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 September 30, 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  000-23741
 
 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 October 31, 2008Common
      Stock $.10 par value per share
              12,334,803
      Shares
  
  INNOTRAC
CORPORATION
 
 INDEX
 
 
 PagePart
      I.  Financial InformationItem
      1.
                  Financial
      Statements:
                  2Condensed
      Balance Sheets at  September 30, 2008 (Unaudited) and December
      31, 2007
                  3Condensed
      Statements of Operations for the Three Months Ended September 30,
      2008 and 2007 (Unaudited)
                  4Condensed
      Statements of Operations for the Nine Months Ended September 30,
      2008 and 2007 (Unaudited)
                  5Condensed
      Statements of Cash Flows for the Nine Months Ended September 30, 2008
      and 2007 (Unaudited)
                  6Notes
      to Condensed Financial Statements (Unaudited)
                  7Item
      2.
                  Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                  18Item
      3.
                  Quantitative
      and Qualitative Disclosures About Market Risk
                  27Item
      4.
                  Controls
      and Procedures
                  27Part
      II.  Other InformationItem
      6.
                  Exhibits
                  28Signatures
                  
                  
                  29
 
 1
  Part I – Financial
Information
 
 Item 1 – Financial
Statements
 The
following condensed financial statements of Innotrac Corporation, a Georgia
corporation (“Innotrac” or the “Company”), as of September 30, 2008 and for the
three and nine month periods ended September 30, 2008 and 2007 have been
prepared in accordance with the Securities and Exchange Commission’s rules for
quarterly financial reporting 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 includes
those necessary for a fair presentation of the financial information for the
interim periods reported.  Results of operations for the nine months
ended September 30, 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 annual audited financial 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
                                    
                                    
                                    
                                    September 30,
      2008
                                    
                                    
                                    December 31,
      2007(unaudited)Current
    assets:Cash and cash
      equivalents
                                    
                                    
                                    
                                    
                                    $
                                    620
                                    
                                    
                                    $
                                    1,079Accounts receivable (net of
      allowance for doubtful accounts of $286 atSeptember 30, 2008 and $288 at
      December 31, 2007)
                                    
                                    
                                    
                                    
                                    24,844
                                    
                                    
                                    
                                    28,090Inventories,
      net
                                    
                                    
                                    
                                    
                                    
                                    1,209
                                    
                                    
                                    
                                    599Prepaid expenses and
      other
                                    
                                    
                                    
                                    
                                    
                                    1,193
                                    
                                    
                                    
                                    1,100Total current
      assets
                                    
                                    
                                    
                                    
                                    
                                    27,866
                                    
                                    
                                    
                                    30,868Property and
      equipment:Rental
      equipment
                                    
                                    
                                    
                                    
                                    
                                    222
                                    
                                    
                                    
                                    286Computer software and
      equipment
                                    
                                    
                                    
                                    
                                    
                                    41,633
                                    
                                    
                                    
                                    40,479Furniture, fixtures and leasehold
      improvements
                                    
                                    
                                    
                                    
                                    8,976
                                    
                                    
                                    
                                    7,81550,831
                                    
                                    
                                    
                                    48,580Less accumulated depreciation and
      amortization
                                    
                                    
                                    
                                    
                                    
                                    (33,925
                                    )
                                    
                                    
                                    (30,878
                                    )16,906
                                    
                                    
                                    
                                    17,702Goodwill
                                    
                                    
                                    
                                    
                                    
                                    25,169
                                    
                                    
                                    
                                    25,169Other assets,
      net
                                    
                                    
                                    
                                    
                                    
                                    1,012
                                    
                                    
                                    
                                    1,192Total
assets
                                    
                                    
                                    
                                    
                                    $
                                    70,953
                                    
                                    
                                    $
                                    74,931LIABILITIES AND SHAREHOLDERS’
      EQUITYCurrent
      liabilities:Accounts
      payable
                                    
                                    
                                    
                                    
                                    $
                                    7,551
                                    
                                    
                                    $
                                    14,050Line of
    credit
                                    
                                    
                                    
                                    
                                    
                                    9,114
                                    
                                    
                                    
                                    6,168Term loan
                                    
                                    
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    5,000Accrued expenses and
      other
                                    
                                    
                                    
                                    
                                    
                                    7,576
                                    
                                    
                                    
                                    5,708Total current
      liabilities
                                    
                                    
                                    
                                    
                                    
                                    24,241
                                    
                                    
                                    
                                    30,926Noncurrent
      liabilities:Other noncurrent
      liabilities
                                    
                                    
                                    
                                    
                                    
                                    857
                                    
                                    
                                    
                                    993Total noncurrent
      liabilities
                                    
                                    
                                    
                                    
                                    
                                    857
                                    
                                    
                                    
                                    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,12,600,759 issued and 12,334,803
      outstanding at September 30, 2008and 12,585,759 issued and
      12,319,803 outstanding at December 31, 2007
                                    
                                    
                                    
                                    1,260
                                    
                                    
                                    
                                    1,259Additional paid-in
      capital
                                    
                                    
                                    
                                    
                                    
                                    66,408
                                    
                                    
                                    
                                    66,251Accumulated
      deficit
                                    
                                    
                                    
                                    
                                    
                                    (21,813
                                    )
                                    
                                    
                                    (24,498
                                    )Total shareholders’
      equity
                                    
                                    
                                    
                                    
                                    
                                    45,855
                                    
                                    
                                    
                                    43,012Total liabilities and
      shareholders’ equity
                                    
                                    
                                    
                                    $
                                    70,953
                                    
                                    
                                    $
                                    74,931
  See notes
to condensed financial statements.
  3
  Financial
Statements-Continued
 
 INNOTRAC
CORPORATION
 CONDENSED
STATEMENTS OF OPERATIONS
 For
the Three Months Ended September 30, 2008 and 2007
 (in
thousands, except per share amounts)
 
 Three Months Ended September
      30,2008
                                                    
                                                    
                                                    2007(unaudited)
                                                    
                                                    
                                                    (unaudited)Service
      revenues
                                                    
                                                    $
                                                    25,138
                                                    
                                                    
                                                    $
                                                    23,536Freight
      revenues
                                                    
                                                    
                                                    6,863
                                                    
                                                    
                                                    
                                                    5,551Total
    revenues
                                                    
                                                    
                                                    32,001
                                                    
                                                    
                                                    
                                                    29,087Cost of service
      revenues
                                                    
                                                    
                                                    11,532
                                                    
                                                    
                                                    
                                                    10,657Freight
    expense
                                                    
                                                    
                                                    6,757
                                                    
                                                    
                                                    
                                                    5,558Selling, general and
      administrative expenses
                                                    
                                                    
                                                    11,419
                                                    
                                                    
                                                    
                                                    10,490Depreciation and
      amortization
                                                    
                                                    
                                                    1,106
                                                    
                                                    
                                                    
