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,
2007




OR




(    ) TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES ACT OF 1934




For the transition period from
 to




Commission file number
000-23740




INNOTRAC CORPORATION (Exact name of registrant as
specified in its charter)




Georgia                    58-1592285
(State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number)




6655 Sugarloaf Parkway Duluth, Georgia 30097
(Address of principal executive offices) (Zip Code)




Registrants telephone number, including area code:
(678) 584-4000




Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes
 No
X




Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act. (Check one):




Large accelerated filer
 Accelerated filer
 Non-accelerated filer
X




Indicate by check mark whether the registrant is a shell
company (as defined in Rule 12-b-2 of the Act) Yes  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 November 9, 2007
|------------------------------------- |  |  |  | -------------------------------
|Common Stock
$.10 par value per share |  |  |  | 12,319,803
Shares              

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INNOTRAC CORPORATION INDEX







|                              |          |  |                                                                                                                    |  | Page
|----------------------------- | -------- |  | ------------------------------------------------------------------------------------------------------------------ |  | ----
|Part I.
Financial Information |          | 
|                              | Item
1.  |  | Financial Statements:                                                                                              |  |     
|                              |          |  | Condensed Consolidated Balance Sheets at September 30, 2007 (Unaudited) and December 31, 2006                      |  |     
|                              |          |  | Condensed Consolidated Statements of Operations for the Three Months Ended September 30, 2007 and 2006 (Unaudited) |  |     
|                              |          |  | Condensed Consolidated Statements of Operations for the Nine Months Ended September 30, 2007 and 2006 (Unaudited)  |  |     
|                              |          |  | Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2006 (Unaudited)  |  |     
|                              |          |  | Notes to Condensed Consolidated Financial Statements (Unaudited)                                                   |  |     
|                              | Item
2.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                              |  |     
|                              | Item
3.  |  | Quantitative and Qualitative Disclosures About Market Risk                                                         |  |     
|                              | Item
4.  |  | Controls and Procedures                                                                                            |  |     
|                             
|Part
II. Other Information    |          | 
|                              | Item
1A. |  | Risk
Factors                                                                                                       |  |     
|                              | Item
6.  |  | Exhibits                                                                                                           |  |     
|Signatures                    |          |  |                                                                                                                    |  |     



1


---



Part I  Financial
Information




Item 1  Financial Statements




The following condensed consolidated financial statements
of Innotrac Corporation, a Georgia corporation (Innotrac or the Company), have been prepared in accordance with the
instructions to Form 10-Q and, therefore, omit or condense certain footnotes and other information normally included in financial statements prepared
in accordance with accounting principles generally accepted in the United States of America. In the opinion of management, all adjustments are of a
normal and recurring nature, except those specified as otherwise, and include those necessary for a fair presentation of the financial information for
the interim periods reported. Results of operations for the three and nine months ended September 30, 2007 are not necessarily indicative of the
results for the entire year ending December 31, 2007. These financial statements should be read in conjunction with the consolidated financial
statements and notes thereto included in the Companys 2006 Annual Report on Form 10-K, which is available on our website at
www.innotrac.com.




2


---



Financial Statements-Continued




INNOTRAC CORPORATION CONDENSED CONSOLIDATED BALANCE
SHEETS (in thousands, except share data)







|ASSETS                                                                                                                                                                                      |  |  |  | September 30, 2007 |         | December 31, 2006
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | ------------------ | ------- | -----------------
|
|Current
assets:                                                                                                                                                                             |  |  |  |                    |         |                  
|Cash and cash
equivalents                                                                                                                                                                   |  |  |  | $                  | 597     |                  
|Accounts
receivable (net of allowance for doubtful accounts of $235 at September 30, 2007       and $257 at December 31, 2006)                                                              |  |  |  |                    | 20,766  |                  
|Inventory                                                                                                                                                                                   |  |  |  |                    | 919     |                  
|Prepaid
expenses and other                                                                                                                                                                  |  |  |  |                    | 1,546   |                  
|Total current
assets                                                                                                                                                                        |  |  |  |                    | 23,828  |                  
|Property and
equipment:                                                                                                                                                                     |  |  |  |                    |         |                  
|Rental
equipment                                                                                                                                                                            |  |  |  |                    | 294     |                  
|Computer
software and equipment                                                                                                                                                             |  |  |  |                    | 42,295  |                  
|Furniture,
fixtures and leasehold improvements                                                                                                                                              |  |  |  |                    | 7,857   |                  
|                                                                                                                                                                                            |  |  |  |                    | 50,446  |                  
|Less
accumulated depreciation and amortization                                                                                                                                              |  |  |  |                    | (32,490 | )                
|Property and equipment, net                                                                                                                                                                 |  |  |  |                    | 17,956  |                  
|                                                                                                                                                                                            |  |  |  |                    |         |                  
|Goodwill                                                                                                                                                                                    |  |  |  |                    | 25,169  |                  
|Other assets,
net                                                                                                                                                                           |  |  |  |                    | 1,269   |                  
|Total
assets                                                                                                                                                                                |  |  |  | $                  | 68,222  |                  
|                                                                                                                                                                                           
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                                        |  |  |  |                    |         |                  
|Current
liabilities:                                                                                                                                                                        |  |  |  |                    |         |                  
|Accounts
payable                                                                                                                                                                            |  |  |  | $                  | 9,857   |                  
|Line of
credit                                                                                                                                                                              |  |  |  |                    | 4,005   |                  
|Term
Loan                                                                                                                                                                                   |  |  |  |                    | 5,000   |                  
|Accrued
expenses and other                                                                                                                                                                  |  |  |  |                    | 5,676   |                  
|Total current
liabilities                                                                                                                                                                   |  |  |  |                    | 24,538  |                  
|Noncurrent
liabilities:                                                                                                                                                                     |  |  |  |                    |         |                  
|Other
noncurrent liabilities.                                                                                                                                                               |  |  |  |                    | 1,165   |                  
|Total
noncurrent liabilities                                                                                                                                                                |  |  |  |                    | 1,165   |                  
|Commitments 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, 12,319,803 and 12,280,610      shares issued and outstanding as of September 30, 2007 and December 31, 2006
      respectively |  |  |  |                    | 1,232   |                  
|Additional
paid-in capital                                                                                                                                                                  |  |  |  |                    | 66,210  |                  
|Accumulated
deficit                                                                                                                                                                         |  |  |  |                    | (24,923 | )                
|Total
shareholders equity                                                                                                                                                                  |  |  |  |                    | 42,519  |                  
|                                                                                                                                                                                           
|Total
liabilities and shareholders equity                                                                                                                                                  |  |  |  | $                  | 68,222  |                  



See notes to condensed consolidated financial
statements.




3


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Financial Statements-Continued




INNOTRAC CORPORATION CONDENSED CONSOLIDATED STATEMENTS
OF OPERATIONS For the Three Months Ended September 30, 2007 and 2006 (in thousands, except per share amounts)







|                                             |  |  |  | Three Months Ended September 30, |       
|-------------------------------------------- |  |  |  | -------------------------------- | ------
|
|
|Revenues                                     |  |  |  | $                                | 29,087
|Cost of
revenues                             |  |  |  |                                  | 16,215
|Selling, general
and administrative expenses |  |  |  |                                  | 10,490
|Depreciation and
amortization                |  |  |  |                                  | 1,185 
|Total
operating expenses                     |  |  |  |                                  | 27,890
|Operating
income (loss)                      |  |  |  |                                  | 1,197 
|                                            
|Other
expense:                               |  |  |  |                                  |       
|Interest
expense                             |  |  |  |                                  | 161   
|Total other
expense                          |  |  |  |                                  | 161   
|Income (loss)
before income taxes            |  |  |  |                                  | 1,036 
|Income
taxes                                 |  |  |  |                                  |      
|Net income
(loss)                            |  |  |  | $                                | 1,036 
|                                            
|Income (loss)
per share:                     |  |  |  |                                  |       
|Basic                                        |  |  |  | $                                | 0.08  
|Diluted                                      |  |  |  | $                                | 0.08  
|                                            
|Weighted average
shares outstanding:         |  |  |  |                                  |       
|Basic                                        |  |  |  |                                  | 12,320
|Diluted                                      |  |  |  |                                  | 12,320



See notes to condensed consolidated financial
statements.




