weighted average interest rate for the three
months ended March 31, 2008, including amounts borrowed under both the revolving
credit agreement and the Second Lien Credit Agreement, was 9.9%.  At
March 31, 2008, the rate of interest being charged on the revolving credit
agreement and the Second Lien Credit Agreement was 5.55% and 15.0%
respectively.  The Company also incurred unused revolving credit
facility fees of approximately $5,000 and $9,000 for the three months ended
March 31, 2008 and 2007 respectively.
 
 Based on
current projections, the Company believes that it will be able to comply with
the terms and conditions of the revolving credit agreement, as amended, and the
Second Lien Credit Agreement.
 
 3.
              EARNINGS PER
      SHARE
 
 The
following table shows the shares (in thousands) used in computing diluted
earnings per share (“EPS”) in accordance with Statement of Financial Accounting
Standards No. 128, “Earnings per Share”:
 
 Three
      Months
                Ended
      March 31,2008
              
              
              2007Diluted
      earnings per share:Weighted
      average shares outstanding
              
              
              12,320
              
              
              
              12,281Employee
      and director stock options and unvested restricted shares
              
              
              285
              
              
              
              -Weighted
      average shares assumingdilution
              
              
              12,605
              
              
              
              12,281
  9
  INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 March
31, 2008 and 2007
 (Unaudited)
 Options
outstanding to purchase 1.2 million shares of the Company’s common stock for the
three months ended March 31, 2008 and 1.6 million shares for the three months
ended March 31, 2007 were not included in the computation of diluted EPS because
their effect was anti-dilutive.  On April 16, 2007 265,956 restricted
shares were issued, but not vested, under the terms provided in the Executive
Retention Plan which plan was ratified on June 5, 2005 at the Company’s 2005
annual meeting.
 
 4.
              INCOME
    TAXES
 
 Innotrac
utilizes the liability method of accounting for income taxes.  Under
the liability method, deferred taxes are determined based on the difference
between the financial and tax basis of assets and liabilities using enacted tax
rates in effect in the years in which the differences are expected to
reverse.  A valuation allowance is recorded against deferred tax
assets if the Company considers it is more likely than not that deferred tax
assets will not be realized.  Innotrac’s gross deferred tax asset as
of March 31, 2008 and December 31, 2007 was approximately $18.6 million and
$18.9 million, respectively.  This deferred tax asset was generated
primarily by net operating loss carryforwards created mainly by a special charge
of $34.3 million recorded in 2000 and the net losses generated in 2002, 2003,
2005 and 2006.  Innotrac has a net operating loss carryforward of
$49.1 million at December 31, 2007 that expires between 2022 and
2027.
 
 Innotrac’s
ability to generate the expected amounts of taxable income from future
operations is dependent upon general economic conditions, competitive pressures
on sales and margins and other factors beyond management’s
control.  These factors, combined with losses in recent years, create
uncertainty about the ultimate realization of the gross deferred tax asset in
future years.  Therefore, a valuation allowance of approximately $13.5
million and $13.8 million has been recorded as of March 31, 2008 and December
31, 2007, respectively.  Income taxes associated with future earnings
will be offset by the utilization of the net operating loss carryforward
resulting in a reduction in the valuation allowance.  For the three
months ended March 31, 2008, the deferred tax expense of $337,000 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 is likely it will be able to
utilize the net operating losses prior to their expiration, then the valuation
allowance can be reduced or eliminated.
 
 In June
2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income
Taxes—an interpretation of FASB Statement No. 109(“FIN 48”), which
clarifies the accounting for uncertainty intax positions. This
Interpretation 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 Company adopted FIN 48 effective
January 1, 2007.  The Company has a gross deferred tax asset of
approximately $18.9 million at December 31, 2007, which did not change
significantly during the three months ended March 31, 2008.  As
discussed in Note 6 to the financial statements in the 2007 Form 10-K, the
Company has a valuation allowance against the full amount of its deferred tax
asset.   The Company currently provides a valuation allowance
against deferred tax assets when it is more likely than not that deferred tax
assets will not be realized.  The Company has recognized tax benefits
from all tax positions we have taken, and there has been no adjustment to any
net operating loss carryforwards as a result of FIN 48 and there are no
unrecognized tax benefits and no related FIN 48 tax liabilities at March 31,
2008.  Therefore, the application of FIN 48 had no material impact on
the financial statements.
  10
  INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 March
31, 2008 and 2007
 (Unaudited)
 The
Company generally recognizes interest and/or penalties related to income tax
matters in general and administrative expenses.  As of March 31, 2008,
we have no accrued interest or penalties related to uncertain tax
positions.
 
 5.
              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.
 
