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, 2006





OR




o
      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
                incorporation
                  or organization)
            
            (I.R.S.
                Employer
              Identification
                Number)




6655
                Sugarloaf ParkwayDuluth,
                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 x No o





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 o
            Accelerated
                filer o
            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 o No x





Indicate
      the number of shares outstanding of each of the issuer’s classes of common
      stock, as of the latest practicable date .




Outstanding
                at November 10, 2006Common
                Stock $.10 par value per share
            12,280,610
                Shares







**INNOTRAC
      CORPORATION**




**INDEX**




Part
                I. Financial Information
            
            PageItem
                1.
            
            Financial
              Statements:Condensed
                      Consolidated Balance Sheets at September 30,
                      2006 (Unaudited) and December 31,
                      2005
            
            3Condensed
                  Consolidated Statements of Operations for the Three
                  Months Ended September 30, 2006 and 2005
                  (Unaudited)
            
            4Condensed
                  Consolidated Statements of Operations for the Nine
                  Months Ended September 30, 2006 and 2005
                  (Unaudited)
            
            5Condensed
                  Consolidated Statements of Cash Flows for the Nine
                  Months Ended September 30, 2006 and 2005
                  (Unaudited)
            
            6Notes
                to Condensed Consolidated Financial Statements
                (Unaudited)
            
            7Item
                2.
            
            Management’s
              Discussion and Analysis of Financial Condition
              and Results of Operations
            
            12Item
                3.
            
            Quantitative
              and Qualitative Disclosures About Market
              Risk
            
            20Item
                4.
            
            Controls
              and Procedures
            
            20Part
                II.Other
                InformationItem
                1.
            
            Legal
              Proceedings
            
            21Item
                1A.
            
            Risk
              Factors
            
            21Item
                6.
            
            Exhibits
            
            22Signatures
            
            
            
            23




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, 2006 are not necessarily indicative of the results
      for the entire year ending December 31, 2006. These financial statements should
      be read in conjunction with the consolidated financial statements and notes
      thereto included in the Company’s 2005 Annual Report on Form 10-K, which is
      available on our website at www.innotrac.com.




2


**INNOTRAC
      CORPORATION**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS**


**(in
      thousands, except share data)**


**ASSETS**
              
              **September
                  30, 2006**
              
              **December
                  31, 2005****(unaudited)**Current
                  assets:Cash
                  and cash equivalents
              
              $
              1,122
              
              $
              2,068Accounts
                  receivable (net of allowance for doubtful accounts of $280 at September
                  30, 2006 and $2,791 at December 31, 2005)
              
              
              14,821
              
              
              12,745Inventory
              
              
              2,077
              
              
              4,676Prepaid
                  expenses and other
              
              
              1,529
              
              
              1,383Total
                  current assets
              
              
              19,549
              
              
              20,872Property
                  and equipment:Rental
                  equipment
              
              
              363
              
              
              427Computer
                  software and equipment
              
              
              36,992
              
              
              30,514Furniture,
                  fixtures and leasehold improvements
              
              
              5,672
              
              
              5,13343,027
              
              
              36,074Less
                  accumulated depreciation and amortization
              
              
              (27,882
              )
              
              (25,320
              )15,145
              
              
              10,754Goodwill
              
              
              25,169
              
              
              25,169Other
                  assets, net
              
              
              1,355
              
              
              1,177Total
                  assets
              
              $
              61,218
              
              $
              57,972**LIABILITIES
                  AND SHAREHOLDERS’ EQUITY**Current
                  liabilities:Accounts
                  payable
              
              $
              5,185
              
              $
              6,707Line
                  of credit
              
              
              5,892
              
              
              —Accrued
                  expenses and other
              
              
              4,386
              
              
              3,036Total
                  current liabilities
              
              
              15,463
              
              
              9,743Noncurrent
                  liabilities:Other
                  noncurrent liabilities
              
              
              1,080
              
              
              1,038Total
                  noncurrent liabilities
              
              
              1,080
              
              
              1,038Commitments
                  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,12,280,610
                  shares issued and outstanding.
              
              
              1,228
              
              
              1,228Additional
                  paid-in capital
              
              
              65,995
              
              
              65,911Accumulated
                  deficit
              
              
              (22,548
              )
              
              (19,948
              )Total
                  shareholders’ equity
              
              
              44,675
              
              
              47,191Total
                  liabilities and shareholders’ equity
              
              $
              61,218
              
              $
              57,972




See
      notes
      to condensed consolidated financial statements.




3




Financial
      Statements-Continued





**INNOTRAC
      CORPORATION**


**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS**


**For
      the Three Months Ended September 30, 2006 and 2005**


**(in
      thousands, except per share amounts)**




**Three
                Months Ended September 30,****2006**
            
            **2005****(unaudited)**
            
            **(unaudited)**Revenues
            
            $
            19,091
            
            $
            17,543Cost
                of revenues
            
            
            9,589
            
            
            8,695Selling,
                general and administrative expenses
            
            
            8,914
            
            
            8,535Depreciation
                and amortization
            
            
            956
            
            
            1,091Total
                operating expenses
            
            
            19,459
            
            
            18,321Operating
                (loss)
            
            
            (368
            )
            
            (778
            )Other
                expense:Interest
                expense
            
            
            120
            
            
            18Total
                other expense
            
            
            120
            
            
            18(Loss)
                before income taxes
            
            
            (488
            )
            
            (796
            )Income
                taxes
            
            
            —
            
            
            —Net
                (loss)
            
            $
            (488
            )
            $
            (796
            )(Loss)
                per share:Basic
            
            $
            (0.04
            )
            $
            (0.06
            )Diluted
            
            $
            (0.04
            )
            $
            (0.06
            )Weighted
                average shares outstanding:Basic
            
            
            12,281
            
            
            12,277Diluted
            
            
            12,281
            
            
            12,277




See
        notes
        to condensed consolidated financial statements.