4


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Financial Statements-Continued




INNOTRAC CORPORATION CONDENSED CONSOLIDATED STATEMENTS
OF OPERATIONS For the Nine Months Ended September 30, 2007 and 2006 (in thousands, except per share amounts)







|                                             |  |  |  | Nine Months Ended September 30, |       
|-------------------------------------------- |  |  |  | ------------------------------- | ------
|
|
|Revenues                                     |  |  |  | $                               | 84,916
|                                            
|Cost of
revenues                             |  |  |  |                                 | 47,960
|Selling, general
and administrative expenses |  |  |  |                                 | 32,392
|Depreciation and
amortization                |  |  |  |                                 | 3,787 
|Total
operating expenses                     |  |  |  |                                 | 84,139
|Operating
income (loss)                      |  |  |  |                                 | 777   
|                                            
|Other
expense:                               |  |  |  |                                 |       
|Interest
expense                             |  |  |  |                                 | 490   
|Total other
expense                          |  |  |  |                                 | 490   
|Income (loss)
before income taxes            |  |  |  |                                 | 287   
|Income
taxes                                 |  |  |  |                                 |      
|                                            
|Net income
(loss)                            |  |  |  | $                               | 287   
|                                            
|Income (loss)
per share:                     |  |  |  |                                 |       
|Basic                                        |  |  |  | $                               | 0.02  
|Diluted                                      |  |  |  | $                               | 0.02  
|                                            
|Weighted average
shares outstanding:         |  |  |  |                                 |       
|Basic                                        |  |  |  |                                 | 12,296
|Diluted                                      |  |  |  |                                 | 12,296



See notes to condensed consolidated financial
statements.




5


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Financial Statements-Continued




INNOTRAC CORPORATION CONDENSED CONSOLIDATED STATEMENTS
OF CASH FLOWS For the Nine Months Ended September 30, 2007 and 2006 (in thousands)







|                                                                                         |  |  |  | Nine Months Ended September 30, |       
|---------------------------------------------------------------------------------------- |  |  |  | ------------------------------- | ------
|
|
|Cash flows from
operating activities:                                                    |  |  |  |                                 |       
|Net income
(loss)                                                                        |  |  |  | $                               | 287   
|Adjustments
to reconcile net income (loss) to net cash provided by operating activities: |  |  |  |                                 |       
|Depreciation
and amortization                                                            |  |  |  |                                 | 3,787 
|Provision for
bad debts                                                                  |  |  |  |                                 | (16   
|Stock issued
to settle employee stock bonus                                              |  |  |  |                                 | 111   
|Loss on
disposal of fixed assets                                                         |  |  |  |                                 |      
|Amortization
of deferred compensation                                                    |  |  |  |                                 | 88    
|Changes in
operating assets and liabilities:                                             |  |  |  |                                 |       
|Decrease
(increase) in accounts receivable, gross                                        |  |  |  |                                 | 2,189 
|Decrease in
inventory                                                                    |  |  |  |                                 | 810   
|Increase in
prepaid expenses and other                                                   |  |  |  |                                 | (7    
|Decrease in
accounts payable                                                             |  |  |  |                                 | (3,305
|Increase in
accrued expenses and other                                                   |  |  |  |                                 | 281   
|Net cash
provided by operating activities                                                |  |  |  |                                 | 4,225 
|                                                                                        
|Cash flows from
investing activities:                                                    |  |  |  |                                 |       
|Capital
expenditures                                                                     |  |  |  |                                 | (3,836
|Installment
payment on previous acquisition of business                                  |  |  |  |                                 | (800  
|Net cash used
in investing activities                                                    |  |  |  |                                 | (4,636
|                                                                                        
|Cash flows from
financing activities:                                                    |  |  |  |                                 |       
|Net
(repayments) borrowings under line of credit                                         |  |  |  |                                 | (4,581
|Proceeds from
term loan                                                                  |  |  |  |                                 | 5,000 
|Loan
commitment fees                                                                     |  |  |  |                                 | (425  
|Net cash
(used in) provided by financing activities                                      |  |  |  |                                 | (6    
|                                                                                        
|Net decrease in
cash and cash equivalents                                                |  |  |  |                                 | (417  
|Cash and cash
equivalents, beginning of period                                           |  |  |  |                                 | 1,014 
|Cash and cash
equivalents, end of period                                                 |  |  |  | $                               | 597   
|                                                                                        
|Supplemental
cash flow disclosures:                                                      |  |  |  |                                 |       
|                                                                                        
|Cash paid for
interest                                                                   |  |  |  | $                               | 505   



See notes to condensed consolidated financial
statements.




6


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INNOTRAC CORPORATIONNOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSSeptember 30, 2007 and 2006(Unaudited)


|1. |  | SIGNIFICANT ACCOUNTING POLICIES
|-- |  | -------------------------------



The accounting policies followed
for quarterly financial reporting are the same as those disclosed in the Notes to Consolidated 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, 2006. 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, 2006 and September 30, 2007 (see Note
4).




Revenue Recognition.
Innotrac derives its revenue primarily from two sources: (1) fulfillment operations and (2) the delivery of call center services. Innotracs
fulfillment services operations record revenue at the conclusion of the material selection, packaging and shipping process. Innotracs call center
services business recognizes revenue according to written pricing agreements based on the number of calls, minutes or hourly rate basis. 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
consolidated 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. The adoption of SFAS No. 123(R) resulted in recording $88,000 and $84,000 in compensation expense for the nine months ended
September 30, 2007 and 2006, respectively and $37,000 and $22,000 in compensation expense for the three months ended September 30, 2007 and 2006
respectively. As of September 30, 2007, approximately $413,000 of unrecognized compensation expense related to non-vested stock options is expected to
be recognized over the following 115 months.




7


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INNOTRAC CORPORATIONNOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSSeptember 30, 2007 and 2006(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 |     
|----------------------- |  |  |  | ----------------- | ----
|
|Risk-free
interest rate |  |  |  |                   | 4.52
|Expected
dividend yield |  |  |  |                   | 0   
|Expected
lives          |  |  |  |                   | 2.0 
|Expected
volatility     |  |  |  |                   | 72.5



Additionally, on April, 16, 2007,
the Compensation Committee approved a bonus in the form of a grant of $165,000 or 58,509 shares at the April 16, 2007 closing price for our stock to four
executives of the Company. The shares vested immediately upon issuance. To remit income taxes on the bonus, 19,316 of the 58,509 shares were not issued
and the cash value of those shares at date of grant, or $54,471 was withheld for income taxes. The remaining value of the bonus, or 39,193 shares and
$110,524 is presented as a non cash expense in cash flows from operations in the Condensed Consolidated Statement of Cash Flows for the nine months
ended September 30, 2007.


|2. |  | FINANCING OBLIGATIONS
|-- |  | ---------------------



The Company has a revolving bank
credit agreement with a maximum borrowing limit of $15.0 million, which will mature in March 2009. Although the maximum borrowing limit is $15.0
million, the credit facility limits borrowings to specified percentages of the value of eligible accounts receivable, inventory and certain personal
assets of the Companys Chairman, President and CEO, which totaled $16.9 million at September 30, 2007. Additionally, the $16.9 million is reduced
by certain reserves for letters of credit outstanding and general lending reserves, which totaled $1.9 million at September 30, 2007. The difference
between the limits on borrowings and the amount borrowed and outstanding at any time is defined as unused availability. At September 30, 2007, the
Company had $4.0 million outstanding borrowings under the revolving bank credit agreement and under the specific calculations defined in the credit
agreement, $11.0 million of unused availability. 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 requirements for periodic reporting of the value of assets underlying the borrowing limit, change in ownership control and other covenants.
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.




On April 16, 2007, the Company
and the bank entered into the third amendment to its revolving bank credit facility entitled Second Waiver and Amendment Agreement (the
Third Amendment) whereby the bank agreed to waive the Companys then-existing defaults under the credit agreement, provided
that the Company comply with the terms
of the credit agreement, as amended, and the additional conditions of the Third Amendment. The defaults included failure to maintain the minimum fixed
charge coverage ratio, failure to make a certain deferred purchase payment in a timely manner and failure to deliver certain financial information as
required by the Credit Agreement. As amended by the Third Amendment, the fixed charge coverage ratio covenant requires the Company to maintain a
minimum fixed charge coverage ratio of between 1.00 and 1.05 to 1.00, depending on the particular fiscal month, for each month beginning December 2007
through May 2008, and a ratio of 1.15 to 1.00 for each month thereafter. In connection with the Third Amendment, Scott Dorfman, the Companys
Chairman, President and CEO agreed to grant the bank a security interest in certain personal assets which will be treated as additional collateral
under the credit agreement. The bank has agreed to release that security interest, so long as no default exists and the fixed charge coverage ratio for
the most recent period shall be equal or greater than 1.05 to 1.00, upon the earlier to occur of (x) April 30, 2008 and (y) the date all deferred
payments in connection with the ClientLogic acquisition are paid in full. The Third Amendment also amends certain other sections of the credit
agreement, including requiring payment of an early termination fee equal to (i) 1.00% of the revolver commitment in the event of termination of the
revolver commitment on or before November 14, 2007, and (ii) 0.25% of the revolver commitment in the event of termination of the revolver commitment
after November 14, 2007, but before November 14, 2008; revising the borrowing base calculation to take into account the additional collateral pledged
by Mr. Dorfman, allowing loan proceeds to be used to make deferred payments required in connection with the ClientLogic acquisition; granting the bank
increased inspection and field examination rights for certain periods; requiring certain financial information reporting on a weekly basis; increasing
the amount of purchase money debt allowed and revising the calculation of the fixed charge coverage ratio.