 Employment
Commitment.  In June 1999, in conjunction with the opening of a
new call center facility, the Company entered into an employment commitment
agreement with the City of Pueblo, Colorado, whereby the Company received cash
incentives of $968,000.  These funds were accounted for as a reduction
in the basis of the assets acquired.  In return for this
consideration, the Company is obligated to employ a minimum number of full-time
employees at its Pueblo facility, measured on a quarterly basis.  This
obligation, which became effective June 2002, will continue through June
2009.  In the event that the number of full-time employees fails to
meet the minimum requirement, the Company will incur a quarterly penalty of
$96.30 for each employee less than the minimum required
amount.  During the three months ended March 31, 2008, the Company met
the minimum employee requirements of 359 full-time employees, as measured on a
quarterly basis.  However, during the three months ended March 31,
2007, the Company did not meet the minimum employee requirements, incurring a
penalty of approximately $4,000.
 
 6.
              RELATED PARTY
      TRANSACTION
 
 In early
2004, the Company learned that certain trading activity of the IPOF Fund L.P.,
an owner of more than 5% of the outstanding Common Stock, may have violated the
short-swing profit rules under Section 16(b) of the Securities Exchange Act of
1934.  The Company promptly conducted an investigation of the
matter.  IPOF Fund L.P. and its affiliates entered into a settlement
agreement with the Company on March 4, 2004 regarding the potential Section
16(b) liability issues that provided for the Company’s recovery of $301,957 no
later than March 3, 2006.  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. Additionally,
the Federal Court has prohibited the financial institutions holding Company
stock owned by the IPOF Fund and Mr. Dadante in margin accounts from selling any
of these shares through June 6, 2008.  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.
  Pursuant
to the Third Amendment to the Company’s revolving bank credit agreement, Scott
Dorfman, the Company’s Chairman, President and CEO has granted the bank a
security interest in certain personal assets which will be treated as additional
collateral under the credit agreement until the earlier of (x) April 30, 2008
(y) the date all deferred payments in connection with the ClientLogic
acquisition are paid in full, so long as no default exists and the fixed charge
coverage ratio for the most recent period is equal to or greater than 1.05 to
1.00.
  11
  INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 March
31, 2008 and 2007
 (Unaudited)
 On
September 28, 2007, the Company entered into a Second Lien Credit Agreement in
the amount of $5.0 million with Chatham Credit Management III, LLC
(“Chatham”).  Scott Dorfman is a private investor in various funds
managed by Chatham.  The Loan is subordinated to the revolving credit
facility held with Wachovia Bank, N.A.  Additionally, the Second Lien
Credit agreement is partially guaranteed by Mr. Dorfman in an amount up to the
value of Mr. Dorfman’s investment in the Chatham Funds.  The terms of
the loan are more fully described in the Liquidity and Capital Resources section
of this Quarterly Report on Form 10-Q.
  12
  Item
2 -
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
 FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 The
following discussion may contain certain forward-looking statements that are
subject to conditions that are beyond the control of the
Company.  Actual results may differ materially from those expressed or
implied by such forward-looking statements.  Factors that could cause
actual results to differ include, but are not limited to, the Company’s reliance
on a small number of major clients; risks associated with the terms and pricing
of our contracts; reliance on the telecommunications and direct marketing
industries and the effect on the Company of the downturns, consolidation and
changes in those industries in the past three years; risks associated with the
fluctuations in volumes from our clients; risks associated with upgrading,
customizing, migrating or supporting existing technology; risks associated with
competition; and other factors discussed in more detail under “Item 1A – Risk
Factors” in our Annual Report on Form 10-K and in Part II – Item 1A – Risk
Factors in this Quarterly Report on Form 10-Q.  We undertake no
obligation to update any forward-looking statements, whether as a result of new
information, future events or otherwise.
 
 Overview
 
 Innotrac
Corporation (“Innotrac” or the “Company”), founded in 1984 and headquartered in
Atlanta, Georgia, is a full-service fulfillment and logistics provider serving
enterprise clients and world-class brands.  The Company employs
sophisticated order processing and warehouse management technology and operates
eight fulfillment centers and two call centers in seven cities spanning all time
zones across the continental United States.
 
 We
receive most of our clients’ orders either through inbound call center services,
electronic data interchange (“EDI”) or the Internet.  On a same-day
basis, depending on product availability, the Company picks, packs, verifies and
ships the item, tracks inventory levels through an automated, integrated
perpetual inventory system, warehouses data and handles customer support
inquiries.  Our 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.
 
 Our core
service offerings include the following:
 
 Fulfillment
Services:
 ●
              sophisticated
      warehouse management technology●
              automated
      shipping solutions●
              real-time
      inventory tracking and order status●
              purchasing
      and inventory management●
              channel
      development●
              zone
      skipping for shipment cost reduction●
              product
      sourcing and procurement●
              packaging
      solutions●
              back-order
      management; and●
              returns
      management.
 