4




Financial
      Statements-Continued





**INNOTRAC
      CORPORATION**


**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS**


**For
      the Nine Months Ended September 30, 2006 and 2005**


**(in
      thousands, except per share amounts)**




**Nine
                Months Ended September 30,****2006**
            
            **2005****(unaudited)**
            
            **(unaudited)**Revenues
            
            $
            52,996
            
            $
            55,724Cost
                of revenues
            
            
            26,467
            
            
            28,328Selling,
                general and administrative expenses
            
            
            26,212
            
            
            25,421Depreciation
                and amortization
            
            
            2,639
            
            
            3,551Total
                operating expenses
            
            
            55,318
            
            
            57,300Operating
                (loss)
            
            
            (2,322
            )
            
            (1,576
            )Other
                expense:Interest
                expense
            
            
            278
            
            
            127Total
                other expense
            
            
            278
            
            
            127(Loss)
                before income taxes
            
            
            (2,600
            )
            
            (1,703
            )Income
                taxes
            
            
            —
            
            
            —Net
                (loss)
            
            $
            (2,600
            )
            $
            (1,703
            )(Loss)
                per share:Basic
            
            $
            (0.21
            )
            $
            (0.14
            )Diluted
            
            $
            (0.21
            )
            $
            (0.14
            )Weighted
                average shares outstanding:Basic
            
            
            12,281
            
            
            12,167Diluted
            
            
            12,281
            
            
            12,167




See
      notes
      to condensed consolidated financial statements.





5




Financial
      Statements-Continued





**INNOTRAC
      CORPORATION**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS**


**For
      the Nine Months Ended September 30, 2006 and 2005**


**(in
      thousands)**




**Nine
                Months Ended September 30,****2006**
            
            **2005****(unaudited)**
            
            **(unaudited)**Cash
                flows from operating activities:Net
                loss
            
            $
            (2,600
            )
            $
            (1,703
            )Adjustments
                to reconcile net loss to net cash (used in) provided by operating
                activities:Depreciation
                and amortization
            
            
            2,639
            
            
            3,551Provision
                for bad debts
            
            
            73
            
            
            (508
            )Loss
                on disposal of fixed assets
            
            
            8
            
            
            12Amortization
                of deferred compensation
            
            
            84
            
            
            —Changes
                in operating assets and liabilities:(Increase)
                decrease in accounts receivable, gross
            
            
            (2,149
            )
            
            6,066Decrease
                (increase) in inventory
            
            
            2,599
            
            
            (1,469
            )(Increase)
                decrease in prepaid expenses and other
            
            
            (307
            )
            
            348Decrease
                in accounts payable
            
            
            (1,522
            )
            
            (1,731
            )Increase
                in accrued expenses and other
            
            
            1,391
            
            
            492Net
                cash provided by operating activities
            
            
            216
            
            
            5,058Cash
                flows from investing activity:Capital
                expenditures
            
            
            (7,034
            )
            
            (800
            )Net
                cash used in investing activities
            
            
            (7,034
            )
            
            (800
            )Cash
                flows from financing activities:Net
                borrowings (repayments) under line of credit
            
            
            5,892
            
            
            (3,063
            )Loan
                commitment fees
            
            
            (20
            )
            
            —Repayment
                of capital lease and other obligations
            
            
            —
            
            
            (54
            )Exercise
                of employee stock options
            
            
            —
            
            
            1,285Net
                cash provided by (used in) financing activities
            
            
            5,872
            
            
            (1,832
            )Net
                (decrease) increase in cash and cash equivalents
            
            
            (946
            )
            
            2,426Cash
                and cash equivalents, beginning of period
            
            
            2,068
            
            
            1,377Cash
                and cash equivalents, end of period
            
            $
            1,122
            
            $
            3,803Supplemental
                cash flow disclosures:Cash
                paid for interest
            
            $
            246
            
            $
            145




See
      notes
      to condensed consolidated financial statements.




6


**INNOTRAC
        CORPORATION**
 **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **September
        30, 2006 and 2005**
 **(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, 2005. 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, 2005 and September 30, 2006 (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 $22,000 and $84,000 in
      compensation expense for the three and nine months ended September 30, 2006,
      respectively. As of September 30, 2006, approximately $109,000 of unrecognized
      compensation expense related to non-vested stock options is expected to be
      recognized over the following 39 months.




7
 
  **INNOTRAC
          CORPORATION**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **September
          30, 2006 and 2005**
 **(Unaudited)**


For
      the
      three and nine months ended September 30, 2005, if compensation cost for stock
      options had been determined under a fair value based method, in accordance
      with
      SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No.
      148, “Accounting for Stock-Based Compensation - Transition and Disclosure,” the
      Company’s net loss and net loss per share would have been the following pro
      forma amounts (in 000’s, except per share data):





**Three
                Months Ended**
              **September
                30, 2005**
            
            **Nine
                Months Ended**
              **September
                30, 2005**Net
                loss
            
            $
            (796
            )
            $
            (1,703
            )Pro
                forma net loss
            
            $
            (1,155
            )
            $
            (2,781
            )Basic
                and diluted net loss per share
            
            $
            (0.06
            )
            $
            (0.14
            )Basic
                and diluted pro forma net loss per share
            
            $
            (0.09
            )
            $
            (0.23
            )





Under
      the
      fair value based method, compensation cost, net of tax would have been $359,000
      and $1.1 million for the three and nine months ended September 30, 2005,
      respectively. During the three and nine months ended September 30, 2005, options
      representing 4,250 and 279,867 shares were exercised, respectively.