                                                    1,185Total operating
      expenses
                                                    
                                                    
                                                    30,814
                                                    
                                                    
                                                    
                                                    27,890Operating
      income
                                                    
                                                    
                                                    1,187
                                                    
                                                    
                                                    
                                                    1,197Other
    expense:Interest
      expense
                                                    
                                                    
                                                    358
                                                    
                                                    
                                                    
                                                    161Total other
      expense
                                                    
                                                    
                                                    358
                                                    
                                                    
                                                    
                                                    161Income before income
      taxes
                                                    
                                                    
                                                    829
                                                    
                                                    
                                                    
                                                    1,036Income
taxes
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -Net income
                                                    
                                                    $
                                                    829
                                                    
                                                    
                                                    $
                                                    1,036Income per
      share:Basic
                                                    
                                                    $
                                                    0.07
                                                    
                                                    
                                                    $
                                                    0.08Diluted
                                                    
                                                    $
                                                    0.07
                                                    
                                                    
                                                    $
                                                    0.08Weighted average shares
      outstanding:Basic
                                                    
                                                    
                                                    12,332
                                                    
                                                    
                                                    
                                                    12,320Diluted
                                                    
                                                    
                                                    12,442
                                                    
                                                    
                                                    
                                                    12,320
  See notes
to condensed financial statements.
   4
  Financial
Statements-Continued
 
 INNOTRAC
CORPORATION
 CONDENSED
STATEMENTS OF OPERATIONS
 For
the Nine Months Ended September 30, 2008 and 2007
 (in
thousands, except per share amounts)
  Nine Months Ended September
      30,2008
                                                            
                                                            
                                                            2007(unaudited)
                                                            
                                                            
                                                            (unaudited)Service
      revenues
                                                            
                                                            $
                                                            74,028
                                                            
                                                            
                                                            $
                                                            68,185Freight
      revenues
                                                            
                                                            
                                                            20,213
                                                            
                                                            
                                                            
                                                            16,731Total
    revenues
                                                            
                                                            
                                                            94,241
                                                            
                                                            
                                                            
                                                            84,916Cost of service
      revenues
                                                            
                                                            
                                                            34,190
                                                            
                                                            
                                                            
                                                            31,372Freight
    expense
                                                            
                                                            
                                                            20,022
                                                            
                                                            
                                                            
                                                            16,588Selling, general and
      administrative expenses
                                                            
                                                            
                                                            33,081
                                                            
                                                            
                                                            
                                                            32,392Depreciation and
      amortization
                                                            
                                                            
                                                            3,178
                                                            
                                                            
                                                            
                                                            3,787Total operating
      expenses
                                                            
                                                            
                                                            90,471
                                                            
                                                            
                                                            
                                                            84,139Operating
      income
                                                            
                                                            
                                                            3,770
                                                            
                                                            
                                                            
                                                            777Other
    expense:Interest
      expense
                                                            
                                                            
                                                            1,084
                                                            
                                                            
                                                            
                                                            490Total other
      expense
                                                            
                                                            
                                                            1,084
                                                            
                                                            
                                                            
                                                            490Income before income
      taxes
                                                            
                                                            
                                                            2,686
                                                            
                                                            
                                                            
                                                            287Income
taxes
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -Net income
                                                            
                                                            $
                                                            2,686
                                                            
                                                            
                                                            $
                                                            287Income per
      share:Basic
                                                            
                                                            $
                                                            0.22
                                                            
                                                            
                                                            $
                                                            0.02Diluted
                                                            
                                                            $
                                                            0.22
                                                            
                                                            
                                                            $
                                                            0.02Weighted average shares
      outstanding:Basic
                                                            
                                                            
                                                            12,324
                                                            
                                                            
                                                            
                                                            12,296Diluted
                                                            
                                                            
                                                            12,429
                                                            
                                                            
                                                            
                                                            12,296
  See notes
to condensed financial statements.
  5
  Financial
Statements-Continued
 
 
 INNOTRAC
CORPORATION
 CONDENSED
STATEMENTS OF CASH FLOWS
 For
the Nine Months Ended September 30, 2008 and 2007
 (in
thousands)
  NineMonths Ended
      September 30,2008
                                            
                                            
                                            2007(unaudited)
                                            
                                            
                                            (unaudited)Cash flows from operating
      activities:Net income
                                            
                                            $
                                            2,686
                                            
                                            
                                            $
                                            287Adjustments to reconcile net
      income to net cash provided by operating
activities:Depreciation and
      amortization
                                            
                                            
                                            3,178
                                            
                                            
                                            
                                            3,787Provision for bad
      debts
                                            
                                            
                                            -
                                            
                                            
                                            
                                            (16
                                            )Stock compensation expense-stock
      options
                                            
                                            
                                            59
                                            
                                            
                                            
                                            88Stock compensation
      expense-restricted stock
                                            
                                            
                                            56
                                            
                                            
                                            
                                            -Stock issued to settle employee
      stock bonus
                                            
                                            
                                            -
                                            
                                            
                                            
                                            111Changes in operating assets and
      liabilities:Decrease in accounts receivable,
      gross
                                            
                                            
                                            3,246
                                            
                                            
                                            
                                            2,189(Increase) decrease in
      inventory
                                            
                                            
                                            (610
                                            )
                                            
                                            
                                            810Decrease (increase) in prepaid
      expenses and other
                                            
                                            
                                            87
                                            
                                            
                                            
                                            (7
                                            )Decrease in accounts
      payable
                                            
                                            
                                            (6,499
                                            )
                                            
                                            
                                            (3,305
                                            )Increase in accrued expenses and
      other
                                            
                                            
                                            1,732
                                            
                                            
                                            
                                            281Net cash provided by operating
      activities
                                            
                                            
                                            3,935
                                            
                                            
                                            
                                            4,225Cash flows from investing
      activities:Capital
      expenditures
                                            
                                            
                                            (2,382
                                            )
                                            
                                            
                                            (3,836
                                            )Installment payment on previous
      acquisition of business
                                            
                                            
                                            -
                                            
                                            
                                            
                                            (800
                                            )Net cash used in investing
      activities
                                            
                                            
                                            (2,382
                                            )
                                            
                                            
                                            (4,636
                                            )Cash flows from financing
      activities:Net borrowings (repayments) under
      line of credit
                                            
                                            
                                            2,946
                                            
                                            
                                            
                                            (4,581
                                            )(Repayment of) proceeds from term
      loan
                                            
                                            
                                            (5,000
                                            )
                                            
                                            
                                            5,000Issuance of stock,
      net
                                            
                                            
                                            42
                                            
                                            
                                            
                                            -Loan commitment
      fees
                                            
                                            
                                            -
                                            
                                            
                                            
                                            (425
                                            )Net cash used in financing
      activities
                                            
                                            
                                            (2,012
                                            )
                                            
                                            
                                            (6
                                            )Net decrease in cash and cash
      equivalents
                                            
                                            
                                            (459
                                            )
                                            
                                            
                                            (417
                                            )Cash and cash equivalents,
      beginning of period
                                            
                                            
                                            1,079
                                            
                                            
                                            
                                            1,014Cash and cash equivalents, end of
      period
                                            
                                            $
                                            620
                                            
                                            
                                            $
                                            597Supplemental cash flow
      disclosures:Cash paid for
      interest
                                            
                                            $
                                            1,012
                                            
                                            
                                            $
                                            505
  See notes
to condensed financial statements.
 6
 INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 September
30, 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 September 30, 2008 (see
Note 4).
 