 Customer
Support Services:
 ●
              inbound
      call center services●
              technical
      support and order status●
              returns
      and refunds processing●
              call
      centers integrated into fulfillment platform●
              cross-sell/up-sell
      services
  13
  Item
2 -
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
 FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
  ●
              collaborative
      chat; and●
              intuitive
      e-mail response.
 
 The
Company is primarily focused on five diverse lines of business, or industry
verticals.  This is a result of a significant effort made by the
Company to diversify both its industry concentration and client base over the
past several years.
 
 Business
Mix
 
 Three
      Months Ended March 31,Business
      Line/Vertical
              
              2008
              
              
              2007Direct
      Marketing
              
              
              36.9
              %
              
              
              31.7
              %Retail/Catalog
              
              
              34.5
              
              
              
              31.8Modems
              
              
              18.4
              
              
              
              17.8Business-to-Business
      (“B2B”)
              
              
              6.9
              
              
              
              12.9Telecommunications
              
              
              3.3
              
              
              
              5.8100.0
              %
              
              
              100.0
              %
 
 Retail, Catalog and Direct
Marketing.  The Company provides a variety of fulfillment and
customer support services for a significant number of retail, catalog and direct
marketing clients, including such companies as Target.com, a Division of Target
Corporation, Ann Taylor Retail, Inc., Smith & Hawken, Ltd., Porsche Cars
North America, Inc. and Thane International.  We take orders for our
retail, catalog and direct marketing clients via the Internet, through customer
service representatives at our Pueblo and Reno call centers or through direct
electronic transmission from our clients.  The orders are processed
through one of our order management systems and then transmitted to one of our
eight fulfillment centers located across the country and are shipped to the end
consumer or retail store location, as applicable, typically within 24 hours of
when the order is received.  Inventory for our retail, catalog and
direct marketing clients is held on a consignment basis, with minor exceptions,
and includes items such as shoes, dresses, accessories, books, outdoor
furniture, electronics, small appliances, home accessories, sporting goods and
toys.  Our revenues are sensitive to the number of orders and customer
service calls received.  Our client contracts do not guarantee
volumes.  We anticipate that the percentage of our total revenues
attributable to our retail and catalog clients will increase during the
remainder of 2008 due to the projected growth rates of our clients’ business in
the retail and catalog vertical being greater than other verticals’ projected
rates of growth.
  Telecommunications and
Modems.  The Company has historically been a major provider of
fulfillment and customer support services to the telecommunications
industry.  In spite of a significant contraction and consolidation in
this industry in the past several years, the Company continues to provide
customer support services and fulfillment of consumer telephones and caller ID
equipment and Digital Subscriber Line Modems (“Modems”) for clients such as
AT&T, Inc. and Qwest Communications International, Inc. and their
customers.  The consolidation in the telecommunications industry
resulted in the acquisition of BellSouth by AT&T in December of
2006.  On November 6, 2007, AT&T notified us that it intended to
transition its fulfillment business in-house.  The transition date was
initially planned for the fourth quarter of 2008 but is now expected to occur
some time in 2009.  After that transition is complete, we project that
our telecommunications and modems customers may represent less than 5% of our
annual revenues.
  14
 Item
2 - MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
 FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
  Business-to-Business.  The
Company also provides fulfillment and customer support services for
business-to-business (“B2B”) clients, including Books Are Fun, Ltd. (a
subsidiary of Reader’s Digest), NAPA and The Walt Disney Company. This is a
relatively steady area of our business.
 
 Results
of Operations
 
 The
following table sets forth unaudited summary operating data, expressed as a
percentage of revenues, for the three months ended March 31, 2008 and
2007.  The data has been prepared on the same basis as the annual
financial statements.  In the opinion of management, it reflects
normal and recurring adjustments necessary for a fair presentation of the
information for the periods presented.  Operating results for any
period are not necessarily indicative of results for any future
period.
 
 The
financial information provided below has been rounded in order to simplify its
presentation.  However, the percentages below are calculated using the
detailed information contained in the condensed financial
statements.
 
 Three
      Months Ended March 31,2008
              
              
              2007Service
      revenues
              
              
              77.9
              %
              
              
              79.6
              %Freight
      revenues
              
              
              22.1
              
              
              
              20.4Total
      Revenues
              
              
              100.0
              %
              
              
              100.0
              %Cost
      of service revenues
              
              
              37.0
              
              
              
              37.4Freight
      expense
              
              
              22.2
              
              
              
              20.0Selling,
      general and administrative expenses
              
              
              33.9
              
              
              
              40.2Depreciation
      and amortization
              
              
              3.5
              
              
              
              4.7Operating  income
      (loss)
              
              
              3.4
              
              
              
              (2.3
              )Other
      expense, net
              
              
              0.8
              
              
              