8


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INNOTRAC CORPORATIONNOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSSeptember 30, 2007 and 2006(Unaudited)




On June 29, 2007, the Company and
the bank entered into the fourth amendment to its revolving bank credit facility entitled Fourth Amendment Agreement (the Fourth
Amendment) whereby the bank agreed to adjust the definition of the defined term availability reserve from $2.0 million to $0.5 million until
December 31, 2007 at which time the availability reserve would revert back to $2.0 million. Under the new definition, the Company was able to obtain an
additional $1.5 million of advanced funds under the revolving credit agreements existing collateral and borrowing base availability until
December 31, 2007. Additionally, the fixed charge ratio requirement included in the Third Amendment dated April 16, 2007 was removed as a requirement
for availability to borrow under the revolving credit agreement, but remains at the same 1.05 to 1.0 requirement to i) allow release of the banks
security interest in the specified personal assets of the Companys Chairman, President and CEO and ii) a regulating factor in the interest rate
charged on borrowings under the line as described below. The Company intends to use the additional availability to fund purchases of long term capital
assets needed to support certain fulfillment operations and general working capital needs. Additionally, the Fourth Amendment provides that if there
were a change in the officer occupying the office of Chief Financial Officer, the Chief Financial Officer position could remain unfilled for a maximum
of 59 days and the new officer retained to hold the position would have to be suitable to the Bank or an Event of Default would occur.




On September 28, 2007 the Company
and the bank entered into the fifth amendment to its revolving bank credit facility entitled Fifth Amendment Agreeement (the Fifth
Amendment) whereby the bank agreed to the Companys entering into a debt obligation described below as the Second Lien Credit
Agreement which is subordinated to the banks position as senior lender to the Company. Additionally, the Fifth Amendment amends certain
provisions of the revolving credit agreement including i) a decrease in the maximum revolver amount that the Company may borrow under the First Lien
Credit Agreement from $25 million to $15 million, ii) amending the fixed charge coverage ratio covenant to the same levels specified in the Second Lien
Credit Agreement and iii) adding a limitation on the Companys capital expenditures at the same levels specified in the Second Lien Credit
Agreement. The reduction of the maximum available revolver amount to $15 million was consistent with the level of outstanding amounts owed under the revolving credit
facility during the previous nine months and will result in lower unused revolving credit facility fees than the Company has experienced while the maximum
availability was $25 million.




9


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INNOTRAC CORPORATIONNOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSSeptember 30, 2007 and 2006(Unaudited)




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. During the three months ended September 30, 2007 and 2006, the Company incurred interest expense related to the
revolving credit agreement of approximately $143,000 and $109,000, respectively. During the nine months ended September 30, 2007 and 2006, the Company
incurred interest expense related to the revolving credit agreement of approximately $453,000 and $228,000, respectively. The Company also incurred
unused revolving credit facility fees of approximately $11,000 and $12,000 during the three months ended September 30, 2007 and 2006, respectively, and
$31,000 and $38,000 during the nine months ended September 30, 2007 and 2006, respectively.




On September 28, 2007, the
Company entered into a Second Lien Term Loan and Security Agreement (the Second Lien Credit Agreement) 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).




Pursuant to the Second Lien
Credit Agreement, the Company borrowed $5.0 million (the Second Lien Loan Amount) under the second lien secured credit facilities (the
Second Lien Credit Facility) on September 28, 2007. The Second Lien Credit Agreement provides for an early termination fee in the event
that the Company prepays all or any portion of the borrowings under Second Lien Credit Facility before December 28, 2007, and provides that the Company
will pay a facility fee at closing, a success fee payable on the first anniversary of the closing and other fees customary for transactions of this
type. The Company intends to use the proceeds of the Second Lien Credit Facility for completion of capital expenditure programs begun in early 2007,
fourth quarter seasonal working capital requirements and other general corporate purposes. The Second Lien Credit Facility has a one year term with the
option to renew for five months resulting in an ultimate maturity date of March 1, 2009, the same date on which the revolving bank credit agreement,
described above, matures. If the option to renew for five months is exercised, the Company will be obligated to pay five-twelfths or 41.7% of the
initial closing and success fees incurred when the Second Lien Credit Facility was entered into on September 28, 2007.




There are no scheduled principal
payments before maturity under the Second Lien Credit Facility. Interest accrued on borrowings outstanding under the Second Lien Credit Facility
generally is payable on a monthly basis. Borrowings under the Second Lien Credit Facility bear interest at an annual rate equal to (a) the greater of
(1) LIBOR or (2) 5.75% plus (b) 9.25%. Interest on borrowings under the Second Lien Credit Facility accruing during the period ending on and including
December 31, 2007 (the PIK Period) will be capitalized on a monthly basis. On January 1, 2008, the Company may elect to pay the interest
accrued during the PIK Period either entirely in cash, or by issuing an additional term note for such amount, payable to Chatham, to be repaid in
accordance with the terms of the Second Lien Credit Agreement. Also on January 1, 2008, the Company must prepay the interest to accrue on borrowings
outstanding under the Second Lien Credit Facility between January 1, 2008 and June 30, 2008, by issuing an additional note for such amount to Chatham,
to be repaid in accordance with the terms of the Second Lien Credit Agreement. In the event of default, all obligations will bear interest at the
otherwise applicable rate plus 2.00% per annum until the event of default is cured.




10


---



INNOTRAC CORPORATIONNOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSSeptember 30, 2007 and 2006(Unaudited)




The Companys obligations
under the Second Lien Credit Facility are secured by a second priority security interest in, and a second priority lien on, substantially all of the
assets and property of the Company. The Companys obligations under the Second Lien Credit Facility are partially guaranteed by Scott Dorfman, the
Companys Chairman, President, and Chief Executive Officer, pursuant to a Limited Guaranty Agreement between Mr. Dorfman and Chatham Credit
Management III, LLC. Mr. Dorfman has also pledged as partial collateral for the loans under the Second Lien Credit Facility, pursuant to a Guarantor
Pledge Agreement between Mr. Dorfman and Chatham Credit Management III, LLC, the membership interests he owns in Chatham Investment Fund II, LLC and
Chatham Investment Fund III, LLC (collectively, the Chatham Funds). Mr. Dorfmans guarantee is limited to the value of this Chatham
Funds collateral. Chatham Investment Fund III, LLC is one of the lenders under the Second Lien Credit Agreement, and both of the Chatham Funds are
affiliated with the other Chatham entities acting as agents and lenders under the Second Lien Credit Agreement. Mr. Dorfman previously served on the
advisory board of Chatham Investment Fund II, LLC.




The Second Lien Credit Agreement
contains a fixed charge coverage ratio covenant that requires the Company to maintain a minimum fixed charge coverage ratio of between 0.90 and 1.05 to
1.00, depending on the particular fiscal month, for each month between December 2007 and September 2008, and a ratio of 1.10 to 1.00 for each month
thereafter. The Second Lien Credit Agreement also limits the amount of capital expenditures the Company may make in any fiscal year beginning in the
fiscal year 2008 to $4,500,000. The Second Lien Credit Agreement contains such other representations and warranties, affirmative and negative covenants
and events of default (and, as appropriate, grace periods) as are usual and customary for financings of this kind.




Simultaneous with the execution
of the Fifth Amendment and the Second Lien Credit Agreement, the bank and Chatham entered into an intercreditor agreement defining the relative
priority of security interests and other subordination terms as are usual and customary for creditors in financings of this kind.




Interest on borrowings under the
Second Lien Credit Agreement, which began on September 28, 2007 amounted to approximately $6,000 and was accrued at the rate of 15.0
%.




Including interest on both the
revolving credit agreement and Second Lien Credit Agreement in 2007 and only the revolving credit agreement in 2006, the Company incurred a weighted
average interest rate of 7.8% and 6.7% for the nine months ended September 30, 2007 and 2006 respectively. For the three months ended September 30,
2007 and 2006, the weighted average interest rate was 8.1% and 6.8% respectively.


|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, | 
|------------------------------------------------------------------ |  |  |  | -------------------------------- | ------ | ------------------------------- | 
|                                                                   |  |  |  | 2007                             |        | 2006                            | 
|Diluted
earnings per share:                                        |  |  |  |                                  |        |                                 | 
|Weighted
average shares outstanding                                |  |  |  |                                  | 12,320 |                                 | 
|Employee and
director stock options and unvested restricted shares |  |  |  |                                  |       |                                 | 
|Weighted
average shares assuming dilution                          |  |  |  |                                  | 12,320 |                                 | 



11


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INNOTRAC CORPORATIONNOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSSeptember 30, 2007 and 2006(Unaudited)




Options outstanding to purchase
1.9 million shares of the Companys common stock 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 strike price was greater than the market value of our common stock
on September 30, 2007. Options outstanding to purchase 1.6 million shares for both the three and nine months ended September 30, 2006 were not included in the computation of diluted
EPS because their effect was anti-dilutive.


|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, 2007 and December 31, 2006 was approximately $18.9 million and $18.3 million,
respectively. This deferred tax asset was generated primarily by net operating loss carryforwards created mainly by a special charge of $34.3 million
recorded in 2000 and the net losses generated in 2002, 2003, 2005 and 2006. Innotrac has a net operating loss carryforward of $46.8 million at December
31, 2006 that expires between 2021 and 2026.