  Revenue
Recognition.Innotrac derives its revenue primarily
from two sources: (1) fulfillment operations and (2) the delivery ofcall centerservicesintegrated with our fulfillment
operations.Innotrac's fulfillment services operations recordrevenue at the conclusion
ofthe 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 centerservice revenueisrecognizedaccording to written pricing agreements
based onthenumber of calls, minutes or hourly rateswhen 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 $13,000 and $37,000 in
compensation expense for the three months ended September 30, 2008 and 2007,
respectively.  For the nine months ended September 30, the Company
recorded $59,000 and $88,000 in 2008 and 2007, respectively.  As of
September 30, 2008, approximately $52,000 of unrecognized compensation expense
related to non-vested stock options is expected to be recognized over the
following 31 months.  In addition, on April, 16, 2007, 265,956
restricted shares were issued under the terms provided in the Executive
Retention Plan, which plan was approved by the Board of Directors in 2005 with
the restricted shares issued from the shares available under the 2000 Stock
Option and Incentive Award Plan.  In accordance with SFAS No. 123(R)
the market value of the 265,956 shares was determined at the date of grant to be
$750,000 and is being amortized using the straight-line method over the 10 year
maximum vesting period defined in the Executive Retention
Plan.  During the three and nine   months ended
September 30, 2008, the Company recorded $19,000 and $56,000, respectively, in
compensation expense related to the issuance of the restricted
stock.
 
 7
 INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 September
30, 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:
 
 Nine
      months ended September 30,2008
                                  
                                  
                                  2007Risk-free
      interest rate
                                  
                                  3.69%
                                  
                                  
                                  4.52%Expected
      dividend yield
                                  
                                  0%
                                  
                                  
                                  0%Expected
      lives
                                  
                                  2.2
      Years
                                  
                                  
                                  2.0
      YearsExpected
      volatility
                                  
                                  76.0%
                                  
                                  
                                  72.5%
  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. 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
 
 8
 INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 September
30, 2008 and 2007
 (Unaudited)
  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.
 
 The
carrying value of our debt instrument approximates fair value since our
debt instrument consists of a revolving credit line which matures within one
year of September 30, 2008, and because of its short term nature, the interest
rate is equal to the market rate for such instruments of similar duration and
credit quality.
 
 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 had a maximum
borrowing limit of $15.0 million as of September 30, 2008.  As
explained in Note 7 Subsequent Events to these condensed financial statements,
the Company entered into the Sixth Amendment to the revolving credit facility
which among other changes increased the limit of borrowing to a maximum of $18.0
million.  The revolving credit facility is used to fund the Company’s
capital expenditures, operational working capital and seasonal working capital
needs.  The amount outstanding at September 30, 2008 under the
revolving credit facility was $9.1 million.
 
 The
revolving bank credit agreement matures in March 2009. Although the maximum
borrowing limit was $15.0 million at September 30, 2008, the credit facility
limits borrowings to a specified percentage of eligible accounts receivable and
inventory, which totaled $20.2 million at September 30, 2008.  As
provided for in the second waiver agreement dated April 16, 2007, our Chairman
and Chief Executive Officer, Scott Dorfman, granted to the bank a security
interest in certain personally owned securities.  After application of
a factor of 75% of current market value, as required by the second waiver, those
securities provided $1.3 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 letters of credit
outstanding be subtracted from the total collateral adjusted for certain
reserves to arrive at an amount of unused availability to borrow under the line
of credit.  The total collateral under the credit facility at
September 30, 2008 amounted to $21.5 million.  The amount borrowed and
outstanding including letters of credit outstanding at September 30, 2008
amounted to $10.4 million.  As a result, the Company had $4.6 million
of borrowing availability under the $15.0 million revolving credit line at
September 30, 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 required the
Company to maintain a minimum twelve month trailing fixed charge coverage ratio
of 1.05 to 1.0 from June through September 2008 and requires a ratio of 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, as of September 30,
2008.
 
 9
 INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 September
30, 2008 and 2007
 (Unaudited)
  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”). On September 26, 2008 the Company repaid all principal amounts and
accumulated interest owed on the Second Lien Credit Agreement.
 
 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.  As explained in Note 7
Subsequent Events to these condensed financial statements, on October 22, 2008,
the Company entered into the Sixth Amendment to the revolving credit facility
which among other changes increased the interest rate to either the prime rate
plus 1.5%, or at the Company’s option, LIBOR plus 2.5%.  While the
Second Lien Credit Agreement was outstanding, interest was 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 and outstanding under
the Second Lien Credit Agreement.
 
 For the
three months ended September 30, 2008, we recorded interest expense of $53,000
on the revolving credit agreement at a weighted average interest rate of 4.08%
and $195,000 of interest expense on the Second Lien Credit Agreement at a
constant interest rate of 15.0% from July 1, 2008 through repayment on September
26, 2008.  Additionally, upon repayment of the Second Lien Credit
Agreement, all deferred loan costs related to the Second Lien Credit Agreement
were fully amortized with amortization expense of $88,000 recorded for the
period July 1, 2008 to September 26, 2008.  For the three months ended
September 30, 2007, we recorded interest expense of $143,000 at a weighted
average rate of 8.0% on the revolving credit agreement and recorded interest
expense of $6,000 on the Second Lien Credit Agreement for the period of 3 days
from its inception of September 28, 2007.  Our weighted average
interest rate for the three months ended September 30, 2008, including amounts
borrowed under both the revolving credit agreement and the Second Lien Credit
Agreement, was 9.56%.  The Company also incurred unused revolving
credit facility fees of approximately $5,000 and $11,000 for the three months
ended September 30, 2008 and 2007, respectively.
 
 For the
nine months ended September 30, 2008, we recorded interest expense of $187,000
on the revolving credit agreement at a weighted average interest rate of 4.51%
and $574,000 of interest expense on the Second Lien Credit Agreement at a
constant interest rate for the nine months of 15.0%, excluding the amortization
of loan costs of $312,000.    For the nine months ended
September 30, 2007, we recorded interest expense of $453,000 on the revolving
credit agreement at a weighted average interest rate of 7.76% and $6,000 of
interest expense on the Second Lien Credit Agreement at a constant interest rate
for the nine months of 15.0%.  Our weighted average interest rate for
the nine months ended September 30, 2008 and 2007, including amounts borrowed
under both the revolving credit agreement and the Second Lien Credit Agreement,
was 9.39% and 7.81% respectively.  The Company also incurred unused
revolving credit facility fees of approximately $14,000 and $31,000 for the nine
months ended September 30, 2008 and 2007, respectively.
 