              0.6Income
      (loss) before income taxes
              
              
              2.6
              
              
              
              (2.9
              )Income
      tax benefit
              
              
              -
              
              
              
              -Net  income
      (loss)
              
              
              2.6
              %
              
              
              (2.9
              )%
  Three
Months Ended March 31, 2008 Compared to Three Months Ended March 31,
2007
 
 Service revenues. Net service
revenues increased 15.2% to $25.5 million for the three months ended March
31, 2008 from $22.1 million for the three months ended March 31,
2007.  This increase was primarily attributable to a $2.2 million
increase in our retail and catalog vertical resulting from increased volume and
improved pricing from existing clients, a $1.9 million increase in our direct
marketing vertical resulting from the addition of several new clients and
increased volume from existing clients, a $1.1 million increase in revenues from
our DSL clients due to increased volumes and improved pricing from existing
clients, offset by a $1.3 million decrease in revenues from our B2B vertical due
to the loss of a customer and a $522,000 reduction in revenue from our Telecom
vertical resulting from decreased volumes.
 
 Freight Revenues.The
Company’s freight revenues increased 28.0% to $7.2 million for the three months
ended March 31, 2008 from $5.7 million for the three months ended March 31,
2007.  The increase in freight revenues of $1.6 million is primarily
attributable to a $1.4 million increase in our direct marketing vertical
resulting from the addition of new clients and increased volume from existing
clients and a $288,000 increase in revenue from our retail and catalog vertical
due to increased volume from an existing client.
  15
 Item
2 -
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
 FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 Cost of service
revenues. Cost of service revenues increased 16.4% to $12.1 million
for the three months ended March 31, 2008, compared to $10.4 million for the
three months ended March 31, 2007.  The cost of revenue increase was
primarily due to the increase in labor costs associated with the increase in
service revenues.
 
 Freight
Expense.  The Company’s freight expense increased 30.3% to $7.2
million for the three months ended March 31, 2008 compared to $5.6 million for
the three months ended March 31, 2007 due to the increase in freight revenue for
the reasons listed above.
 
 Selling, General and Administrative
Expenses.S,G&A expenses for the three months ended March
31, 2008 decreased slightly to $11.1 million, or 33.9% of total revenues,
compared to $11.2 million, or 40.2% of total revenues, for the same period in
2007.  The decrease in S,G&A expenses as a percentage of revenue
in 2008 as compared to 2007 was primarily attributable to the overall increase
in revenue and our ability to manage our business growth while maintaining a
constant administrative overhead expense.
 
 Interest
Expense.Interest expense for the three months ended March 31,
2008 and March 31, 2007 was $269,000 and $167,000, respectively.  The
increase was related to loans outstanding under the $5.0 million term loan which
was not outstanding in the first quarter of 2007, partially offset by a decrease
in the amount outstanding under the revolving credit agreement and a reduction
in the weighted average interest rate.
 
 Income Taxes.The Company’s
effective tax rate for the three months ended March 31, 2008 and 2007 was
0%.  At December 31, 2003, a valuation allowance was recorded against
the Company’s net deferred tax assets as losses in recent years created
uncertainty about the realization of tax benefits in future
years.  Income taxes associated with income for the three months ended
March 31, 2008 were offset by a corresponding decrease of the valuation
allowance resulting in an effective tax rate of 0% for the three months ended
March 31, 2008.  Income taxes associated with the loss for the three
months ended March 31, 2007 were offset by a corresponding increase of the
valuation allowance resulting in an effective tax rate of 0% for the three
months ended March 31, 2007.
 
 Liquidity
and Capital Resources
 
 The
Company has a revolving credit facility with Wachovia Bank, which has a maximum
borrowing limit of $15.0 million.  The revolving credit facility is
used to fund the Company’s capital expenditures, operational working capital and
seasonal working capital needs.  At March 31, 2008 the Company also
had a $5.0 million second lien loan outstanding to a credit management
company.  The specific terms of the $5.0 million second lien loan are
more fully described below.  The combined amount outstanding at March
31, 2008 under these two financing obligations was $10.0 million.
 