The
      fair
      value of each option was estimated on the date of grant using the Black-Scholes
      option-pricing model with the following weighted average
      assumptions:





**Nine
                months ended****September
                30, 2006**
            
            **September
                30, 2005**Risk-free
                interest rate
            
            
            4.72%
            
            
            4.20%Expected
                dividend yield
            
            
            0%
            
            
            0%Expected
                lives
            
            
            2.0
                Years
            
            
            2.4
                YearsExpected
                volatility
            
            
            72.3%
            
            
            72.2%




2.
            **FINANCING
                OBLIGATIONS**





The
      Company has a revolving bank credit agreement with a maximum borrowing limit
      of
      $25.0 million, which will mature in March 2009. Although the maximum borrowing
      limit is $25.0 million, the credit facility limits borrowings to a specified
      percentage of eligible accounts receivable and inventory, which totaled $13.1
      million at September 30, 2006. At September 30, 2006 the Company had $5.9
      million outstanding and $4.5 million of additional availability under the
      revolving credit agreement.




8
 
  **INNOTRAC
          CORPORATION**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **September
          30, 2006 and 2005**
 **(Unaudited)**


The
      Company has granted a security interest in all of its assets to the lender
      as
      collateral under this revolving credit agreement. The revolving credit agreement
      contains fixed charge coverage ratio, change of ownership control  and
      other  covenants.
      Noncompliance with any of the covenants allows the lender to declare any
      outstanding borrowing amounts to be immediately due and payable.





The
        financial covenants required the Company to maintain a minimum fixed charge
        coverage ratio of 0.75 to 1.00 for the quarter ended September 30, 2006.
        The
        Company was not in compliance at September 30, 2006 with a fixed charge coverage
        ratio of 0.64 to 1.00. Additionally, the Company’s acquisition of certain assets
        from ClientLogic (described in Note 7 below) violated additional covenants
        in
        the credit agreement regarding debt.
 
 On
        November 14, 2006, the Company and the bank entered into a Waiver and Amendment
        Agreement (the “Waiver Agreement”) whereby the bank agreed to waive the
        Company’s existing defaults under the credit agreement, provided that the
        Company comply with the terms of the credit agreement, as amended by the
        Waiver
        Agreement, and the additional conditions of the Waiver Agreement. Based on
        current projections, the Company believes that it will be able to comply
        with
        the terms and conditions of the credit agreement, as amended, and the Waiver
        Agreement.
 
 As
        amended by the Waiver Agreement, the financial covenants require the Company
        to
        maintain a minimum fixed charge coverage ratio of between 0.65 and 1.10 to
        1.00,
        depending on the particular fiscal month, for each month through May 2007,
        and a
        ratio of 1.15 to 1.00 for each month thereafter. The Waiver Agreement also
        amends certain other sections of the credit agreement, including increasing
        the
        Applicable Margin, instituting an early termination fee, requiring weekly
        Borrowing Base reporting when availability is below a specified amount, and
        requiring monthly compliance certification. A copy of the Waiver Agreement
        is
        attached to this Form 10-Q as Exhibit 10.4, and this discussion is qualified
        by
        the terms of such agreement.


As
      amended by the Waiver Agreement, interest on borrowings is payable monthly
      at rates equal to the prime rate, or at the Company’s option,  LIBOR
      plus up to 200 basis points. During any period in which the Company’s fixed
      charge
      coverage ratio is less than 1.00 to 1.00, the applicable margin will increase
      by
      100 basis points on prime rate loans and by 85 basis points on LIBOR rate
      loans.  During the three months ended September 30, 2006 and 2005, the
      Company incurred  interest
      expense related to the line of credit of approximately  $109,000
      and $4,000, respectively, resulting in a weighted average interest rate of
      6.84%
      and 6.33%, respectively. During the nine months ended September 30, 2006 and
      2005, the Company incurred interest expense related to the line of credit of
      approximately $228,000 and $86,000, respectively, resulting in a weighted
      average interest rate of 6.65% and 5.00%, respectively. The Company also
      incurred unused revolving credit facility fees of approximately $12,000 and
      $10,000 during the three months ended September 30, 2006 and 2005, respectively,
      and $38,000 and $34,000 during the nine months ended September 30, 2006 and
      2005, 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,**
            ********
            ****
            **2006**
            ****
            **2005**
            ****
            **2006**
            ****
            **2005**Diluted
                earnings per share:Weighted
                average shares outstanding
            
            
            12,281
            
            
            12,277
            
            
            12,281
            
            
            12,167Employee
                and director stock options and unvested restricted shares
            
            
            —
            
            
            —
            
            
            —
            
            
            —Weighted
                average shares assumingdilution
            
            
            12,281
            
            
            12,277
            
            
            12,281
            
            
            12,167




Options
      outstanding to purchase 1.6 million shares of the Company’s common stock for
      both the three and nine months ended September 30, 2006, and 1.6 million shares
      for both the three and nine months ended September 30, 2005, were not included
      in the computation of diluted EPS because their effect was
      anti-dilutive.




9


**INNOTRAC
        CORPORATION**
 **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **September
        30, 2006 and 2005**
 **(Unaudited)**




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, 2006 and
      December 31, 2005 was approximately $17.0 million and $15.6 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 and 2005. Innotrac has a
      net
      operating loss carryforward of $37.5 million at December 31, 2005 that expires
      between 2020 and 2025.





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 $13.1 million and $12.2 million has
      been
      recorded as of September 30, 2006 and December 31, 2005, 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, 2006, the deferred tax
      benefit of $895,000 was offset by a corresponding increase 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.





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 has been increased to 40% for a particular
      shareholder that owned approximately 34.0% of the shares outstanding on
      September 30, 2006. 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 was named as a defendant in a third party complaint filed on October
      31,
      2006 by Frank Regalbuto and Michael Regalbuto (the “Regalbutos”) in the U.S.
      District Court for the District in Cleveland, Ohio arising out of the
      Regalbutos’ investments in the IPOF Fund, L.P. The complaint alleges securities
      fraud, RICO violations and common law fraud by the Company and unnamed
      individual defendants who appear to be the Company’s directors. The receiver of
      the IPOF Fund has filed motions to intervene, sever the third party complaint,
      and stay the proceedings, and for an order to show cause for why the plaintiffs
      should not be held in contempt of the court. The court has scheduled a hearing
      on the receiver’s motions for November 14, 2006. Based on the information
      available to date, the Company believes that the asserted claims are without
      merit and believes that this matter will not have a material adverse effect
      on
      the Company’s financial position or its results of operations.