 10
 INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 September
30, 2008 and 2007
 (Unaudited)
  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.
 
  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
      September 30,
                      
                      
                      Nine
      months
                        Ended
      September 30,2008
                      
                      
                      2007
                      
                      
                      2008
                      
                      
                      2007Diluted
      earnings per share:Weighted
      average shares outstanding
                      
                      
                      12,332
                      
                      
                      
                      12,320
                      
                      
                      
                      12,324
                      
                      
                      
                      12,296Employee
      and director stock options and unvested restricted shares
                      
                      
                      110
                      
                      
                      
                      -
                      
                      
                      
                      105
                      
                      
                      
                      -Weighted
      average shares assumingdilution
                      
                      
                      12,442
                      
                      
                      
                      12,320
                      
                      
                      
                      12,429
                      
                      
                      
                      12,296
 
 Options
outstanding to purchase 936,000 shares of the Company’s common stock for the
three months ended September 30, 2008 and 1.0 million shares for nine months
ended September 30, 2008 were not included in diluted earnings per share because
their effect was anti-dilutive. Options outstanding to purchase 1.9 million
shares for the three months ended September 30, 2007 and 1.8 million shares for
the nine months ended September 30, 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 approved by the Board of
Directors in 2005 with the restricted shares issued from the shares available
under the 2000 Stock Option and Incentive Award Plan.  These
restricted shares are included in the fully diluted earnings per share
calculation.
 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 September   30, 2008 and December 31, 2007 was approximately
$18.7 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 which expires between 2022 and 2027 and totaled $49.1 million
at December 31, 2007.
 
 11
 INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 September
30, 2008 and 2007
 (Unaudited)
 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 $12.8
million and $13.8 million has been recorded as of September 30, 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 and nine months ended September 30, 2008, the deferred tax expense of
$326,000 and $1.1 million, respectively, 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 had a gross deferred tax asset of
approximately $18.9 million at December 31, 2007.    Due to
taxable earnings generated for the nine months ended September 3, 2008 of $1.2
million, the gross deferred tax asset at September 30, 2008 has been reduced by
approximately $275,000 to $18.7 million.  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 September 30,
2008.  Therefore, the application of FIN 48 had no material impact on
the financial statements.
 
 The
Company generally recognizes interest and/or penalties related to income tax
matters in general and administrative expenses.  As of September 30,
2008, we have no accrued interest or penalties related to uncertain tax
positions.
 5.
                      COMMITMENTS AND
      CONTINGENCIES
 Legal
Proceedings.The
Company issubject 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 and nine months ended September 30, 2008 and
2007, the Company did not meet the minimum employee requirements of 359
full-time employees, as measured on a quarterly basis, incurring a penalty of
approximately $5,000 and $3,000 for the three months ended September 30, 2008
and 2007, respectively.  The Company incurred a penalty of
approximately $9,000 and $10,000 for the nine months ended September 30, 2008
and 2007, respectively.
  12
 INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 September
30, 2008 and 2007
 (Unaudited)
 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 December 5,
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.  As explained in
Note 7 Subsequent Events to these condensed financial statements, the Company
and the IPOF receiver have reached a settlement agreement which is subject to
final court approval.
 
 Pursuant
to the Third Amendment to the Company’s revolving bank credit agreement, Scott
Dorfman, the Company’s Chairman, President and CEO has granted Wachovia Bank a
security interest in certain personal assets to be treated as additional
collateral under the credit agreement until the earlier of (x) April 30, 2008
and (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.  As of September 30, 2008, the Company still included the
personal assets as collateral.
 
 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 was subordinated to the revolving credit
facility held with Wachovia Bank, N.A.  On September 26, 2008 the
Company repaid in full the $5.0 million Second Lien Credit
Agreement.
  7.
                    SUBSEQUENT
      EVENTS
 
 The
Merger and the Merger Agreement
 
 On
October 5, 2008, Innotrac entered into an Agreement and Plan of Merger (the
“Merger Agreement”) with GSI Commerce, Inc., a Delaware corporation (“GSI”), and
Bulldog Acquisition Corp., a Georgia corporation and wholly-owned subsidiary of
GSI (“Acquisition Sub”).
 
 13
 INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 September
30, 2008 and 2007
 (Unaudited)
 Upon the
terms and subject to the conditions of the Merger Agreement, Acquisition Sub
will merge with and into Innotrac, with Innotrac continuing as the surviving
corporation and a wholly-owned subsidiary of GSI (the “Merger”). The Merger
Agreement provides that GSI will acquire Innotrac for $52.0 million, consisting
of cash of $22.0 million and shares of GSI common stock valued at $30.0 million.
The cash amount and the number of shares to be received are subject to
adjustment. At GSI’s option, all or a portion of the stock component may be paid
in cash.
 
 
 The
number of shares to be issued as the stock component of the merger consideration
will be calculated based on the volume weighted average price of GSI common
stock during the twenty trading days ending on (and including) the third trading
day prior to the scheduled date of the Innotrac shareholders meeting to approve
the Merger. If the average GSI stock price during this period is greater than or
equal to $13.03 or less than or equal to $20.85, the value of the stock
component is fixed and the number of shares comprising the stock component will
equal $30.0 million divided by the average GSI stock price during this period.
If the average GSI stock price during this period is greater than $20.85, the
number of shares comprising the stock component will be fixed at 1,438,849 and,
accordingly, the value of the stock component will be greater than $30.0
million; however, GSI may, at its election, pay all or a portion of the stock
component in cash in lieu of issuing stock, and thus reduce the value of this
portion of the consideration to no less than $30.0 million.  If the
average GSI stock price during this period is less than $13.03, the number of
shares comprising the stock component will be fixed at 2,302,379 and,
accordingly, the value of the stock component will be less than $30.0 million.
If the average GSI stock price during this period is less than $11.12, either
party will have the right to terminate the agreement. If this termination right
is exercised by Innotrac, GSI may, at its election, avoid termination of the
agreement by paying the stock component of the merger consideration in either
cash or stock that has a value of $25.6 million.
 
 The
Merger is expected to close during the first half of 2009 and is subject to
customary and other closing conditions, including (i) approval of the Merger
Agreement by the holders of Innotrac common stock, (ii) receipt of certain third
party consents, (iii) that there be no material adverse effect on Innotrac’s
business between the execution of the Merger Agreement and consummation of the
Merger and (iv) court approval by the United States District Court for the
Northern District of Ohio (the “Court”) of a Settlement Agreement between
Innotrac and the court-appointed receiver for the IPOF Fund (as defined below),
as described in further detail below.
 