 The
Company had cash and cash equivalents of approximately $51,000 at March 31, 2008
as compared to $1.1 million at December 31, 2007.  The reduced amount
of cash and cash equivalents at March 31, 2008 as compared to December 31, 2007
is the result of our consolidation of cash accounts under our revolving credit
line at March 31, 2008 thereby lowering our loan outstanding and increasing our
availability under the credit line.  Additionally, the Company
decreased its borrowings outstanding under its revolving credit facility
(discussed below) to $5.0 million at March 31, 2008, as compared to $6.2 million
at December 31, 2007.  This reduction resulted from the use of funds
provided by a reduction in Accounts Receivable of $3.3 million during the three
months ended March 31, 2008 which are normally higher at December 31st of each
year due to seasonally higher revenues in the fourth quarter of the calendar
year.  The Company generated positive cash flow from operations of
$224,000 during the three months ended March 31, 2008, as compared to negative
cash flow from operations of $118,000 in the same period in 2007.  The
$342,000 improvement in cash flow generated from operations was mostly due to
the combined result of generating a net profit of $862,000 compared to a net
loss of $793,000 offset by the net effect of all working capital accounts using
$1.9 million of cash during the three months ended March 31, 2008 compared with
the net effect of all working capital accounts using $583,000 of cash during the
three months ended March 31, 2007.
  16
 Item
2 -
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
 FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 The
revolving bank credit agreement matures in March 2009 and has a maximum
borrowing limit of $15.0 million.  Although the maximum borrowing
limit is $15.0 million, the credit facility limits borrowings to a specified
percentage of eligible accounts receivable and inventory, which totaled $17.9
million at March 31, 2008.  As provided for in the second waiver
agreement dated April 16, 2007, our Chairman and Chief Executive Officer, Scott
Dorfman, has granted to the bank a security interest in $2.0 million of his
personal securities, which after application of a 75% factor, results in $1.5
million of additional collateral to support the borrowing limit of $15.0 million
under the credit facility.  Additionally, the terms of the credit
facility provide that the amount borrowed and outstanding at any time combined
with certain reserves for rental payments, letters of credit outstanding and
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
March 31, 2008 amounted to $19.4 million.  The amount borrowed and
outstanding and the total value of reserves and letters of credit outstanding at
March 31, 2008 amounted to $5.0 million.  As a result, the Company had
$10.0 million of borrowing availability under the revolving credit line at March
31, 2008.
 
 The
Company has granted a security interest in all of its assets to the lender as
collateral under this revolving credit agreement.  The revolving
credit agreement contains a restrictive fixed charge coverage
ratio.  The provisions of the revolving credit agreement require that
the Company maintain a lockbox arrangement with the lender, and allows the
lender to declare any outstanding borrowing amounts to be immediately due and
payable as a result of noncompliance with any of the
covenants.  Accordingly, in the event of noncompliance, these amounts
could be accelerated.  The fixed charge coverage ratio requires the
Company to maintain a minimum twelve month trailing fixed charge coverage ratio
of 0.9 to 1.0 from December 2007 through March 2008, 1.0 to 1.0 for the months
of April and May 2008, 1.05 to 1.0 from June through September 2008 and 1.1 to
1.0 from October 2008 through the maturity of the facility in March
2009.  The Company was  in compliance with the terms and
conditions of the revolving credit agreement, as amended, and the Second Lien
Credit Agreement as of March 31, 2008.
 
 On
September 28, 2007 the Company and the bank entered into the fifth amendment to
its revolving bank credit facility entitled “Fifth Amendment Agreement” (the
“Fifth Amendment”) whereby the bank agreed to the Company’s entering into a debt
obligation described as the “Second Lien Credit Agreement” which is subordinated
to the bank’s position as senior lender to the Company.  The Second
Lien Credit Agreement was entered into with Chatham Credit Management III, LLC,
as agent for Chatham Investment Fund III, LLC, Chatham Investment Fund QP III,
LLC, and certain other lenders party thereto from time to time, and Chatham
Credit Management III, LLC, as administrative agent (Chatham Credit Management
III, LLC, Chatham Investment Fund III, LLC, Chatham Investment Fund QP III, LLC,
and Chatham Credit Management III, LLC are collectively referred to as
“Chatham”).  The proceeds of the $5.0 million Second Lien Credit
Agreement were needed to fund fourth quarter 2007 capital expenditure projects
and provide seasonal working capital needs in the same quarter resulting from
high revenue growth through the nine months ended September 30,
2007.  We anticipate repaying the term loan, from cash generated from
operations, before September 28, 2008; the one year anniversary of its
inception.
  17
 Item
2 -
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
 FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 The
Second Lien Credit Facility has a one year term with the option to renew for
five months resulting in an ultimate maturity date of March 1, 2009, the same
date on which the revolving bank credit agreement, described above,
matures.  There are no scheduled principal payments before maturity
under the Second Lien Credit Facility.  If the option to renew for
five months is exercised, the Company will be obligated to pay a $62,500 success
fee which amount is five twelfth’s of the success fee paid when the loan was
entered into on September 28, 2007.  There are no scheduled principal
payments before maturity under the Second Lien Credit
Facility.  Borrowings under the Second Lien Credit Facility bear
interest at an annual rate equal to the greater of (a) LIBOR or (b) 5.75% plus
9.25% for a rate of 15%.  Interest on borrowings under the Second Lien
Credit Facility which accrued from inception to December 31, 2007 was paid on
January 2, 2008.  Interest accruing during the period from January 1,
2008 through June 30, 2008 was, according to the terms of the Second Lien Credit
Facility paid on January 1, 2008 when the Company signed an additional note for
the value of the interest for that period of $379,000.  Under the
terms of the additional note, if the Company repays any or all of the $5.0
million outstanding under the Second Lien Credit Facility before June 30, 2008,
the amount owed under the additional note would not change.  The
additional note will be repaid in accordance with the terms of the Second Lien
Credit Agreement.  In the event of default, all obligations will bear
interest at the otherwise applicable rate plus 2.00% per annum until the event
of default is cured.
 