Innotracs ability to
generate the expected amounts of taxable income from future operations is dependent upon general economic conditions, competitive pressures on sales
and margins and other factors beyond managements control. These factors, combined with losses in recent years, create uncertainty about the
ultimate realization of the gross deferred tax asset in future years. Therefore, a valuation allowance of approximately $13.9 million and $14.0 million
has been recorded as of September 30, 2007 and December 31, 2006, 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, 2007,
the deferred tax expense of $156,000 was offset by a corresponding decrease of the deferred tax asset valuation allowance. When, and if, the Company
can return to consistent profitability, and management determines that it is likely it will be able to utilize the net operating losses prior to their
expiration, then the valuation allowance can be reduced or eliminated.




In June 2006, the FASB issued
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109 (FIN 48),
which clarifies the accounting for uncertainty in tax positions and in May 2007 the FASB issued FASB Staff Position (FSP) 48-1 which amended FIN 48 to
provide guidance on how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously
unrecognized tax benefits. The combined effect of FIN 48 and FSP 48-1 requires that the Company determine whether it is more likely than not that a tax
position will be sustained upon audit, based on the technical merits of the position. A tax position that meets the more likely than not recognition
threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount
of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. The Company adopted FIN 48 effective January 1, 2007. The
Company has a gross deferred tax asset of approximately $18.3 million at December 31, 2006, which did not change significantly during the nine months
ended September 30, 2007. As discussed in Note 6 to the consolidated financial statements in the 2006 Form 10-K, the Company has a valuation allowance
against the full amount of its net 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, 2007. In addition, future changes in the unrecognized tax benefits will likely have no impact on the effective tax rate
due to the existence of the valuation allowance. Therefore, the application of FIN 48 and FSP 48-1 had no material impact on the financial
statements.




12


---



INNOTRAC CORPORATIONNOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSSeptember 30, 2007 and 2006(Unaudited)




The Company generally recognizes
interest and/or penalties related to income tax matters in general and administrative expenses. As of September 30, 2007, we have no accrued interest
or penalties related to uncertain tax positions.


|5. |  | COMMITMENTS AND CONTINGENCIES
|-- |  | -----------------------------



Shareholder Rights Plan.
In December 1997, the Companys Board of Directors approved a Shareholder Rights Plan (the Rights Plan). The Rights Plan provides for
the distribution of one right for each outstanding share of the Companys common stock held of record as of the close of business on January 1,
1998 or that thereafter becomes outstanding prior to the earlier of the final expiration date of the rights or the first date upon which the rights
become exercisable. Each right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series A participating
cumulative preferred stock, par value $.10 per share, at a price of $60.00 (the Purchase Price), subject to adjustment. The rights are not
exercisable until ten calendar days after a person or group (an Acquiring Person) buys, or announces a tender offer for, 15% or more of the
Companys common stock. Such ownership level was increased on November 5, 2003 to 40% for IPOF Fund, LP that owned approximately 34.0% of the
shares outstanding on September 30, 2007. In the event the rights become exercisable, each right will entitle the holder to receive that number of shares of
common stock having a market value equal to the Purchase Price. If, after any person has become an Acquiring Person (other than through a tender offer
approved by qualifying members of the Board of Directors), the Company is involved in a merger or other business combination where the Company is not
the surviving corporation, or the Company sells 50% or more of its assets, operating income, or cash flow, then each right will entitle the holder to
purchase, for the Purchase Price, that number of shares of common or other capital stock of the acquiring entity which at the time of such transaction
have a market value of twice the Purchase Price. The rights will expire on January 1, 2008, unless extended, unless the rights are earlier exchanged,
or unless the rights are earlier redeemed by the Company in whole, but not in part, at a price of $0.001 per right. No shares have been issued under
the Rights Plan.




Legal Proceedings. The
Company is subject to various legal proceedings and claims that arise in the ordinary course of business. There are no material pending legal
proceedings to which the Company is a party.




Employment Commitment. In
June 1999, in conjunction with the opening of a new call center facility, the Company entered into an employment commitment agreement with the City of
Pueblo, Colorado, whereby the Company received cash incentives of $968,000. These funds were accounted for as a reduction in the basis of the assets
acquired. In return for this consideration, the Company is obligated to employ a minimum number of full-time employees at its Pueblo facility, measured
on a quarterly basis. This obligation, which became effective June 2002, will continue through June 2009. In the event that the number of full-time
employees fails to meet the minimum requirement, the Company will incur a quarterly penalty of $96.30 for each employee less than the minimum required
amount. During the three and nine months ended September 30, 2007 and 2006, 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 $3,000 for both the three months ended September 30, 2007 and
2006 respectively. The Company incurred a penalty of
approximately $10,000 and $21,000 for the nine months ended September 30, 2007 and 2006 respectively.




13


---



INNOTRAC CORPORATIONNOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTSSeptember 30, 2007 and 2006(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.




Pursuant to the Third Amendment
to the Companys revolving bank credit agreement, Scott Dorfman, the Companys Chairman, President and CEO has granted the bank a security
interest in certain personal assets which will be treated as additional collateral under the credit agreement until the earlier of (x) April 30, 2008
(y) the date all deferred payments in connection with the ClientLogic acquisition are paid in full, so long as no default exists and the fixed charge
coverage ratio for the most recent period is equal to or greater than 1.05 to 1.00.




On September 28, 2007, the
Company entered into a Second Lien Credit Agreement in the amount of $5.0 million with Chatham Credit Management III, LLC (Chatham). Scott
Dorfman is a private investor in various funds managed by Chatham. The Loan is subordinated to the revolving credit facility held with Wachovia Bank,
N.A. Additionally, the Second Lien Credit agreement is partially guaranteed by Mr. Dorfman in an amount up to the value of Mr. Dorfmans
investment in the Chatham Funds. The terms of the loan are more fully described in the Liquidity and Capital Resources section of this Quarterly Report
on Form 10-Q.


|7. |  | SUBSEQUENT EVENTS
|-- |  | -----------------



On October 10, 2007 certain
investors in the IPOF Fund filed a complaint in Ohio state court against the Company and certain officers and former officers of the Company raising
various claims related to the actions of Mr. Dadante or Dadante-related entities and the IPOF Fund. The Company intends to file a motion to remove the
matter to the United States District Court, Northern District of Ohio. The Company believes the claims are without merit.




On November 2, 2007 the United
States District Court in Cleveland, Ohio granted the court appointed receivers motion to extend the period during which financial institutions
holding Company stock owned by the IPOF Fund, Mr. Dadante or Dadante-related entities are restricted from trading any of these shares as defined in the
Courts prior orders until February 1, 2008. The Company continues to be engaged in discussions with the receiver to explore avenues for the
disposition of the shares in a manner that causes as little disruption to the market for Company stock as possible, and which would reasonably assure
that the shares held by the receiver would be fairly valued in any disposition.




On  November 6, 2007,  AT&T  notified us that they have  decided to  transition
       their  fulfillment  business  in-house.  AT&T  indicated  that their  expectation is to transition the business late in 2008 and
       that they plan to start the details of transition  timelines over the next several  months. For the nine months ended September
       30, 2007,  the AT&T business  represented  approximately  13% of our total  revenue.  During this  transition  period we will be
       reviewing  our  operations  to provide a stable  transition in our operating  infrastructure.  Our  communications  with AT&T on
       their  decision have  confirmed that we have a very positive  relationship  with them and that our services are highly  regarded
       within the AT&T organization.




14


---



Item 2  Managements Discussion and Analysis of
Financial Condition and Results of Operations




The following discussion may
contain certain forward-looking statements that are subject to conditions that are beyond the control of the Company. Actual results may differ
materially from those expressed or implied by such forward-looking statements. Factors that could cause actual results to differ include, but are not
limited to, the Companys reliance on a small number of major clients; risks associated with the terms and pricing of our contracts; reliance on
the telecommunications and direct marketing industries and the effect on the Company of the downturns, consolidation and changes in those industries in
the past three years; risks associated with the fluctuations in volumes from our clients; risks associated with upgrading, customizing, migrating or
supporting existing technology; risks associated with competition; and other factors discussed in more detail under Item 1A  Risk
Factors in our Annual Report on Form 10-K and in Part II  Item 1A  Risk Factors in this Quarterly Report on Form 10-Q. We undertake
no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.