 Under the
Merger Agreement, Innotrac may not solicit or participate in discussions or
negotiations with a third party regarding an acquisition of the stock or assets
of Innotrac, except that under certain circumstances Innotrac may respond to an
unsolicited bona fide proposal for an alternative acquisition that is a Superior
Proposal (as defined in the Merger Agreement); provided Innotrac otherwise
complies with certain terms of the Merger Agreement.
 
 Innotrac
and GSI have agreed to customary representations, warranties and covenants in
the Merger agreement, including, among others, covenants by Innotrac (i) to
conduct its business in the ordinary course consistent with past practices
during the interim period between the execution of the Merger Agreement and
consummation of the Merger, (ii) not to engage in certain kinds of transactions
during such period without the consent of GSI, (iii) to convene and hold a
meeting of the shareholders of Innotrac to consider and vote upon the approval
of the Merger, and (iv) that, subject to certain exceptions, the Board of
Directors of Innotrac will recommend approval of the Merger by its
shareholders.
 
 The
Merger Agreement also contains certain termination rights for both GSI and
Innotrac. Upon termination of the Merger Agreement under specified circumstances
Innotrac will be required to pay GSI a termination fee of $1.6 million and
reimburse GSI for up to $1.0 million of its expenses incurred in connection with
the Merger.
 
 14
 INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 September
30, 2008 and 2007
 (Unaudited)
 
 The
foregoing description of the material terms of the Merger and the Merger
Agreement does not purport to be complete and is qualified in its entirety by
reference to the full text of the Merger Agreement, which has been filed on a
Current Report onForm
8-K.
 
 IPOF
Fund Settlement Agreement
 
 Also on
October 5, 2008, Innotrac entered into a Settlement Agreement (the “Settlement
Agreement”) with Mark E. Dottore, as the Court appointed receiver (the
“Receiver”) for all assets of any kind of IPOF L.P., IPOF Fund, IPOF Fund II,
L.P., GSI and GSGI (“IPOF Fund”). The Settlement Agreement provides that, upon
the terms and subject to the conditions set forth in the Settlement Agreement,
the Receiver shall receive IPOF Fund’s share of the Merger consideration, with
respect to the shares owned by IPOF Fund, directly from GSI. (IPOF Fund holds
4,321,771 shares, or approximately 35.1%, of Innotrac Common Stock currently
outstanding.) The Settlement Agreement also provides that the Receiver will file
a motion with the Court requesting that the Court (i) grant conditional and
final approval of the Settlement Agreement, (ii) grant conditional and final
approval of the sale, pursuant to the Merger Agreement, of the shares of
Innotrac Common Stock owned by IPOF Fund, (iii) order the dismissal with
prejudice of all claims against Innotrac or any of its affiliates from the
actions captioned Sheldon
Gordon, et al. v. David Dadante, et al., Case No. 1:05 CV 2726, in the
United States District Court for the Northern District of Ohio, Small v. Regalbuto, Case
No.1:06 CV 01721, in the United States District Court for the Northern District
of Ohio, and Amantea v.
Innotrac, et al., Case No. 07 CV 03542, in the United States District
Court for the Northern District of Ohio, and (iv) issue a Bar Order pursuant to
which all other participants in any litigation involving IPOF Fund are barred
from pursuing any claims against Innotrac or any of its affiliates.
 
 In
accordance with the terms of the Settlement Agreement, Innotrac will pay to the
Receiver the sum of $100,000 for distribution to IPOF Fund, separate from IPOF
Fund’s share of the Merger consideration to be received from GSI. Additionally,
each of Innotrac and IPOF Fund will fully release the other from all causes of
action, suits, complaints, claims, liabilities, obligations, damages and
expenses (including attorneys’ fees and costs).
 
 The
foregoing description of the material terms of the Settlement Agreement does not
purport to be complete and is qualified in its entirety by reference to the full
text of the Settlement Agreement, which has been filed on a Current Report on
Form 8-K.
 
 Voting,
Cooperation and Indemnification Agreement
 
 Also on
October 5, 2008, Scott D. Dorfman, Innotrac’s Chairman, President and Chief
Executive Officer (“Mr. Dorfman”), and his wife entered into a Voting,
Cooperation and Indemnification Agreement (the “Voting Agreement”) with GSI. The
Voting Agreement, upon the terms and subject to the conditions set forth
therein, generally imposes on both Mr. Dorfman and his wife certain restrictions
and obligations with respect to their ownership of Innotrac Common Stock until
the earlier of a valid termination of the Merger Agreement and the date the
Merger is deemed effective. Specifically, the Voting Agreement prohibits each of
Mr. Dorfman and his wife from transferring any of their respective shares of
Innotrac common stock, and requires that both Mr. Dorfman and his wife vote all
such shares of Innotrac Common Stock in favor of the Merger and the Merger
Agreement and support actions necessary to consummate the Merger. The Voting
Agreement also prohibits each of Mr. Dorfman and his wife from soliciting or
knowingly facilitating inquiries or proposals relating to alternative business
combination transactions.
 
 15
 INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 September
30, 2008 and 2007
 (Unaudited)
 Additionally,
the Voting Agreement provides that if the Merger Agreement is terminated under
certain circumstances, Mr. Dorfman will pay to GSI two-thirds of the amount by
which the proceeds payable to Mr. Dorfman in connection with any Acquisition
Proposal (as defined in the Merger Agreement) exceeds the merger consideration
payable to Mr. Dorfman under the Merger Agreement provided that such Acquisition
Proposal is completed or entered into (and subsequently completed) during the
one year period after termination.
 
 The
Voting Agreement also requires Mr. Dorfman to indemnify GSI and Acquisition Sub,
beginning after the effective date of the Merger, from and against all claims,
damages or expenses arising out of (i) any breach of a representation or
warranty contained in the Voting Agreement or the capitalization representation
in the Merger Agreement, (ii) any failure or refusal to satisfy or perform any
covenant of the Voting Agreement, and (iii) subject to certain exceptions,
matters related to litigation involving the IPOF Fund. Claims for such amounts
must be made by GSI within two years of the closing of the Merger. Mr. Dorfman’s
indemnification liability is capped at $10.0 million, subject to certain
exceptions. In order to secure his indemnification obligations, Mr. Dorfman will
cause $4.0 million of his Merger consideration to be placed into an escrow
account. The escrow amount may be decreased as releases from IPOF Fund investors
are received.
 
 The
foregoing description of the material terms of the Voting Agreement does not
purport to be complete and is qualified in its entirety by reference to the full
text of the Voting Agreement, which has been filed on a Current Report on Form
8-K.
 