The
        Company is also 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.




10
 
 **INNOTRAC
          CORPORATION**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **September
          30, 2006 and 2005**
 **(Unaudited)**


*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, 2006 and 2005, 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 and $5,000 for the three months
      ended September 30, 2006 and 2005, respectively, and approximately $21,000
      and
      $10,000 for the nine months ended September 30, 2006 and 2005,
      respectively.





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.




7.
            **SUBSEQUENT
                  EVENT**




On
      October 31, 2006, the Company acquired the fulfillment and reverse logistics
      business of ClientLogic, located in Columbus, Ohio, for $1.8 million plus an
      earn-out payment equal to ten percent of net revenues for a twelve month period
      beginning on or before April 1, 2007. The $1.8 million payment is payable in
      two
      installments, $1.0 million was paid at closing and the remaining $800,000 is
      due
      February 28, 2007. The acquisition will be funded from the Company’s revolving
      credit facility, reducing the availability under the credit facility.





The
      approximate book value of the assets acquired is $2.7 million. During the fourth
      quarter, the Company will determine the fair market value of the tangible and
      intangible assets acquired and to the extent that the purchase price exceeds
      the
      fair value of these net assets, then the excess will be allocated to
      goodwill.




11




**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 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 ten
      fulfillment centers and two call centers in seven cities spanning all time
      zones
      across the continental United States.





We
      receive most of our clients’ orders either through inbound call center services,
      electronic data interchange (“EDI”) or the Internet. On a same-day basis,
      depending on product availability, the Company picks, packs, verifies and ships
      the item, tracks inventory levels through an automated, integrated perpetual
      inventory system, warehouses data and handles customer support inquiries. Our
      fulfillment and customer support services interrelate and are sold as a package,
      however they are individually priced. Our clients may utilize our fulfillment
      services, our customer support services, or both, depending on their individual
      needs.





Our
      core
      service offerings include the following:




·
              Fulfillment
                  Services:
 ·
              sophisticated
                  warehouse management technology
 ·
              automated
                  shipping solutions
 ·
              real-time
                  inventory tracking and order status
 ·
              purchasing
                  and inventory management
 ·
              channel
                  development
 ·
              zone
                  skipping for shipment cost
                  reduction
 ·
              product
                  sourcing and procurement
 ·
              packaging
                  solutions
 ·
              back-order
                  management; and
 ·
              returns
                  management.
 
 ·
              Customer
                  Support Services:
 ·
              inbound
                  call center services
 ·
              technical
                  support and order status
 ·
              returns
                  and refunds processing
 ·
              call
                  centers integrated into fulfillment
                  platform
 ·
              cross-sell/up-sell
                  services
 ·
              collaborative
                  chat; and
 ·
              intuitive
                  e-mail response.




12


**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
            
            **2006**
            ****
            **2005**
            ****
            **2006**
            ****
            **2005**Telecommunications
            
            
            6.4
            %
            
            12.7
            %
            
            7.5
            %
            
            13.1
            %Modems
            
            
            24.4
            
            
            24.7
            
            
            25.5
            
            
            20.6Retail/Catalog
            
            
            37.0
            
            
            29.4
            
            
            33.4
            
            
            28.8Direct
                Marketing
            
            
            23.1
            
            
            21.1
            
            
            22.3
            
            
            26.5Business-to-Business
                (“B2B”)
            
            
            9.1
            
            
            12.1
            
            
            11.3
            
            
            11.0100.0
            %
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %


****


Telecommunications
      and Modems .
      The
      Company continues to be a major provider of fulfillment and customer support
      services to the telecommunications industry. In spite of a significant
      contraction and consolidation in this industry in the past several years, the
      Company continues to provide customer support services and fulfillment of
      telephones, caller ID equipment, digital subscriber line (“DSL”) and other
      telecommunications products to companies such as BellSouth Corporation and
      Qwest
      Communications International, Inc. and their customers. Inventory for our
      telecommunications and DSL modem clients is held on a consignment basis, with
      the exception of certain BellSouth inventory for which we are contractually
      indemnified, and includes items such as telephones, caller ID equipment, DSL
      modems and ancillary equipment. Despite a decline in our telecommunications
      business as a result of reduced volumes due to the maturity of the telephone
      and
      Caller ID equipment business, we anticipate that the percentage of our revenues
      attributable to telecommunications and DSL modem clients will remain fairly
      constant during the remainder of 2006 due mainly to increased volumes from
      our
      DSL modem business, which we believe is still in a strong growth
      mode.





Retail,
      Catalog and Direct Marketing. The
      Company also 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 ten 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 2006 due to the addition of several new clients, including
      Target.com, late in the second quarter of 2006, while the revenues attributable
      to our direct marketing clients will decrease as a percentage of overall revenue
      due to the increase in revenues related to retail and catalog
      clients.