Overview




Innotrac Corporation (Innotrac or the
Company), founded in 1984 and headquartered in Atlanta, Georgia, is a full-service fulfillment and logistics provider serving enterprise
clients and world-class brands. The Company employs sophisticated order processing and warehouse management technology and operates eight fulfillment
centers and two call centers in six 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.                       



15


---



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       |  |  |  | 2007                             |       | 2006                            | 
|Telecommunications           |  |  |  |                                  | 4.6   | %                               | 
|Modems                       |  |  |  |                                  | 19.1  |                                 | 
|Retail/Catalog               |  |  |  |                                  | 37.6  |                                 | 
|Direct
Marketing             |  |  |  |                                  | 28.9  |                                 | 
|Business-to-Business (B2B) |  |  |  |                                  | 9.8   |                                 | 
|                             |  |  |  |                                  | 100.0 | %                               | 



Retail, Catalog and Direct
Marketing. The Company provides a variety of fulfillment and customer support services for a significant number of retail, catalog and direct
marketing clients, including such companies as Target.com, a Division of Target Corporation, Ann Taylor Retail, Inc., Smith & Hawken, Ltd., Porsche
Cars North America, Inc. and Thane International. We take orders for our retail, catalog and direct marketing clients via the Internet, through
customer service representatives at our Pueblo and Reno call centers or through direct electronic transmission from our clients. The orders are
processed through one of our order management systems and then transmitted to one of our eight fulfillment centers located across the country and are
shipped to the end consumer or retail store location, as applicable, typically within 24 hours of when the order is received. Inventory for our retail,
catalog and direct marketing clients is held on a consignment basis, with minor exceptions, and includes items such as shoes, dresses, accessories,
books, outdoor furniture, electronics, small appliances, home accessories, sporting goods and toys. Our revenues are sensitive to the number of orders
and customer service calls received. Our client contracts do not guarantee volumes. We anticipate that the percentage of our revenues attributable to
our retail and catalog clients will increase during the remainder of 2007 due to the additional revenue from seasonal clients, including Target.com, in
the fourth quarter of 2007, while the revenues attributable to our direct marketing clients will decrease slightly as a percentage of overall revenue
due to the increase in revenues related to retail and catalog clients.




Telecommunications and
Modems. The Company continues to be a major provider of fulfillment and customer support services to the telecommunications industry. Inventory for
our telecommunications and DSL modem clients is held on a consignment basis, with the exception of certain AT&T inventory for which we are
contractually indemnified, and includes items such as telephones, caller ID equipment, DSL modems and ancillary equipment. Due to a decline in our
telecommunications business as a result of reduced volumes resulting from the maturity of the telephone and Caller ID equipment business and an increase in
revenues generated from our retail, catalog and direct marketing clients, we anticipate that the percentage of our revenues attributable to
telecommunications and DSL modem clients will decline during the remainder of 2007 despite increased volumes from our DSL modern business.




On November 6,
2007, AT&T notified us that they have decided to transition their fulfillment
business in-house.  AT&T indicated that their expectation is to transition the
business late in 2008 and that they plan to start the details of transition timelines
over the next several months.  For the nine months ended September 30, 2007,
the AT&T business represented approximately 13% of our total revenue.  During this
transition period we will be reviewing our operations to provide a stable transition in
our operating infrastructure.  Our communications with AT&T on their decision have
confirmed that we have a very positive relationship with them and that our services are
highly regarded within the AT&T organization.




Business-to-Business. The
Company also provides fulfillment and customer support services for business-to-business (B2B) clients, including Books Are Fun, Ltd. (a
subsidiary of Readers Digest), NAPA and The Walt Disney Company. This is a relatively steady area of our business.




16


---



Item 2  Managements Discussion and Analysis of
Financial Condition and Results of Operations




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, 2007 and 2006. The data has been prepared on the same
basis as the annual consolidated 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
consolidated financial statements.







|                                             |  |  |  | Three Months Ended September 30, |       | Nine Months Ended September 30, | 
|-------------------------------------------- |  |  |  | -------------------------------- | ----- | ------------------------------- | 
|                                             |  |  |  | 2007                             |       | 2006                            | 
|Revenues                                     |  |  |  |                                  | 100.0 | %                               | 
|Cost of
revenues                             |  |  |  |                                  | 55.7  |                                 | 
|Selling,
general and administrative expenses |  |  |  |                                  | 36.1  |                                 | 
|Depreciation
and amortization                |  |  |  |                                  | 4.1   |                                 | 
|Operating
income (loss)                      |  |  |  |                                  | 4.1   |                                 | 
|Other
expense, net                           |  |  |  |                                  | 0.5   |                                 | 
|Income (loss)
before income taxes            |  |  |  |                                  | 3.6   |                                 | 
|Income tax
benefit                           |  |  |  |                                  |      |                                 | 
|Net income
(loss)                            |  |  |  |                                  | 3.6   | %                               | 



17


---



Item 2  Managements Discussion and Analysis of
Financial Condition and Results of Operations




Three Months Ended September 30, 2007 Compared to Three
Months Ended September 30, 2006




Revenues.Net revenues increased 52.4% to $29.1
million for the three months ended September 30, 2007 from $19.1 million for the three months ended September 30, 2006. This increase was primarily
attributable to a $4.2 million increase in revenue from our direct marketing vertical resulting from the addition of several new clients, including
those resulting from the ClientLogic acquisition, a $3.9 million increase in retail and catalog revenue due to the addition of several new clients,
including Target.com, a $1.1 million increase in revenues from our B2B vertical due to the addition of a client acquired in the ClientLogic
acquisition, a $883,000 increase in revenues from our DSL clients due to increased volumes and a $123,000 increase in revenues from our
telecommunications clients related to the addition of a client from the ClientLogic acquisition offset by decreased volumes from our existing clients
due to the maturity of the telephone and Caller ID equipment business.




Cost of Revenues. Cost of revenues increased 69.1%
to $16.2 million for the three months ended September 30, 2007, compared to $9.6 million for the three months ended September 30, 2006. Cost of
revenues as a percent of revenue increased to 55.7% from 50.2% for the three months ended September 30, 2007 and 2006 respectively. The increase in
cost of revenues was primarily due to an increase in labor and freight expense related to the increase in revenue from the addition of new clients,
including Target.com and those resulting from the ClientLogic acquisition. The increase in cost of revenues as a percentage of revenue primarily
relates to a change in the business mix to clients with lower gross profit as a percent of revenue.




Selling, General and Administrative Expenses.
S,G&A expenses for the three months ended September 30, 2007 increased to $10.5 million, or 36.1% of revenues, compared to $8.9 million, or 46.7%
of revenues, for the same period in 2006. The increase in expenses in 2007 as compared to 2006 was primarily attributable to an increase in facility,
equipment and management expense of approximately $1.1 million due to the additional space taken in the second quarter of 2007 for Target.com and the
addition of the facility relating to the ClientLogic acquisition in the fourth quarter of 2006. SG&A expenses as a percentage of revenue have
declined as a result of our growth in revenue requiring comparatively less additional administrative expenses to support and manage the
organization.




Interest Expense. Interest expense for the three
months ended September 30, 2007 and September 30, 2006 was $161,000 and $120,000, respectively. The $41,000 increase resulted mainly from the combined
effect of an increase in the amount outstanding under the revolving credit agreement and an increase in the interest rate charged by our bank while our
fixed charge ratio is below 1.0 causing our weighted average interest rate to increase to 8.1% from 6.8% for the three months ended September 30, 2007
and 2006 respectively.




Income Taxes. The Companys effective tax rate
for the three months ended September 30, 2007 and 2006 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
profits for the three months ended September 30, 2007 and losses for the three months ended September 30, 2006 were offset by a corresponding decrease
and increase of this valuation allowance resulting in an effective tax rate of 0% for the three months ended September 30, 2007 and
2006.




Nine Months Ended September 30, 2007 Compared to Nine
Months Ended September 30, 2006




18


---



Item 2  Managements Discussion and Analysis of
Financial Condition and Results of Operations




Revenues.Net revenues increased 60.2% to $84.9
million for the nine months ended September 30, 2007 from $53.0 million for the nine months ended September 30, 2006. This increase was primarily
attributable to a $14.1 million increase in revenue from our direct marketing vertical resulting from the addition of several new clients, including
those resulting from the ClientLogic acquisition, a $12.0 million increase in retail and catalog revenue due to the addition of several new clients,
including Target.com, a $3.6 million increase in revenues from our B2B vertical due to the addition of a client acquired in the ClientLogic
acquisition, a $2.0 million increase in revenues from our DSL clients due to increased volumes and a $547,000 increase in revenues from our
telecommunications clients related to the addition of a client from the ClientLogic acquisition offset by decreased volumes from our existing clients
due to the maturity of the telephone and Caller ID equipment business.