 Sixth
Amendment to the Loan and Security Agreement
 
 On
October 22, 2008 the Company and the bank entered into the sixth amendment to
its revolving bank credit facility entitled “Sixth Amendment Agreement” (the
“Sixth Amendment”).  The Sixth Amendment i) allows Innotrac to
increase the maximum limit on borrowing from $15.0 million to $18.0 million,
under certain circumstances, ii) increases the interest rate charged on
borrowings under the revolving credit agreement to either the prime rate plus
150 basis points, or, at Innotrac’s option, LIBOR plus 250 basis points, from
either the prime rate, or LIBOR plus 200 basis points, iii) increases the unused
line fee from 0.25% to 0.50%, iv) provides for an increase in the Availability
Reserve (as defined in the revolving credit agreement) from $2.0 million to $3.0
million prorated in increments of $50,000 per week beginning October 22, 2008,
and v) changes Innotrac’s obligation to report its borrowing base under the
revolving loan agreement from a weekly cycle to a monthly cycle.
 
 Additionally,
the Sixth Amendment amends the Loan Agreement’s restrictions on changes in
control of Innotrac to allow for the consummation of the transactions
contemplated by the previously announced Merger Agreement.  The
provision in the Sixth Amendment that allows consummation of the Merger is
conditioned upon i) all amounts owed under the Loan Agreement being paid in full
prior to completion of the Merger, and ii) the Merger being consummated on or
before March 1, 2009.
 
 The Sixth
Amendment also provides that if George M. Hare, the current Chief Financial
Officer (“CFO”) of Innotrac, were to cease being the CFO, an Event of Default
would occur.
 
 16
 INNOTRAC
CORPORATION
 NOTES
TO CONDENSED FINANCIAL STATEMENTS
 September
30, 2008 and 2007
 (Unaudited)
 Also on
October 22, 2008, Mr. Dorfman entered into the Second Amendment to the Security
Agreement (the “Second Amendment”), between Mr. Dorfman and the Bank, to the
Security Agreement dated April 16, 2007 (as previously amended on May 31,
2007).  The Second Amendment provides that the securities pledged by
Mr. Dorfman as collateral under the revolving credit facility between the
Company and the Bank will be released by the Bank following the full repayment
of all amounts owed under the revolving credit facility.
  17
  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.  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
 ·      collaborative
chat; and
 ·      intuitive
e-mail response.
 
 18
 Item
2 -
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF
 FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 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
                              September
      30,
                            
                            
                            Nine
      months Ended
                              September
      30,Business
      Line/Vertical
                            
                            2008
                            
                            
                            2007
                            
                            
                            2008
                            
                            
                            2007eCommerce
      / Direct to Consumer
                            
                            
                            34.9
                            %
                            
                            
                            37.6
                            %
                            
                            
                            35.2
                            %
                            
                            
                            34.9
                            %Direct
      Marketing
                            
                            
                            34.8
                            
                            
                            
                            28.9
                            
                            
                            
                            35.9
                            
                            
                            
                            30.2
 
 Modems
                              
                              
                              20.8
                              
                              
                              
                              19.1
                              
                              
                              
                              19.2
                              
                              
                              
                              18.3Business-to-Business
      (“B2B”)
                              
                              
                              5.6
                              
                              
                              
                              9.8
                              
                              
                              
                              6.0
                              
                              
                              
                              11.3Telecommunications
                              
                              
                              3.9
                              
                              
                              
                              4.6
                              
                              
                              
                              3.7
                              
                              
                              
                              5.3100.0
                              %
                              
                              
                              100.0
                              %
                              
                              
                              100.0
                              %
                              
                              
                              100.0
                              %
  
 eCommerce
/ Direct-to-Consumer and Direct Marketing.  The
Company provides a variety of fulfillment and customer support services for a
significant number of eCommerce, direct–to-consumer 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
eCommerce 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 eCommerce 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 eCommerce and direct marketing clients will increase during
the remainder of 2008 due to the projected growth rates of our clients’ business
in these verticals 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 in
June 2009.  After that transition is complete, we project that our
telecommunications and modems customers may represent less than 5% of our annual
revenues.
 
 19
 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.
 
 Results
of Operations
 
 The
following table sets forth unaudited summary operating data, expressed as a
percentage of revenues, for the three and nine months ended September 30, 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
                        September
      30,
                      
                      
                      Nine
      months Ended
                        September
      30,2008
                      
                      
                      2007
                      
                      
                      2008
                      
                      
                      2007Service
      revenues
                      
                      
                      78.6
                      %
                      
                      
                      80.9
                      %
                      
                      
                      78.6
                      %
                      
                      
                      80.3
                      %Freight
      revenues
                      
                      
                      21.4
                      
                      
                      
                      19.1
                      
                      
                      
                      21.4
                      
                      
                      
                      19.7Total
      Revenues
                      
                      
                      100.0
                      %
                      
                      
                      100.0
                      %
                      
                      
                      100.0
                      %
                      
                      
                      100.0
                      %Cost
      of service revenues
                      
                      
                      36.0
                      
                      
                      
                      36.6
                      
                      
                      
                      36.3
                      
                      
                      
                      37.0Cost
      of freight expense
                      
                      
                      21.1
                      
                      
                      
                      19.1
                      
                      
                      
                      21.2
                      
                      
                      
                      19.5Selling,
      general and administrative expenses
                      
                      
                      35.7
                      
                      
                      
                      36.1
                      
                      
                      
                      35.1
                      
                      
                      
                      38.1Depreciation
      and amortization
                      
                      
                      3.5
                      
                      
                      
                      4.1
                      
                      
                      
                      3.4
                      
                      
                      
                      4.5Operating  income
                      
                      
                      3.7
                      
                      
                      
                      4.1
                      
                      
                      
                      4.0
                      
                      
                      
                      0.9Other
      expense, net
                      
                      
                      1.1
                      
                      
                      
                      0.5
                      
                      
                      
                      1.1
                      
                      
                      
                      0.6Income
      before income taxes
                      
                      
                      2.6
                      
                      
                      
                      3.6
                      
                      
                      
                      2.9
                      
                      
                      
                      0.3Income
      tax benefit
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Net  income
                      
                      
                      2.6
                      %
                      
                      
                      3.6
                      %
                      
                      
                      2.9
                      %
                      
                      
                      0.3
                      %
 
 
 Three
Months Ended September 30, 2008 Compared to Three Months Ended September 30,
2007
 
 Service revenues.Net service revenuesincreased 6.8% to $25.1
million for the three months ended September 30, 2008 from $23.5 million for the
three months ended September 30, 2007.  This increase was primarily
attributable to a $1.5 million increase in our direct marketing vertical
resulting from the addition of several new clients and increased volume from
existing clients and a $1.1 million increase in revenues from our DSL clients
due to improved pricing from existing clients, offset by a $1.1 million decrease
in revenues from our B2B vertical due to the loss of a customer.
 