13
 
 **MANAGEMENT’S
          DISCUSSION AND ANALYSIS OF**
 **FINANCIAL
          CONDITION AND RESULTS OF OPERATIONS**


On
      October 21, 2004, Tactica International, Inc. (“Tactica”), one of the Company’s
      direct response clients, filed a voluntary petition for relief under Chapter
      11
      in U.S. Bankruptcy Court. **** On
      October 25, 2004 the Bankruptcy Court approved, on an interim basis, a
      Stipulation and Consent Order (“Stipulation”) entered into between Tactica and
      Innotrac, whereby Tactica acknowledged the validity of Innotrac’s claim and
      Innotrac’s first priority security interest in, and warehouseman’s lien on,
      Tactica’s inventory held by Innotrac. This Stipulation allowed Tactica to
      continue to sell its inventory while reducing the receivables owed by Tactica
      to
      Innotrac. Tactica defaulted on the Stipulation and on January 18, 2005, Innotrac
      issued a Notice of Default to Tactica. In March 2005, Innotrac and Tactica
      reached a verbal agreement that would permit Innotrac to liquidate the Tactica
      inventory in order to pay down the receivable balance, with any excess proceeds
      to be remitted to Tactica. Innotrac, Tactica and the Creditor’s Committee in the
      Tactica bankruptcy case reached an agreement on the terms of the liquidation
      and
      an additional amount of the proceeds to be remitted to the unsecured creditors
      of Tactica, which was approved by the bankruptcy court on June 23, 2005. Based
      on this agreement and management’s estimate of the net realizable value of the
      inventory, the reserve associated with the Tactica receivable was reduced from
      $1.2 million to $775,000 at March 31, 2005. In the fourth quarter 2005, the
      reserve associated with the Tactica receivable was increased to $2.5 million.
      The additional reserve was based on management’s estimate of the net realizable
      value of the inventory, which was considerably reduced in the fourth quarter
      as
      a result of buyers not materializing as initially indicated by the third party
      independent appraiser and a continuing reduction in value of the merchandise.
      The liquidation was completed and the receivable written off against the reserve
      during the second quarter of 2006.





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
      small, but growing area of our business.





**Results
      of Operations**





The
      following table sets forth unaudited summary operating data, expressed as a
      percentage of revenues, for the three and nine months ended September 30, 2006
      and 2005. 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.




14


**MANAGEMENT’S
        DISCUSSION AND ANALYSIS OF**
 **FINANCIAL
        CONDITION AND RESULTS OF OPERATIONS**





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,**
            ********
            ****
            **2006**
            ****
            **2005**
            ****
            **2006**
            ****
            **2005**Revenues
            
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %Cost
                of revenues
            
            
            50.2
            
            
            49.6
            
            
            49.9
            
            
            50.8Selling,
                general and administrative expenses
            
            
            46.7
            
            
            48.6
            
            
            49.5
            
            
            45.6Depreciation
                and amortization
            
            
            5.0
            
            
            6.2
            
            
            5.0
            
            
            6.4Operating
                (loss) income
            
            
            (1.9
            )
            
            (4.4
            )
            
            (4.4
            )
            
            (2.8
            )Other
                expense, net
            
            
            0.7
            
            
            0.1
            
            
            0.5
            
            
            0.2(Loss)
                income before income taxes
            
            
            (2.6
            )
            
            (4.5
            )
            
            (4.9
            )
            
            (3.0
            )Income
                tax benefit
            
            
            —
            
            
            —
            
            
            —
            
            
            —Net
                (loss) income
            
            
            (2.6
            )%
            
            (4.5
            )%
            
            (4.9
            )%
            
            (3.0
            )%





**Three
      Months Ended September 30, 2006 Compared to Three Months Ended September 30,
      2005**





*Revenues.* **  Net
      revenues  increased
      8.8% to $19.1 million for the three months ended September 30, 2006 from $17.5
      million for the three months ended September 30, 2005. This increase was
      primarily attributable to a $1.9 million increase in retail and catalog revenue
      due to the addition of several new clients, a $559,000 increase in revenue
      from
      our direct marketing fulfillment and support services due to increased volumes
      offset by a $1.0 million decrease in revenue from our telecommunications
      fulfillment and support services resulting from reduced volumes due to the
      maturity of the telephone and Caller ID equipment business.





*Cost
      of Revenues.*  Cost
      of
      revenues increased 10.3% to $9.6 million for the three months ended September
      30, 2006, compared to $8.7 million for the three months ended September 30,
      2005. The cost of revenue increase was primarily due to an increase in labor
      expense related to the addition of new clients offset by a decrease in labor
      costs related to the decrease in volumes from our telecommunications clients.





*Selling,
      General and Administrative Expenses.* S,G&A
      expenses for the three months ended September 30, 2006 increased to $8.9
      million, or 46.7% of revenues, compared to $8.5 million, or 48.6% of revenues,
      for the same period in 2005. This net increase was primarily attributable to
      a
      $840,000 increase in facility, equipment and management costs associated with
      the new facility in the three months ended September 30, 2006 as compared to
      the
      same period in 2005 offset by cost savings efforts in 2006 that included
      reductions in information technology costs, account services related costs,
      travel and meals and entertainment expenses resulting in a $372,000 saving
      for
      the three months ended September 30, 2006 as compared to the same period in
      2005. SG&A expenses decreased as a percentage of revenue due to the increase
      in net revenues in 2006 as compared to 2005.




*Interest
      Expense.* Interest
      expense for the three months ended September 30, 2006 and September 30, 2005
      was
      $120,000 and $18,000, respectively. The increase was related to an increase
      in
      the amount outstanding under the revolving credit agreement.




15




**MANAGEMENT’S
        DISCUSSION AND ANALYSIS OF**
 **FINANCIAL
        CONDITION AND RESULTS OF OPERATIONS**




*Income
      Taxes.* The
      Company’s effective tax rate for the three months ended September 30, 2006 and
      2005 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 three months ended September 30, 2006 and 2005
      were offset by a corresponding increase of this valuation allowance resulting
      in
      an effective tax rate of 0% for the three months ended September 30, 2006 and
      2005.





**Nine
      Months Ended September 30, 2006 Compared to Nine Months Ended September 30,
      2005**





*Revenues.* **  Net
      revenues  decreased
      4.9% to $53.0 million for the nine months ended September 30, 2006 from $55.7
      million for the nine months ended September 30, 2005. This decrease was
      primarily attributable to $3.3 million reduction in revenue from our
      telecommunications fulfillment and support services as a result of reduced
      volumes due to the maturity of the telephone and Caller ID equipment business
      and a $3.0 million reduction in revenue from our direct marketing vertical
      due
      to reduced volumes offset by a $2.1 million increase in revenues from our DSL
      clients and a $1.6 million increase in revenues from our retail and catalog
      vertical resulting from the addition of several new clients.