Cost of Revenues. Cost of revenues increased 81.2%
to $48.0 million for the nine months ended September 30, 2007, compared to $26.5 million for the nine months ended September 30, 2006. Cost of revenues
as a percent of revenue increased to 56.5% from 49.9% for the nine months ended September 30, 2007 and 2006 respectively. The cost of revenues increase
was primarily due to an increase in labor and freight expense related to the increase in revenue from the addition of new clients, including Target.com
and those resulting from the ClientLogic acquisition. The increase in cost of revenues as a percentage of revenue primarily relates to a change in the
business mix to clients with lower gross profit as a percent of revenue.




Selling, General and Administrative Expenses.
S,G&A expenses for the nine months ended September 30, 2007 increased to $32.4 million or 38.1% of revenues, compared to $26.2 million, or 49.5% of
revenues, for the same period in 2006. The increase in expenses in 2007 as compared to 2006 was primarily attributable to an increase in facility,
equipment and management expense of approximately $4.8 million due to additional space taken in the second quarter 2007 for Target.com and the addition
of the facility relating to the ClientLogic acquisition in the fourth quarter of 2006. S,G & A expense as a percentage of revenue have declined as
a result of our growth in revenue requiring comparatively less additional administrative expenses to support and manage the
organization.




Interest Expense. Interest expense for the nine
months ended September 30, 2007 and 2006 was $490,000 and $278,000, respectively. The $212,000 increase resulted mainly from the combined effect of an
increase in the amount outstanding under the revolving credit agreement and an increase in the interest rate charged by our bank while our fixed charge
ratio is below 1.0 causing our weighted average interest rate to increase to 7.8% from 6.7% for the nine months ended September 30, 2007 and 2006
respectively.




Income Taxes. The Companys effective tax rate
for the nine months ended September 30, 2007 and 2006 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
losses for the nine months ended September 30, 2007 and 2006 were offset by a corresponding increase of this valuation allowance resulting in an
effective tax rate of 0% for the nine months ended September 30, 2007 and 2006.




Liquidity and Capital Resources




The Company funds its operations and capital expenditures
primarily through cash flow from operations and borrowings under a revolving bank credit facility. In August 2007, the Company determined additional
liquidity was required to support capital expenditures and working capital needs which were forecasted to occur during 2007 end of year seasonal
business volumes. As more fully described below, the Company entered into a $5.0 million Second Lien Credit Agreement to provide that
liquidity.




19


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Item 2  Managements Discussion and Analysis of
Financial Condition and Results of Operations




The Company had cash and cash equivalents of approximately
$597,000 at September 30, 2007 as compared to $1.0 million at December 31, 2006. Additionally, the Company decreased its borrowings outstanding under
its revolving credit facility (discussed below) to $4.0 million at September 30, 2007, as compared to $8.6 million at December 31, 2006. This reduction
resulted from the use of the proceeds from a $5.0 million one year term loan from Chatham Credit Management III, LLC more fully described below. The
Company generated positive cash flow from operations of $4.2 million during the nine months ended September 30, 2007, as compared to positive cash flow
from operations of $216,000 in the same period in 2006.




The Company has a revolving bank credit agreement with a
maximum borrowing limit of $15.0 million, which will mature in March 2009. Although the maximum borrowing limit is $15.0 million, the credit facility
limits borrowings to specified percentages of the value of eligible accounts receivable, inventory and certain personal assets of the Companys
Chairman, President and CEO. The difference between the limits on borrowings and the amount borrowed and outstanding at any time is defined as unused
availability. Under the specific calculations defined in the credit agreement, the Company had $11.0 million of unused availability at September 30,
2007. 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 requirements for periodic reporting of the value of the assets underlying the borrowing limit, change of ownership control
and other covenants. The provisions of the revolving credit agreement require that the Company maintain a lockbox arrangement with the lender.
Noncompliance with any of the covenants allows the lender to declare any outstanding borrowing amounts to be immediately due and
payable.




On April 16, 2007, the Company and the bank entered into
the third amendment to its revolving bank credit facility entitled Second Waiver and Amendment Agreement (the Third Amendment)
whereby the bank agreed to waive the Companys then-existing defaults under the credit agreement, provided that the Company comply with the terms
of the credit agreement, as amended, and the additional conditions of the Third Amendment. The defaults included failure to maintain the minimum fixed
charge coverage ratio, failure to make a certain deferred purchase payment in a timely manner and failure to deliver certain financial information as
required by the Credit Agreement. As amended by the Third Amendment, the fixed charge coverage ratio covenant requires the Company to maintain a
minimum fixed charge coverage ratio of between 1.00 and 1.05 to 1.00, depending on the particular fiscal month, for each month beginning December 2007
through May 2008, and a ratio of 1.15 to 1.00 for each month thereafter. In connection with the Third Amendment, Scott Dorfman, the Companys
Chairman, President and CEO agreed to grant the bank a security interest in certain personal assets which will be treated as additional collateral
under the credit agreement. The bank has agreed to release that security interest, so long as no default exists and the fixed charge coverage ratio for
the most recent period shall be equal or greater than 1.05 to 1.00, upon the earlier to occur of (x) April 30, 2008 and (y) the date all deferred
payments in connection with the ClientLogic acquisition are paid in full. The Third Amendment also amends certain other sections of the credit
agreement, including requiring payment of an early termination fee equal to (i) 1.00% of the revolver commitment in the event of termination of the
revolver commitment on or before November 14, 2007, and (ii) 0.25% of the revolver commitment in the event of termination of the revolver commitment
after November 14, 2007, but before November 14, 2008; revising the borrowing base calculation to take into account the additional collateral pledged
by Mr. Dorfman, allowing loan proceeds to be used to make deferred payments required in connection with the ClientLogic acquisition; granting the bank
increased inspection and field examination rights for certain periods; requiring certain financial information reporting on a weekly basis; increasing
the amount of purchase money debt allowed and revising the calculation of the fixed charge coverage ratio.




20


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Item 2  Managements Discussion and Analysis of
Financial Condition and Results of Operations




On June 29, 2007, the Company and the bank entered into the
fourth amendment to its revolving bank credit facility entitled Fourth Amendment Agreement (the Fourth Amendment) whereby the
bank agreed to adjust the definition of the defined term availability reserve from $2.0 million to $0.5 million until December 31, 2007 at which time
the availability reserve would revert back to $2.0 million. Under the new definition, the Company was able to obtain an additional $1.5 million of
advanced funds under the revolving credit agreements existing collateral and borrowing base availability until December 31, 2007. Additionally,
the fixed charge ratio requirement included in the Third Amendment dated April 16, 2007 was removed as a requirement for availability to borrow under
the revolving credit agreement, but remains at the same 1.05 to 1.0 requirement to i) allow release of the banks security interest in the
specified personal assets of the Companys Chairman, President and CEO and ii) a regulating factor in the interest rate charged on borrowings
under the line as described below. The Company intends to use the additional availability to fund purchases of long term capital assets needed to
support certain fulfillment operations and general working capital needs. Additionally, the Fourth Amendment provides that if there were a change in
the officer occupying the office of Chief Financial Officer, the Chief Financial Officer position could remain unfilled for a maximum of 59 days and
the new officer retained to hold the position would have to be suitable to the Bank or an Event of Default would occur.




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 below as the Second Lien Credit Agreement which is subordinated
to the banks position as senior lender to the Company. Additionally, the Fifth Amendment amends certain provisions of the revolving credit
agreement including i) a decrease in the maximum revolver amount that the Company may borrow under the First Lien Credit Agreement from $25 million to
$15 million, ii) amending the fixed charge coverage ratio covenant to the same levels specified in the Second Lien Credit Agreement and iii) adding a
limitation on the Companys capital expenditures at the same levels specified in the Second Lien Credit Agreement. The reduction of the maximum
available revolver amount to $15 million was consistent with the level of outstanding amounts owed under the revolving credit facility during the
previous nine months and will result in lower unused revolving credit facility fees than the Company has experienced while the maximum availability was
$25 million.




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. During the three months ended September 30, 2007 and 2006, the Company incurred interest expense related to the revolving credit agreement of
approximately $143,000 and $109,000, respectively. During the nine months ended September 30, 2007 and 2006, the Company incurred interest expense
related to the revolving credit agreement of approximately $453,000 and $228,000, respectively. The Company also incurred unused revolving credit
facility fees of approximately $11,000 and $12,000 during the three months ended September 30, 2007 and 2006, respectively, and $31,000 and $38,000
during the nine months ended September 30, 2007 and 2006, respectively.




On September 28, 2007, the Company entered into a Second
Lien Term Loan and Security Agreement (the Second Lien Credit Agreement) 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).