 Freight Revenues.The
Company’s freight revenues increased to $6.9 million for the three months ended
September 30, 2008 from $5.6 million for the three months ended September 30,
2007.  The increase in freight revenues of $1.3 million is primarily
attributable to a $1.2 million increase in our direct marketing vertical
resulting from the addition of new clients and increased volume from existing
clients.
 
 20
 Item
2 -
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF
 FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 Cost of service
revenues.Cost
of service revenues increased 8.2% to $11.5 million for the three months ended
September 30, 2008, compared to $10.7 million for the three months ended
September 30, 2007.  The cost of service 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 21.6% to $6.8
million for the three months ended September 30, 2008 compared to $5.6 million
for the three months ended September 30, 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
September 30, 2008 increased to $11.4 million, or 35.7% of total revenues,
compared to $10.5 million, or 36.1% of total revenues, for the same period in
2007.  The increase in S,G&A expenses was primarily related to
transaction costs incurred during the quarter for the Merger Agreement discussed
in Note 7-Subsequent Events to the condensed financial statements in Item 1 and
increases in administrative salaries, equipment expense and other corporate
expenses, offset by a reduction in worker’s compensation expense.  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 increasing administrative overhead
expense at a lesser rate.
 
 Interest
Expense.Interest expense for the three months ended September
30, 2008 and September 30, 2007 was $358,000 and $161,000,
respectively.  The increase was related to the interest and
amortization of loan costs for the loans outstanding under the $5.0 million term
loan, 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 September 30, 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
September 30, 2008 were offset by a corresponding decrease of the valuation
allowance resulting in an effective tax rate of 0% for the three months ended
September 30, 2008.  Income taxes associated with the profit for the
three months ended September 30, 2007 were offset by a corresponding decrease of
the valuation allowance resulting in an effective tax rate of 0% for the three
months ended September 30, 2007.
 
 Nine
Months Ended September 30, 2008 Compared to Nine Months Ended September 30,
2007
 
 Service revenues.Net service revenuesincreased 8.6% to $74.0
million for the nine months ended September 30, 2008 from $68.2 million for the
nine months ended September 30, 2007.  This increase was primarily
attributable to a $5.0 million increase in our direct marketing vertical
resulting from the addition of several new clients and increased volume from
existing clients, a $2.4  million increase in our eCommerce vertical
resulting from increased volume and improved pricing from existing clients, a
$2.6  million increase in revenues from our DSL clients due to
increased volumes and improved pricing from existing clients, offset by a
$3.8  million decrease in revenues from our B2B vertical due to the
loss of a customer and a $1.1 million reduction in revenue from our Telecom
vertical resulting from decreased volumes.
 
 Freight Revenues.The
Company’s freight revenues increased to $20.2 million for the nine months ended
September 30, 2008 from $16.7 million for the nine months ended
September   30, 2007.  The increase in freight revenues
of $3.5 million is primarily attributable to a $3.1 million increase in our
direct marketing vertical resulting from the addition of new clients and
increased volume from existing clients and a $423,000  increase in
revenue from our eCommerce / direct-to-consumer vertical due to increased volume
from an existing client.
 
 21
 Item
2 -
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF
 FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 Cost of service
revenues.Cost
of service revenues increased to $34.2 million for the nine months ended
September 30, 2008, compared to $31.4 million for the nine months ended
September 30, 2007.  The cost of service 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 20.7% to
$20.0 million for the nine months ended September 30, 2008 compared to $16.6
million for the nine months ended September 30, 2007 due to the increase in
freight revenue for the reasons listed above.
 
 Selling, General and Administrative
Expenses.S,G&A expenses for the nine months ended
September 30, 2008 increased slightly to $33.1 million, or 35.1% of total
revenues, compared to $32.4  million, or 38.1%  of total
revenues, for the same period in 2007.  The increase in S,G&A
expenses was primarily related to transaction costs incurred during the quarter
for the Merger Agreement discussed in Note 7-Subsequent Events to the condensed
financial statements in Item 1 and increases in administrative salaries and
other corporate expenses, offset by a reduction in worker’s compensation expense
and reduced facility costs.  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 increasing administrative overhead expense at a lesser rate.
 
 Interest
Expense.Interest expense for the nine months ended September
30, 2008 and September 30, 2007 was $1.1 million and $490,000,
respectively.  The increase was related to the interest and
amortization of loan costs for the loans outstanding under the $5.0 million term
loan which was not outstanding in the first, second or third quarters 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 nine months ended September 30, 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 nine months ended
September 30, 2008 were offset by a corresponding decrease of the valuation
allowance resulting in an effective tax rate of 0% for the nine months ended
September 30, 2008.  Income taxes associated with the loss for the
nine months ended September 30, 2007 were offset by a corresponding increase of
the valuation allowance resulting in an effective tax rate of 0% for the nine
months ended September 30, 2007.
 
 Liquidity
and Capital Resources
 
 The
Company has a revolving credit facility with Wachovia Bank, which had a maximum
borrowing limit of $15.0 million as of September 30, 2008.  As
explained in Note 7 Subsequent Events to the condensed financial statements in
Item 1, the Company entered into the Sixth Amendment to the revolving credit
facility which among other changes increased the limit of borrowing to a maximum
of $18.0 million.  The revolving credit facility is used to fund the
Company’s capital expenditures, operational working capital and seasonal working
capital needs.  The $3.0 million increase in the borrowing limit
provided for by the Sixth Amendment is projected to be used to support fourth
quarter 2008 seasonal working capital needs.
  The
Company had cash and cash equivalents of approximately $620,000 at September 30,
2008 as   compared to $1.1 million at December 31,
2007.  The reduced amount of cash and cash equivalents at September
30, 2008 as compared to December 31, 2007 is the result of our consolidation of
cash accounts under our revolving credit line at September 30, 2008 thereby
lowering our loan outstanding and increasing our availability under the credit
line.
 
 22
 Item
2 -
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF
 FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 Additionally,
the Company increased its borrowings outstanding under its revolving credit
facility (discussed below) to $9.1 million at September 30, 2008, as compared to
$6.2 million at December 31, 2007.  This increase was made to repay
the $5.0 million Second Lien Credit Agreement on September 26,
2008.  The combination of a reduction in Accounts Receivable of $3.2
million during the nine months ended September 30, 2008, which reduction is
mostly due to seasonally adjusted levels of Accounts Receivable, and positive
cash flow from operations allowed for the repayment of the Second Lien Credit
Agreement through borrowings within the borrowing limit of the revolving credit
facility.  The Company generated positive cash flow from operations of
$3.9 million during the nine months ended September 30, 2008, as compared to
$4.2 million in the same period in 2007.
 