 The
Company’s obligations under the Second Lien Credit Facility are secured by a
second priority security interest in, and a second priority lien on,
substantially all of the assets and property of the Company.  The
Company’s obligations under the Second Lien Credit Facility are partially
guaranteed by Scott Dorfman, the Company’s Chairman, President, and Chief
Executive Officer, pursuant to a Limited Guaranty Agreement between Mr. Dorfman
and Chatham Credit Management III, LLC.  Mr. Dorfman has also pledged
as partial collateral for the loans under the Second Lien Credit Facility,
pursuant to a Guarantor Pledge Agreement between Mr. Dorfman and Chatham Credit
Management III, LLC, the membership interests he owns in Chatham Investment Fund
II, LLC and Chatham Investment Fund III, LLC (collectively, the “Chatham
Funds”).  Mr. Dorfman’s guarantee is limited to the value of this
Chatham Funds collateral.  Chatham Investment Fund III, LLC is one of
the lenders under the Second Lien Credit Agreement, and both of the Chatham
Funds are affiliated with the other Chatham entities acting as agents and
lenders under the Second Lien Credit Agreement.  Mr. Dorfman
previously served on the advisory board of Chatham Investment Fund II,
LLC.
 
 The
Second Lien Credit Agreement contains a fixed charge coverage ratio covenant
with the same ratio requirements as those included in the revolving credit
agreement with Wachovia.  The Second Lien Credit Agreement also limits
the amount of capital expenditures the Company may make in any fiscal year
beginning in the fiscal year 2008 to $4,500,000.  The Second Lien
Credit Agreement contains representations and warranties, affirmative and
negative covenants and events of default (and, as appropriate, grace
periods).  Simultaneous with the execution of the Fifth Amendment and
the Second Lien Credit Agreement on September 28, 2007, the bank and Chatham
entered into an intercreditor agreement defining the relative priority of
security interests and other subordination terms.
 
 Interest
on borrowings under the revolving credit agreement is payable monthly at rates
equal to the prime rate, or at the Company’s option, LIBOR plus up to 200 basis
points; however so long as the fixed charge ratio is less than 1.00 to 1.00, the
interest rate will be equal to the prime rate plus 1% or at the Company’s
option, LIBOR plus 285 basis points.  Beginning with the month of
December 2007 and during the three months ended March 31, 2008, the Company
maintained a fixed charge ratio above 1.0.  For the three months ended
March 31, 2008 and 2007, the Company incurred interest expense related to
the revolving credit agreement of approximately $77,000 and $158,000,
respectively.  The Company also incurred unused revolving credit
facility fees of approximately $5,000 and $9,000 during the three months ended
March 31, 2008 and 2007, respectively.
  18
 Item
2 -
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
 FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 Interest
on borrowings under the Second Lien Credit Agreement is accrued on a monthly
basis equal to the greater of (a) LIBOR or (b) 5.75% plus 9.25% for a rate of
15% of the principal balance plus accrued interest payable outstanding on the
$5.0 million loan.  For the three months ended March 31 2008 and 2007,
the Company incurred interest expense related to the Second Lien Credit
Agreement of approximately $190,000 and $0, respectively.
 
 For the
three months ended March 31, 2008, we recorded interest expense of $77,000 on
the revolving credit agreement at a weighted average interest rate of 5.42% and
$190,000 of interest expense on the Second Lien Credit Agreement at a constant
rate of 15.0%.  Our weighted average interest rate for the three
months ended March 31, 2008, including amounts borrowed under both the revolving
credit agreement and the Second Lien Credit Agreement, was 9.9%.  At
March 31, 2008, the rate of interest being charged on the revolving credit
agreement and the Second Lien Credit Agreement was 5.55% and 15.0%
respectively.
 
 For the
three months ended March 31, 2008, compared to the same three month period in
2007, the Company had an improvement in cash generated from operating activities
of $342,000 resulting from positive cash flow from operations of $224,000 in
2008 compared to negative cash flow from operations in 2007 of
$118,000.  The $342,000 improvement for the three months ended March
31, 2008 from the same period ended 2007 was mostly due to the combined result
of generating a net profit of $862,000 compared to a net loss of $793,000 offset
by the net effect of all working capital accounts using $1.9 million of cash
during the three months ended March 31, 2008 compared with the net effect of all
working capital accounts using $583,000 of cash during the three months ended
March 31, 2007.  Additionally, non cash expenses for depreciation,
which are included in the net profit, were $1.2 million compared to $1.3 million
for the three months ended March 31, 2008 and 2007 respectively.
 