*Cost
      of Revenues.*  Cost
      of
      revenues decreased 6.6% to $26.5 million for the nine months ended September
      30,
      2006, compared to $28.3 million for the nine months ended September 30, 2005.
      The cost of revenue decrease was primarily due to a decrease in labor expense
      related to the decrease in volumes from our telecommunications and direct
      marketing fulfillment and support services offset by an increase in labor
      expense related to the increase in volume for our DSL clients and the addition
      of new retail and catalog clients.





*Selling,
      General and Administrative Expenses.* S,G&A
      expenses for the nine months ended September 30, 2006  increased
      to $26.2 million, or 49.5% of revenues, compared to $25.4 million, or 45.6%
      of
      revenues, for the same period in 2005. This net increase was primarily
      attributable to lower S,G&A expense in the nine months ended September 30,
      2005 as a result of a $440,000 reduction in the allowance for doubtful accounts
      related to the Tactica receivable recorded as a reduction to bad debt expense.
      Additionally, facility, equipment and management expense increased by
      approximately $1.6 million for the nine months ended September 30, 2006 as
      compared to the nine months ended September 30, 2005 due to additional space
      taken during the second half of 2005 in our existing facilities and the addition
      of a new facility in the second quarter of 2006. This increase was offset by
      a
      reduction in other professional services of approximately $254,000 for work
      performed for internal control documentation in 2005 that was not performed
      in
      the comparable period in 2006 and a $949,000 reduction in information technology
      costs, account services related costs, travel and meals and entertainment due
      to
      cost savings efforts.




*Interest
      Expense.* Interest
      expense for the nine months ended September 30, 2006 and September 30, 2005
      was
      $278,000 and $127,000, respectively. The increase was related to an increase
      in
      the amount outstanding under the revolving credit agreement.





*Income
      Taxes.* The
      Company’s effective tax rate for the nine months ended September 30, 2006 and
      2005 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, 2006 and 2005
      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, 2006 and
      2005.




16




**MANAGEMENT’S
        DISCUSSION AND ANALYSIS OF**
 **FINANCIAL
        CONDITION AND RESULTS OF OPERATIONS**


**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.
      The
      Company had cash and cash equivalents of approximately $1.1 million at September
      30, 2006 as compared to $2.1 million at December 31, 2005. Additionally, the
      Company increased its borrowings under its revolving credit facility (discussed
      below) to $5.9 million at September 30, 2006, as compared to no borrowings
      outstanding at December 31, 2005. The Company generated positive cash flow
      from
      operations of $216,000 during the nine months ended September 30, 2006, as
      compared to $5.1 million in the same period in 2005.





The
      Company has a revolving bank credit agreement with a maximum borrowing limit
      of
      $25.0 million, which will mature in March 2009. Although the maximum borrowing
      limit is $25.0 million, the credit facility limits borrowings to a specified
      percentage of eligible accounts receivable and inventory, which totaled $13.1
      million at September 30, 2006.  At September 30, 2006 the Company had $5.9
      million outstanding and $4.5 million of additional availability under the
      revolving credit agreement.




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 fixed charge coverage ratio, 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.
 
 The
        financial covenants required the Company to maintain a minimum fixed charge
        coverage ratio of 0.75 to 1.00 for the quarter ended September 30, 2006.
        The
        Company was not in compliance at September 30, 2006, with a fixed charge
        coverage ratio of 0.64 to 1.00. Additionally, The Company’s acquisition of
        certain assets from ClientLogic (discussed below) violated additional covenants
        in the credit agreement regarding debt.
 
 On
        November 14, 2006, the Company and the bank entered into a Waiver and Amendment
        Agreement (the “Waiver Agreement”) whereby the bank agreed to waive the
        Company’s existing defaults under the credit agreement, provided that the
        Company comply with the terms of the credit agreement, as amended by the
        Waiver
        Agreement, and the additional conditions of the Waiver Agreement. Based on
        current projections, the Company believes that it will be able to comply
        with
        the terms and conditions of the credit agreement, as amended, and the Waiver
        Agreement.
 
 As
        amended by the Waiver Agreement, the financial covenants require the Company
        to
        maintain a minimum fixed charge coverage ratio of between 0.65 and 1.10 to
        1.00,
        depending on the particular fiscal month, for each month through May 2007,
        and a
        ratio of 1.15 to 1.00 for each month thereafter. The Waiver Agreement also
        amends certain other sections of the credit agreement, including increasing
        the
        Applicable Margin, institution an early termination fee, requiring weekly
        Borrowing Base reporting when availability is below a specified amount, and
        requiring monthly compliance certification. A copy of the Forbearance Agreement
        is attached to this Form 10-Q as Exhibit 10.4, and this discussion is qualified
        by the terms of such agreement.
  As
        amended by the Waiver Agreement, interest on borrowings is payable monthly
        at
        rates equal to the prime rate, or at the Company’s option,  LIBOR
        plus up to 200 basis points. During any period in which the Company's fixed
        charge coverage ratio is less than 1.00 to 1.00, the applicable margin will
        increase by 100 basis points on prime rate loans and 85 basis points on LIBOR
        rate loans.  During the three months ended September 30, 2006 and 2005, the
        Company incurred  interest
        expense related to the line of credit of approximately  $109,000
        and $4,000, respectively, resulting in a weighted average interest rate of
        6.84%
        and 6.33%, respectively. During the nine months ended September 30, 2006
        and
        2005, the Company incurred interest expense related to the line of credit
        of
        approximately $228,000 and $86,000, respectively, resulting in a weighted
        average interest rate of 6.65% and 5.00%, respectively. The Company also
        incurred unused revolving credit facility fees of approximately $12,000 and
        $10,000 during the three months ended September 30, 2006 and 2005, respectively,
        and $38,000 and $34,000 during the nine months ended September 30, 2006 and
        2005, respectively.