 The
revolving credit facility matures in March 2009 and, prior to the Sixth
Amendment, had a maximum borrowing limit of $15.0 million as of September 30,
2008.  Additionally,  the credit facility limits borrowings
to a specified percentage of eligible accounts receivable and inventory, which
totaled $20.2 million at September 30, 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 $1.3 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 letters of credit outstanding be subtracted from the total
collateral adjusted for certain reserves to arrive at an amount of unused
availability to borrow under the line of credit.  The total collateral
under the credit facility at September 30, 2008 amounted to $21.5
million.  The amount borrowed and outstanding including letters of
credit outstanding at September 30, 2008 amounted to $10.4
million.  As a result, the Company had $4.6 million of borrowing
availability under the $15.0 million revolving credit line at September 30,
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 allow the lender
to declare any outstanding borrowing amounts to be immediately due and payable
as a result of noncompliance with any of the covenants.  Accordingly,
in the event of noncompliance, these amounts could be
accelerated.  The fixed charge coverage ratio required the Company to
maintain a minimum twelve month trailing fixed charge coverage ratio of 1.05 to
1.0 from June through September 2008 and requires a ratio of 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 as of September 30, 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 was
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”).  On
September 26, 2008, the Company repaid all amounts borrowed including accrued
interest owed under the Second Lien Credit Agreement.
 
 23
 Item
2 -
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF
 FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 
 Prior to
the Sixth Amendment on October 22, 2008, interest on borrowings under the
revolving credit agreement was 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 was less than 1.00 to 1.00, the interest rate would be
equal to the prime rate plus 1% or at the Company’s option, LIBOR plus 285 basis
points.  During the nine month period ended September 30, 2008, the
Company maintained a fixed charge ratio above 1.0 to 1.0.  For the
nine months ended September 30, 2008 and 2007, the Company incurredinterest expense related to
the revolving credit agreement of approximately $187,000and $453,000,
respectively.  The Company also incurred unused revolving credit
facility fees of approximately $14,000 and $31,000 during the nine months ended
September 30, 2008 and 2007, respectively.
 
 Prior to
repayment on September 26, 2008, interest on borrowings under the Second Lien
Credit Agreement 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 nine
months ended September 30, 2008 and 2007, the Company incurredinterest expense related to
the Second Lien Credit Agreement of approximately $574,000 and $6,000
respectively.
 
 For the
nine months ended September 30, 2008, we recorded interest expense of $187,000
on the revolving credit agreement at a weighted average interest rate of 4.51%
and $574,000 of interest expense on the Second Lien Credit Agreement at a
constant rate of 15.0%.  Our weighted average interest rate for the
nine months ended September 30, 2008, including amounts borrowed under both the
revolving credit agreement and the Second Lien Credit Agreement, was
9.39%.  At September 30, 2008, the rate of interest being charged on
the revolving credit agreement was 5.43%.
 
 For the
nine months ended September 30, 2008, compared to the same nine month period in
2007, the Company generated positive cash flow from operations of $3.9 million
and $4.2 million respectively.  The $290,000 decrease for the nine
months ended September 30, 2008 from the same period ended 2007 was mostly due
to the combined result of generating a net profit of $2.7 million compared to a
net profit of $287,000, offset by the net effect of all working capital accounts
using $2.0 million of cash during the nine months ended September 30, 2008
compared with the net effect of all working capital accounts using $32,000 of
cash during the nine months ended September 30, 2007.  The $2.0
million use of cash in 2008 working capital accounts for the nine months ended
September 30, 2008 resulted from  a $6.5 million reduction in accounts
payable and a $0.6 million increase in inventory offset by a $3.2 million
increase in accounts receivable and $1.7 million increase in accrued
liabilities.  The $6.5 million reduction in accounts payable included
a $2.2 million liability amount related to the Client Logic acquisition which
was settled by reduction of an offsetting equal amount receivable from Client
Logic.  The $1.7 million increase in accrued liabilities was mainly
due to the timing of payroll expenditures at September 30, 2008 and not higher
costs.  Additionally, non cash expenses for depreciation, which are
included in net profit, were $3.2 million compared to $3.8 million for the nine
months ended September 30, 2008 and 2007, respectively.
 
 During
the nine months ended September 30, 2008, net cash used in investing activities
was $2.4 million as compared to $4.6 million in the same period in
2007.  The decrease of $2.3 million was mainly due to expenditures
made in 2007 relating to the Target facility that did not reoccur in
2008.  Expenditures have been made in the second and third quarters of
2008 to improve certain work flow and accommodate increases in volume at certain
facilities.
 
 24
 Item
2 -
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF
 FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 During
the nine months ended September 30, 2008, net cash used in financing activities
was $2.0 million compared to net cash used in financing activities of $6,000 in
the same period of 2007.  The $2.0 million increase in cash used in
financing activities is due to the repayment of the term loan offset by
additional borrowings under the revolving credit facility in 2008 as compared to
2007.
 
 The
Company estimates that its cash and financing needs through the rest of 2008
will be met by cash flows from operations and the revolving bank credit
facility.
 
 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 September 30, 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 earn out 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 September 30, 2008 and December 31, 2007 was
approximately $18.7 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’s net
operating loss carryforward expires between 2022 and 2027 and totaled $49.1
million at December 31, 2007.
 
 25
 Item
2 -
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF
 FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 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 $12.8
million and $13.8 million has been recorded as of September 30, 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 nine months ended September 30, 2008, an income tax expense of $1.1 million
was offset by a corresponding decrease of the deferred tax asset valuation
allowance.  When, and if, the Company can return to consistent
profitability, and management determines that it will be able to utilize net
operating losses prior to their expiration, then the valuation allowance can be
reduced or eliminated.
 
 Accounting Estimates.The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the disclosures of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period.  Actual results could differ from those
estimates.
 
 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.
  26
 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 revolving credit facility, the Company will
have market risk relating to the amount of borrowings due to variable interest
rates under the credit facility.  All of the Company’s lease
obligations are fixed in nature as noted in Note 5 to the 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
September 30, 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
 
 During
the three months ended September 30, 2008, we completed our review of our
staffing requirements for our financial reporting and disclosure
functions.  At September 30, 2008 we had partially filled, and in
October 2008, we completed hiring efforts and had filled the positions
identified.  Accordingly, as of September 30, 2008 the material
weakness discussed above had 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 review of staffing requirements to remediate the material
weakness.
 
 27
 
 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 Chief Financial Officer Pursuant to Rule 13a-14(a)/15d –
      14(a).
 32.1
                  Certification
      of Chief Executive Officer Pursuant to 18 U.S.C. §
  1350.
 32.2
                  Certification
      of Chief Financial Officer Pursuant to 18 U.S.C. §
  1350.
   28
 SIGNATURES
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
 
 INNOTRAC
      CORPORATION(Registrant)Date:  November
      14, 2008
                    By:
                    /s/ Scott
      D. DorfmanScott
      D. DorfmanPresident,
      Chief Executive Officer and Chairmanof
      the Board (Principal Executive Officer)
 Date:  November
      14, 2008
                            By:
                            /s/ George
      M. HareGeorge
      M. HareChief
      Financial Officer (Principal FinancialOfficer
      and Principal Accounting Officer)
   29