 During
the three months ended March 31, 2008, net cash used in investing activities was
$120,000 as compared to $691,000 in the same period in 2007.  The
decrease of $571,000 was due to expenditures made in 2007 relating to the Target
facility that did not reoccur in 2008.
 
 During
the three months ended March 31, 2008, net cash used in financing activities was
$1.1 million compared to $140,000 in the same period of 2007.  The
$1.0 million increase in cash used in financing activities is due to additional
repayments of the obligations outstanding under the revolving credit facility in
2008 as compared to 2007.
 
 The
Company has generated $224,000 of positive cash flows and net income from
operations for the three months ended March 31, 2008 compared to $118,000 of
negative cash flows and net loss from operations for the same period in
2007.  This improvement of $342,000 has resulted mainly from the
combination of improved operating costs and pricing in several of our key
customer accounts and the benefit of sustained higher revenues with continued
control over selling, general and administrative expenses.  The
Company estimates that its cash and financing needs through the rest of 2008
will be met by cash flows from operations and its operating cash flows will
provide sufficient liquidity to repay the Second Lien Credit Agreement before
its one year anniversary on September 28, 2008.
  19
 Item
2 -
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
 FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 Critical
Accounting Policies
 
 Critical
accounting policies are those policies that can have a significant impact on the
presentation of our financial position and results of operations and demand the
most significant use of subjective estimates and management
judgment.  Because of the uncertainty inherent in such estimates,
actual results may differ from these estimates.  Specific risks
inherent in our application of these critical policies are described
below.  For all of these policies, we caution that future events
rarely develop exactly as forecasted, and the best estimates routinely require
adjustment.  These policies often require difficult judgments on
complex matters that are often subject to multiple sources of authoritative
guidance.  Additional information concerning our accounting policies
can be found in Note 1 to the condensed financial statements in this Form 10-Q
and Note 2 to the financial statements appearing in our Annual Report on Form
10-K for the year ended December 31, 2007.  The policies that we
believe are most critical to an investor’s understanding of our financial
results and condition and require complex management judgment are discussed
below.
 
 Goodwill and Other Acquired
Intangibles.   The Company accounts for goodwill and other
intangible assets in accordance with SFAS No. 142, “Goodwill and Other
Intangible Assets”.  Under SFAS No. 142, goodwill impairment is deemed
to exist if the net book value of a reporting unit exceeds its estimated fair
value.
 
 Innotrac’s
goodwill carrying amount as of March 31, 2008 was $25.2 million. This asset
relates to the goodwill associated with the Company’s acquisition of Universal
Distribution Services (“UDS”) in December 2000 (including an earnout payment
made to the former UDS shareholders in February 2002), and the acquisition of
iFulfillment, Inc. in July 2001.  In accordance with SFAS No. 142, the
Company performed a goodwill valuation in the first quarter of
2008.  The valuation supported that the fair value of the reporting
unit at January 1, 2008 exceeded the carrying amount of the net assets,
including goodwill, and thus no impairment was determined to
exist.  The Company performs this impairment test annually as of
January 1 or sooner if circumstances indicate.
 
 Accounting for Income
Taxes.Innotrac utilizes the liability method of accounting
for income taxes.  Under the liability method, deferred taxes are
determined based on the difference between the financial and tax basis of assets
and liabilities using enacted tax rates in effect in the years in which the
differences are expected to reverse.  A valuation allowance is
recorded against deferred tax assets if the Company considers it more likely
than not that deferred tax assets will not be realized.  Innotrac’s
gross deferred tax asset as of March 31, 2008 and December 31, 2007 was
approximately $18.6 million and $18.9 million, respectively.  This
deferred tax asset was generated primarily by net operating loss carryforwards
created primarily by the special charge of $34.3 million recorded in 2000 and
the net losses generated in 2002, 2003, 2005 and 2006.  Innotrac has a
net operating loss carryforward of $49.1 million at December 31, 2007 that
expires between 2022 and 2027.
 
 Innotrac’s
ability to generate the expected amounts of taxable income from future
operations is dependent upon general economic conditions, competitive pressures
on sales and margins and other factors beyond management’s
control.  These factors, combined with losses in recent years, create
uncertainty about the ultimate realization of the gross deferred tax asset in
future years.  Therefore, a valuation allowance of approximately $13.5
million and $13.8 million has been recorded as of March 31, 2008 and December
31, 2007, respectively.  Income taxes associated with future earnings
will be offset by the utilization of the net operating loss carryforward
resulting in a reduction in the valuation allowance.  For the three
months ended March 31, 2008, an income tax expense of $337,000 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 net
operating losses prior to their expiration, then the valuation allowance can be
reduced or eliminated.
  20
  Item
2 - MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
 FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 Accounting Estimates.The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the disclosures of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period.  Actual results could differ from those
estimates.
 