During
      the nine months ended September 30, 2006, the Company generated $216,000 in
      cash
      flow from operating activities compared to $5.1 million in the same period
      in
      2005. The decrease in cash provided from operating activities was primarily
      the
      result of a $2.1 million increase in net accounts receivable in 2006 compared
      to
      a $5.6 million net decrease in accounts receivable in 2005 and a net loss of
      $2.6 million in 2006 compared to a net loss of $1.7 million in 2005, offset
      by a
      $2.6 million decrease in inventory in 2006 compared to a $1.5 million increase
      in 2005.





During
      the nine months ended September 30, 2006, net cash used in investing activities
      for capital additions was $7.0 million as compared to $800,000 in 2005. The
      increase in capital expenditures is primarily attributable to purchases
      associated with the opening of a new fulfillment center in Hebron, Kentucky
      that
      will handle the expected volumes from the addition of a new client, Target.com.
      All of these expenditures were funded through existing cash on hand and
      borrowings under the Company’s credit facility.




17


**MANAGEMENT’S
        DISCUSSION AND ANALYSIS OF**
 **FINANCIAL
        CONDITION AND RESULTS OF OPERATIONS**


During
      the nine months ended September 30, 2006, cash provided by financing activities
      was $5.9 million compared to $1.8 million net cash used in financing activities
      in the same period in 2005. The primary difference between years is attributable
      to a reduction in outstanding borrowings of $3.1 million in 2005 compared to
      borrowings of $5.9 million in 2006. Additionally, during 2005, the Company
      generated cash of $1.3 million through the exercise of previously granted
      employee stock options.




The
      Company estimates that its cash and financing needs through 2006 will be met
      by
      cash flows from operations and its credit facility. The Company has generated
      positive cash flows from operations in each of the last four years and
      anticipates positive cash flows from operations during the remainder of 2006.
      The Company may need to raise additional funds in order to take advantage of
      unanticipated opportunities, such as acquisitions of complementary businesses,
      or the opening of new facilities. There can be no assurance that the Company
      will be able to raise any such capital on terms acceptable to the Company or
      at
      all.





On
      October 31, 2006, the Company acquired the fulfillment and reverse logistics
      business of ClientLogic, located in Columbus, Ohio, for $1.8 million plus an
      earn-out payment equal to ten percent of net revenues for a twelve month period
      beginning on or before April 1, 2007. The $1.8 million payment is payable in
      two
      installments, $1.0 million was paid at closing and the remaining $800,000 is
      due
      February 28, 2007. The acquisition will be funded from the Company’s revolving
      credit facility, reducing the availability under the credit facility.





The
      approximate book value of the assets acquired is $2.7 million. During the fourth
      quarter, the Company will determine the fair market value of the tangible and
      intangible assets acquired and to the extent that the purchase price exceeds
      the
      fair value of these net assets, then the excess will be allocated to
      goodwill.





**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, 2005. 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, 2006 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 2006. The valuation
      supported that the fair value of the reporting unit at January 1, 2006 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.




18
 
 **MANAGEMENT’S
          DISCUSSION AND ANALYSIS OF**
 **FINANCIAL
          CONDITION AND RESULTS OF OPERATIONS**


*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, 2006 and December 31,
      2005 was approximately $17.0 million and $15.6 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 and 2005. Innotrac has a net operating
      loss carryforward of $37.5 million at December 31, 2005 that expires between
      2020 and 2025.





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 $13.1 million and $12.2 million has
      been
      recorded as of September 30, 2006 and December 31, 2005, 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, 2006, an income tax benefit
      of $895,000 was offset by a corresponding increase of the deferred tax asset
      valuation allowance. When, and if, the Company can return to consistent
      profitability, and management determines that it will be able to utilize net
      operating losses prior to their expiration, then the valuation allowance can
      be
      reduced or eliminated.





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





**Recent
      Accounting Pronouncements**





In
      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.”
The revised Statement clarifies and expands SFAS No. 123’s guidance in several
      areas, including measuring fair value, classifying an award as equity or as
      a
      liability, and attributing compensation cost to reporting periods. The revised
      statement supercedes Accounting Principles Board Opinion No. 25, “Accounting for
      Stock Issued to Employees” (“APB 25”), and its related implementation guidance.
      Under the provisions of SFAS No. 123(R), the alternative to use APB 25’s
      intrinsic value method of accounting that was provided in SFAS No. 123, as
      originally issued, is eliminated, and entities are required to measure
      liabilities incurred to employees in share-based payment transactions at fair
      value. SFAS No. 123(R) became effective for the Company January 1,
      2006.





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. This Interpretation requires that the Company determine whether
      it is
      more likely than not that a tax position will be sustained upon audit, based
      on
      the technical merits of the position. A tax position that meets the more likely
      than not recognition threshold is measured to determine the amount of benefit
      to
      recognize in the financial statements. The tax position is measured at the
      largest amount of benefit that is greater than 50 percent likely of being
      realized upon ultimate settlement. The provisions of FIN 48 will be effective
      as
      of the beginning of the Company’s 2007 fiscal year, with the ** cumulative
      effect of the change in accounting principle recorded as an adjustment to
      opening retained earnings. ** The
      Company is currently evaluating the impact of adopting FIN 48 on the
      Consolidated Financial Statements.


19




**Item
      3 - Quantitative and Qualitative Disclosures About Market
      Risks**





Management
      believes the Company’s exposure to market risks (investments, interest rates and
      foreign currency) is immaterial. Innotrac holds no market risk sensitive
      instruments for trading purposes. At present, the Company does not employ any
      derivative financial instruments, 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
      credit facility, 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 our Annual Report on Form 10-K for the year ended
      December 31, 2005 and other filings on file with the Securities and Exchange
      Commission.





**Item
      4 – Controls
      and
      Procedures**





Our
      management, with the participation of the Chief Executive Officer and the
      principal financial officer, evaluated our disclosure controls and procedures
      (as defined in federal securities rules) as of September 30, 2006. No system
      of
      controls, no matter how well designed and operated, can provide absolute
      assurance that the objectives of the system of controls are met, and no
      evaluation of controls can provide absolute assurance that the system of
      controls has operated effectively in all cases. Our disclosure controls and
      procedures are designed to provide reasonable assurance that the objectives
      of
      disclosure controls and procedures are met. Based on the evaluation discussed
      above, our CEO and principal financial officer have concluded that our
      disclosure controls and procedures were effective as of the date of that
      evaluation to provide reasonable assurance that the objectives of disclosure
      controls and procedures are met.