Pursuant to the Second Lien Credit Agreement, the Company
borrowed $5 million (the Second Lien Loan Amount) under the second lien secured credit facilities (the Second Lien Credit
Facility) on September 28, 2007. The Second Lien Credit Agreement
provides for an early termination fee in the event that the Company prepays all or any portion of the borrowings under Second Lien Credit Facility
before December 28, 2007, and provides that the Company will pay a facility fee at closing, a success fee payable on the first anniversary of the
closing and other fees customary for transactions of this type. The Company intends to use the proceeds of the Second Lien Credit Facility for
completion of capital expenditure programs begun in early 2007, fourth quarter seasonal working capital requirements and other general corporate
purposes. The Second Lien Credit Facility has a one year term with the option to renew for five months resulting in an ultimate maturity date of March
1, 2009, the same date on which the revolving bank credit agreement, described above, matures. If the option to renew for five months is exercised, the
Company will be obligated to pay five-twelfths or 41.7% of the initial closing and success fees incurred when the Second Lien Credit Facility was
entered into on September 28, 2007.




21


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Item 2  Managements Discussion and Analysis of
Financial Condition and Results of Operations




There are no scheduled principal payments before maturity
under the Second Lien Credit Facility. Interest accrued on borrowings outstanding under the Second Lien Credit Facility generally is payable on a
monthly basis. Borrowings under the Second Lien Credit Facility bear interest at an annual rate equal to (a) the greater of (1) LIBOR or (2) 5.75% plus
(b) 9.25%. Interest on borrowings under the Second Lien Credit Facility accruing during the period ending on and including December 31, 2007 (the
PIK Period) will be capitalized on a monthly basis. On January 1, 2008, the Company may elect to pay the interest accrued during the PIK
Period either entirely in cash, or by issuing an additional term note for such amount, payable to Chatham, to be repaid in accordance with the terms of
the Second Lien Credit Agreement. Also on January 1, 2008, the Company must prepay the interest to accrue on borrowings outstanding under the Second
Lien Credit Facility between January 1, 2008 and June 30, 2008, by issuing an additional note for such amount to Chatham, to be repaid in accordance
with the terms of the Second Lien Credit Agreement. In the event of default, all obligations will bear interest at the otherwise applicable rate plus
2.00% per annum until the event of default is cured.




The Companys obligations under the Second Lien Credit
Facility are secured by a second priority security interest in, and a second priority lien on, substantially all of the assets and property of the
Company. The Companys obligations under the Second Lien Credit Facility are partially guaranteed by Scott Dorfman, the Companys Chairman,
President, and Chief Executive Officer, pursuant to a Limited Guaranty Agreement between Mr. Dorfman and Chatham Credit Management III, LLC. Mr.
Dorfman has also pledged as partial collateral for the loans under the Second Lien Credit Facility, pursuant to a Guarantor Pledge Agreement between
Mr. Dorfman and Chatham Credit Management III, LLC, the membership interests he owns in Chatham Investment Fund II, LLC and Chatham Investment Fund
III, LLC (collectively, the Chatham Funds). Mr. Dorfmans guarantee is limited to the value of this Chatham Funds collateral. Chatham
Investment Fund III, LLC is one of the lenders under the Second Lien Credit Agreement, and both of the Chatham Funds are affiliated with the other
Chatham entities acting as agents and lenders under the Second Lien Credit Agreement. Mr. Dorfman previously served on the advisory board of Chatham
Investment Fund II, LLC.




The Second Lien Credit Agreement contains a fixed charge
coverage ratio covenant that requires the Company to maintain a minimum fixed charge coverage ratio of between 0.90 and 1.05 to 1.00, depending on the
particular fiscal month, for each month between December 2007 and September 2008, and a ratio of 1.10 to 1.00 for each month thereafter. The Second
Lien Credit Agreement also limits the amount of capital expenditures the Company may make in any fiscal year beginning in the fiscal year 2008 to
$4,500,000. The Second Lien Credit Agreement contains such other representations and warranties, affirmative and negative covenants and events of
default (and, as appropriate, grace periods) as are usual and customary for financings of this kind.




22


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Item 2  Managements Discussion and Analysis of
Financial Condition and Results of Operations




Simultaneous with the execution of the Fifth Amendment and
the Second Lien Credit Agreement, the bank and Chatham entered into an intercreditor agreement defining the relative priority of security interests and
other subordination terms as are usual and customary for creditors in financings of this kind.




Interest on borrowings under the Second Lien Credit
Agreement, which began on September 28, 2007 amounted to approximately $6,000 and was accrued at the rate of 15.0 %.




Including interest on both the revolving credit agreement
and Second Lien Credit Agreement in 2007 and only the revolving credit agreement in 2006, the Company incurred a weighted average interest rate of 7.8%
and 6.7% for the nine months ended September 30, 2007 and 2006 respectively. For the three months ended September 30, 2007 and 2006, the weighted
average interest rate was 8.1% and 6.8% respectively.




For the nine months ended September 30, 2007, compared to
September 30, 2006, the Company had an improvement in cash generated from operating activities of $4.0 million resulting from positive cash flow from
operations of $4.2 million in 2007 compared to positive cash flow from operations in 2006 of $216,000. The $4.0 improvement for the nine months ended
September 30, 2007 from the same period ended 2006 was due to the combination of a $2.9 million reduction in our net loss to income of $287,000 in 2007
from a loss of $2.6 million in 2006, non cash expenses for depreciation, which are included in the net loss, in 2007 of $3.8 million compared to $2.6
million in 2006 and the net effect of changes in the balances of all other working capital accounts mainly consisting of accounts receivable, accounts
payable, accrued expenses and inventories using $100,000.




During the nine months ended September 30, 2007, net cash
used in investing activities was $4.6 million as compared to $7.0 million in the same period in 2006. The decrease of $2.4 million was due to a $3.2
million reduction in capital expenditures primarily attributable to purchases made in 2006 associated with the opening of a new fulfillment center in
Hebron, Kentucky for Target.com, offset by an $800,000 installment payment made in the second quarter of 2007 related to the fourth quarter 2006
ClientLogic acquisition. All of these expenditures were funded through existing cash on hand and borrowings under the Companys credit facility or
the proceeds from the $5.0 million term loan discussed above.




During the nine months ended September 30, 2007, net cash
used in financing activities was $6,000 compared to $5.9 million net cash provided by financing activities in the same period in 2006. The difference
between periods is mainly attributable to higher borrowings under the line of credit in 2006 for capital expenditures supporting the 2006 opening of
the second Hebron, Kentucky fulfillment center while, in 2007, the proceeds of the $5.0 million term loan were used to repay amounts owed under the
already existing revolving credit agreement with the bank.




The Company has generated positive cash flows and net
income from operations for the nine months ended September 30, 2007 and has generated positive cash flows from operations for the calendar years 2005,
2004 and 2003; however we had negative cash flows from operations in 2006. Also in 2006, the Company borrowed a significant portion of the availability
on its line of credit to provide funds for capital expenditures to build the Hebron, Kentucky fulfillment center, acquire the fulfillment center assets
and client accounts of ClientLogic and fund the $2.7 million fourth quarter 2006 net loss. The acquisition of the ClientLogic accounts and the addition
of the Hebron, Kentucky fulfillment center have been the major contributing factors generating a growth in revenues of 60% when comparing revenues of $84.9 million and $53.0 million for
the nine months ended September 30, 2007 and 2006 respectively. We anticipate net income from operations for the remainder of 2007.




23


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Item 2  Managements Discussion and Analysis of
Financial Condition and Results of Operations




The Company estimates that its cash and financing needs
through 2007 will be met by cash flows from operations, its credit facility and the proceeds of the Second Lien Credit Agreement.




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 consolidated financial statements in this Form 10-Q and Note 2 to the consolidated financial statements appearing in our Annual Report
on Form 10-K for the year ended December 31, 2006. 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, 2007 was $25.2 million. This asset relates to the goodwill associated with the Companys acquisition of Universal Distribution Services
(UDS) in December 2000 (including an earnout payment made to the former UDS shareholders in February 2002), and the acquisition of
iFulfillment, Inc. in July 2001. In accordance with SFAS No. 142, the Company performed a goodwill valuation in the first quarter of 2007. The
valuation supported that the fair value of the reporting unit at January 1, 2007 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, 2007 and December 31, 2006 was approximately $18.9 million and $18.3 million,
respectively. This deferred tax asset was generated primarily by net operating loss carryforwards created primarily by the special charge of $34.3
million recorded in 2000 and the net losses generated in 2002, 2003, 2005 and 2006. Innotrac has a net operating loss carryforward of $46.8 million at
December 31, 2006 that expires between 2021 and 2026.




Innotracs ability to generate the expected amounts of
taxable income from future operations is dependent upon general economic conditions, competitive pressures on sales and margins and other factors
beyond managements control. These factors, combined with losses in recent years, create uncertainty about the ultimate realization of the gross
deferred tax asset in future years. Therefore, a valuation allowance of approximately $13.9 million and $14.0 million has been recorded as of September
30, 2007 and December 31, 2006, 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, 2007, an income tax expense of
$156,000 was offset by a corresponding decrease of the deferred tax asset valuation allowance. When, and if, the Company can return to consistent
profitability, and management determines that it will be able to utilize net operating losses prior to their expiration, then the valuation allowance
can be reduced or eliminated.