 Recent
Accounting Pronouncements
 
 In
September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value,
establishes a framework for measuring fair value in accordance with accounting
principles generally accepted in the United States, and expands disclosures
about fair value measurements. SFAS No. 157 was effective for fiscal
years beginning after November 15, 2007, with earlier application
encouraged. Any amounts recognized upon adoption as a cumulative effect
adjustment will be recorded to the opening balance of retained earnings
(deficit) in the year of adoption. There was no impact on the Company’s
financial statements upon adoption on January 1, 2008.
  In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities – Including an amendment of FASB
Statement No. 115” (“SFAS No. 159”). This standard permits an entity to choose
to measure certain financial assets and liabilities at fair
value.  SFAS No. 159 also revises provisions of SFAS No. 115 that
apply to available-for-sale and trading securities.  This statement is
effective for fiscal years beginning after November 15, 2007.  There
was no impact on the Company's financial statements upon adoption on January 1,
2008.
 
 In
December 2007, the FASB issued SFAS No 141(R) which revised SFAS 141 “Business
Combinations”.  This revised standard will be effective for fiscal
years beginning after December 15, 2008 and changes the requirements for
measuring the value of acquired assets, the date of the measurement of the
acquired assets, the use of fair value accounting and rules for capitalization
of costs of acquisition.  Since SFAS 141(R) will apply to acquisitions
occurring in the future, the Company does not expect there to be any impact on
the historic reported financial statements of the Company when it is
adopted.
 
 In
December 2007, the FASB issued SFAS No. 160 “Noncontrolling Interests in
Consolidated Financial Statements” which amended Accounting Research Bulletin
No. 51.  This standard will be effective for fiscal years beginning
after December 15, 2008 and applies to reporting requirements for minority
interest ownership.  The Company does not expect the effect, if any,
of adopting SFAS No. 160 on its financial statements will be
material.
  21
  Item 3 - Quantitative and
Qualitative Disclosures About Market Risks
 
 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.  The Company does not transact any
sales in foreign currency.  To the extent that the Company has
borrowings outstanding under its credit facility and its second lien term loan,
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
Financial Statements contained in our Annual Report on Form 10-K for the year
ended December 31, 2007, and the Company has no long-term purchases
commitments.
 
 Item 4 – 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 Financial (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 March
31, 2008.  Based upon that evaluation, and the identification of the
material weakness in the Company’s internal control over financial reporting as
described below and more fully in “Item 9A – Controls and Procedures –
Management’s Report on Internal Control over Financial Reporting” in the
Company’s Annual Report on Form 10-K for the year ended December 31, 2007, the
Chief Executive Officer and Chief Financial Officer concluded that the
disclosure controls and procedures were ineffective as of the end of the period
covered by this report.  The identified material weakness consists of
an understaffed financial and accounting function, and the need for additional
personnel to prepare and analyze financial information in a timely manner and to
allow review and on-going monitoring and enhancement of our
controls.
 
 Changes in Internal Control Over
Financial Reporting
 
 There was
no material change in our internal control over financial reporting during the
quarter ended March 31, 2008.  The material weakness discussed above
has not been corrected resulting in a reasonable possibility that a material
misstatement could result in our financial reporting.  As described
more fully in "Item 9A - Controls and Procedures - Plan for Remediation of
material weaknesses" in the Company's Annual Report on Form 10-K for the year
ended December 31, 2007, to address such material weakness, we continue to
monitor our disclosure and financial reporting control procedures and are
reviewing staffing requirements to remediate the material
weakness.
 
 22
  Part II – Other
Information
 
 Item 6 –
Exhibits
 
 Exhibits:
 
 31.1
              Certification
      of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d –
      14(a).31.2
              Certification
      of principal financial officer Pursuant to Rule 13a-14(a)/15d –
      14(a).32.1
              Certification
      of Chief Executive Officer Pursuant to 18 U.S.C. §
1350.32.2
              Certification
      of principal financial officer Pursuant to 18 U.S.C. §
    1350.
 
 23
 
 
 SIGNATURES
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
  INNOTRAC CORPORATION(Registrant)Date:  May
      15, 2008
              By:/s/ Scott D.
      DorfmanScott
      D. DorfmanPresident,
      Chief Executive Officer and Chairmanof
      the Board (Principal Executive Officer)Date:  May
      15, 2008
              /s/ George M. HareGeorge
      M. HareChief
      Financial Officer (Principal FinancialOfficer
      and Principal Accounting
Officer)






24