There
      were no changes in our internal control over financial reporting that have
      materially affected, or are reasonably likely to materially affect, Innotrac’s
      internal control over financial reporting during the third quarter of
      2006.




20





**Part
      II – Other
      Information**




**Item
      1.  LegalProceedings**




The
        Company was named as a defendant in a third party complaint filed on October
        31,
        2006 by Frank Regalbuto and Michael Regalbuto (the “Regalbutos”) in the U.S.
        District Court for the District in Cleveland, Ohio arising out of the
        Regalbutos’ investments in the IPOF Fund, L.P. The complaint alleges securities
        fraud, RICO violations and common law fraud by the Company and unnamed
        individual defendants who appear to be the Company’s directors. The receiver of
        the IPOF Fund has filed motions to intervene, sever the third party complaint,
        and stay the proceedings, and for an order to show cause for why the plaintiffs
        should not be held in contempt of the court. The court has scheduled a hearing
        on the receiver’s motions for November 14, 2006. Based on the information
        available to date, the Company believes that the asserted claims are without
        merit and believes that this matter will not have a material adverse effect
        on
        the Company’s financial position or its results of operations.
 
 The
        Company is also 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.
 **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, 2005, Innotrac officers and directors owned approximately 47.3%
      of
      the outstanding common stock and an institutional shareholder, IPOF Fund, L.P.,
      and its affiliates held 34.0%. 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 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, David Dadante. Based on information from the receiver, the Company
      understands that the Fund and Mr. Dadante own 4,176,725 shares of common stock
      of the Company, representing approximately 34.0% 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 the Company’s common stock as
      possible. The court has prohibited the financial institutions holding the
      Company’s common stock owned by the IPOF Fund and Mr. Dadante in margin accounts
      from selling any of these shares through at least January 7, 2007. 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 common stock.
      Nevertheless, as long as these shares are held in margin accounts where the
      lenders desire to liquidate the positions, there will be significant downward
      pressure on the market price of our common stock because the market is concerned
      that these shares may be sold in a manner that causes the price of our common
      stock to decline precipitously. This concern is ameliorated to some degree
      by
      the continuing prohibition by the court on sales of our shares by financial
      institutions that hold the shares in margin accounts. The court has extended
      this prohibition on several occasions, most recently to January 7, 2007, while
      we and the receiver pursue the sale of these shares in a manner that would
      not
      disrupt the market for our common stock. If the court were to not extend this
      prohibition before the shares have been sold in such a transaction, then the
      financial institutions might foreclose on some or all of these shares and sell
      them into the market, which could have an extremely negative impact on the
      market price for our common stock.





**Noncompliance
        with any of the covenants under our revolving credit agreement allows the
        lender
        to declare any outstanding borrowing amounts to be immediately due and
        payable.**
 
 Our
        revolving line of credit agreement contains financial, change of ownership
        control and other restrictive covenants. Noncompliance with any of the covenants
        allows the lender to declare any outstanding borrowed amounts to be immediately
        due and payable. From time to time in the past, and currently (as of September
        30, 2006), we have violated various restrictive covenants, and have been
        obligated to obtain waivers or amendments from the lender. Pursuant to the
        Waiver and Amendment Agreement dated November 14, 2006, the lender has agreed
        to
        waive our existing defaults under the loan agreement, provided that we comply
        with the terms of the loan agreement, as amended by the Waiver and Amendment
        Agreement, and the additional conditions of the Waiver and Amendment Agreement.
        Although we have been able to obtain waivers and amendments in the past,
        there
        is no guarantee that we will be able to do so for any future covenant breaches.
        If the lender does not waive a future covenant violation, and accelerates
        the
        payment date for any amounts outstanding under the credit facility, we might
        not
        be able to pay these amounts. Failure to comply with the covenants, even
        if
        waived by our lenders, also could adversely affect our credit ratings, which
        could increase our costs of debt financings and impair our ability to obtain
        additional debt financing.


There
      were no other material changes except as disclosed above from risk factors
      previously disclosed in our 2005 Annual Report on Form 10-K, as filed with
      the SEC.




21




**Item
      6 –
      Exhibits**





Exhibits:




10.4
              
              Waiver
                  and Amendment Agreement by and Between the Registrant and Wachovia
                  Bank, National Association, Successor by merger to SouthTrust Bank,
                  dated
                  November 14, 200610.16
              
              Third
                  Amendment to Lease Agreement dated September 21, 2006 by and between
                  ProLogis-Macquarie Kentucky I LLC and the Registrant10.20
              
              Second
                  Amendment to Lease Agreement, dated August 15, 2006, by and between
                  Centerpoint 800 LLC, Centerpoint 1000, LLC and the
                  Registrant10.22
              
              First
                  Amendment to Lease Agreement, dated October 19, 2006, by and between
                  Duke
                  Realty Limited Partnership and the Registrant31.1
              
              Certification
                  of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d -
                  14(a).31.2
              
              Certification
                  of principal financial officer Pursuant to Rule 13a-14(a)/15d -
                  14(a).32.1
              
              Certification
                  of Chief Executive Officer Pursuant to 18 U.S.C. §
1350.32.2
              
              Certification
                  of principal financial officer Pursuant to 18 U.S.C. §
                  1350.





22




**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, 2006
            By:
            /s/ Scott
              D.
              DorfmanScott
              D. DorfmanPresident,
                Chief Executive Officer and Chairman
              of
                the Board (Principal Executive
                Officer)




Date: November
              14, 2006
            
            /s/ Christine
              A. HerrenChristine
              A. HerrenSenior
                  Director and Controller (Principal
                Financial
                  Officer and Principal Accounting
                Officer)




23