24


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Item 2  Managements Discussion and Analysis of
Financial Condition and Results of Operations




Accounting Estimates. The preparation of financial
statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.




Recent Accounting Pronouncements




In 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 in tax positions. Additionally, in May 2007, the FASB issued FASB Staff Position No. FIN 48-1 which provides further guidance on how an
enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. The
combined effect of FIN 48 and FIN 48-1 is a requirement that the Company determine whether it is more likely than not that a tax position will be
sustained upon audit, based on the technical merits of the position. A tax position that meets the more likely than not recognition threshold is
measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit
that is greater than 50 percent likely of being realized upon ultimate settlement. The Company adopted FIN 48 effective January 1, 2007. The Company
has a gross deferred tax asset of approximately $18.3 million at December 31, 2006, which did not change significantly during the nine months ended
September 30, 2007. As discussed in Note 6 to the consolidated financial statements in the 2006 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 FIN 48-1 and there are no unrecognized tax benefits and no
related FIN 48 tax liabilities at September 30, 2007. In addition, future changes in the unrecognized tax benefits will likely have no impact on the
effective tax rate due to the existence of the valuation allowance. 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, 2007, we have no accrued interest or penalties related to
uncertain tax positions.




In September 2006, the SEC staff issued Staff Accounting
Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements (SAB 108). SAB 108 was issued in order to eliminate the diversity of practice in how public companies quantify
misstatements of financial statements, including misstatements that were not material to prior years financial statements. The Company adopted
the provisions of SAB 108 effective December 31, 2006, as required. The adoption of such provisions did not impact the financial
statements.




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. The Company is currently evaluating the effect, if any, that the adoption of this pronouncement will have on its financial
statements.




25


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Item 3  Quantitative and Qualitative Disclosures
About Market Risk




Management believes the Companys exposure to market
risks (investments, interest rates and foreign currency) is immaterial. Innotrac holds no market risk sensitive instruments for trading purposes. At
present, the Company does not employ any derivative financial instruments, other financial instruments or derivative commodity instruments to hedge any
market risks 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 and its Second Lien Credit Agreement, the Company will have market risk
relating to the amount of borrowings due to variable interest rates under the credit facility. The Company believes this exposure is immaterial due to
the short-term nature of these borrowings. Additionally, all of the Companys lease obligations are fixed in nature as discussed in Note 5 to the
Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2006 and other filings on file with the
Securities and Exchange Commission, and the Company has no long-term purchases commitments.




Item 4  Controls and
Procedures




Evaluation of Disclosure Controls and
Procedures




Our management, with the participation of the Chief
Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as
defined in federal securities rules) as of September 30, 2007.




Disclosure controls and procedures are controls and
procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the federal securities laws is
recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms. Management recognizes that a control system,
no matter how well conceived and operated, can provide only reasonable assurance that the objectives of the control system are met. Further, the design
of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.
Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues within the
company have been detected. Therefore, assessing the costs and benefits of such controls and procedures necessarily involves the exercise of judgment
by management. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving the objective of ensuring that
information required to be disclosed in our reports filed or submitted under the federal securities laws is recorded, processed, summarized and
reported within the time periods specified in the SEC rules and forms. In addition, our disclosure controls and procedures include, without limitation,
controls and procedures designed to ensure that the information required to be disclosed by us in the reports we file or submit under the federal
securities laws is accumulated and communicated to management, including our principal executive and principal financial officers or persons performing
similar functions, as appropriate, to allow timely decisions regarding required disclosure.




Our Chief Executive Officer and Chief Financial Officer
have concluded, based on our evaluation of our disclosure controls and procedures that our disclosure controls and procedures were ineffective as
of September 30, 2007, due to the conditions that led to
the identification of the material weakness in internal control over financial reporting discussed below.




26


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In the course of conducting the audit of our 2006
Consolidated Financial Statements, our independent auditors identified a material weakness, as defined in standards established by the Public Company
Accounting Oversight Board (United States). A material weakness is a significant deficiency, or combination of significant deficiencies, in internal
control over financial reporting that results in more than a remote likelihood that a material misstatement of the financial statements will not be
prevented or detected by the internal control. The identified material weakness consists of an understaffed financial and accounting function, and
current personnel that lack certain technical accounting skills necessary to prepare financial statements that properly reflect our current level and
scope of activities.




Changes in Internal Control Over Financial
Reporting




On May 16, 2007 the Board of Directors of Innotrac
Corporation (the Company) appointed George M. Hare as the Companys new Chief Financial Officer. As reported in the Companys
Current Report on Form 8-K on May 17, 2007, Mr. Hare has served as the Chief Financial and principal financial officer of other publically traded
companies prior to joining Innotrac. As of the date of filing this Form 10-Q, the Chief Executive Officer and Chief Financial Officer have developed a
specific plan for enhancing the Companys internal controls over financial reporting. That plan includes the addition of two staff members in the
area of accounting and financial analysis, documentation and testing of the Companys more significant financial reporting, operating and
disclosure controls and improved controls over delegated authority by the Chief Executive Officer and Chief Financial Officer. Implementation of these
various improvements are scheduled to be completed before the end of the first quarter of 2008. Accordingly, the material weakness in our internal
control over financial reporting discussed above has not been fully corrected and there is a reasonable possibility that a material misstatement in our
financial statements will not be prevented or detected on a timely basis.




Part II Other Information




Item 1A. Risk Factors




Our common stock lacks liquidity and is held by a small
number of investors, one of which is in receivership where its creditors would like to sell our shares as soon as possible.




As of December 31, 2006, Innotrac officers and directors
owned approximately 48.8% of the outstanding common stock and an institutional shareholder, IPOF Fund, L.P., and their affiliates held 34%. These
ownership positions have resulted in a lack of liquidity in our common stock. Additionally, if any of Innotracs significant shareholders decided
to liquidate its or their position, our common stock price would likely decline materially.




The United States District Court in Cleveland, Ohio has
appointed a receiver to identify and administer the assets of the IPOF Fund, L.P. and its general partner, Mr. David Dadante. Based on information from
the receiver, the Company understands that as of April 3, 2007, the date of record for the 2007 Annual Meeting of Shareholders held on June 8, 2007,
the Fund and Mr. Dadante owned 4,176,725 shares of common stock of the Company, representing approximately 34% of the total shares outstanding, all of
which are held as collateral in margin accounts maintained at several financial institutions. The Company has been engaged in discussions with the
receiver in an effort to cause the shares to be sold in a manner that causes as little disruption to the market for Company stock as possible. The
Federal Court has prohibited the financial institutions holding Company stock owned by the IPOF Fund and Mr. Dadante in margin accounts
from selling any of these shares through at least February
1, 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. Nevertheless, as long as these shares are held in margin accounts where the lenders desire to liquidate the
positions, there will be significant downward pressure on the market price of our common stock because the market is concerned that these shares may be
sold in a manner that causes the price of our common stock to decline precipitously.




27


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There were no other material changes except as disclosed
above from risk factors previously disclosed in our 2006 Annual Report on Form 10-K, as filed with the SEC.




Item 6  Exhibits




Exhibits:


|10.4(aa) |  |  | Fifth Amendment to Loan and Security Agreement with Wachovia
Bank, National Association
|-------- |  |  | ---------------------------------------------------------------------------------------

|10.29(a) |  |  | Second Lien Term Loan and Security Agreement with Chatham Credit
Management III, LLC as Agent for Chatham Investment Fund III, LLC and Chatham Investment Fund QP III, LLC
|-------- |  |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.29(b) |  |  | Limited Guaranty Agreement between Scott Dorfman and Chatham
Credit management III, LLC.
|-------- |  |  | ----------------------------------------------------------------------------------------

|10.29(c) |  |  | Guarantor Pledge Agreement between Scott Dorfman and Chatham
Credit Management III, LLC
|-------- |  |  | ---------------------------------------------------------------------------------------

|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.
|---- |  |  | ----------------------------------------------------------------------



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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, 2007 |  |  |  | By:  /s/ Scott D. Dorfman                           
|----------------------- |  |  |  | ----------------------------------------------------
|                        |  |  |  | Scott D. Dorfman                                    
|                        |  |  |  | President, Chief Executive Officer and Chairman     
|                        |  |  |  | of the Board (Principal Executive Officer)          
|                       
|Date: November
14, 2007 |  |  |  | By:  /s/ George M. Hare                             
|                        |  |  |  | George M. Hare                                      
|                        |  |  |  | Chief Financial Officer (Principal Financial Officer
|                        |  |  |  | and Principal AccountingOfficer)                    



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