UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549




FORM 10-Q




xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE


SECURITIES EXCHANGE ACT OF 1934




For the Quarterly Period Ended September 30, 2010




OR




oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE


SECURITIES ACT OF 1934




For the transition period from ______ to ______




Commission file number 000-23740


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




Georgia

58-1592285(State or other jurisdiction of

(I.R.S. Employerincorporation or organization)

Identification Number)





6465 East Johns Crossing, Johns Creek, 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 xNo o




Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files) Yes oNo o




Indicate by a check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer o
Accelerated filer oNon-accelerated filer o
(Do not check if a smaller reporting company)
Smaller reporting company x




Indicate by check mark whether the registrant is a shell company (as defined in Rule 12-b-2 of the Act) Yes oNo 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 3, 2010Common Stock $.10 par value per share

12,334,804 Shares









INNOTRAC CORPORATION




INDEX


PagePart I. Financial InformationItem 1.
Financial Statements:

2Condensed Balance Sheets at

September 30, 2010 (Unaudited) and December 31, 2009

3Condensed Statements of Operations for the

Three Months Ended September 30, 2010 and 2009 (Unaudited)

4Condensed Statements of Operations for the

Nine Months Ended September 30, 2010 and 2009 (Unaudited)

5Condensed Statements of Cash Flows for the

Nine Months Ended September 30, 2010 and 2009 (Unaudited)

6Notes to Condensed Financial Statements (Unaudited)

7Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

15Item 3.
Quantitative and Qualitative Disclosures About Market Risks

25Item 4.
Controls and Procedures

25Part II. Other InformationItem 6.
Exhibits

26Signatures


27




1




Part I – Financial Information




Item 1 – Financial Statements




The following condensed financial statements of Innotrac Corporation, a Georgia corporation (“Innotrac” or the “Company”), have been prepared in accordance with the instructions to Form 10-Q and, therefore, omit or condense certain footnotes and other information normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America. In the opinion of management, all adjustments are of a normal and recurring nature, except those specified as otherwise, and include those necessary for a fair presentation of the financial information for the interim periods reported. Results of operations for the three and nine months ended September 30, 2010 are not necessarily indicative of the results for the entire year ending December 31, 2010. These financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s 2009 Annual Report on Form 10-K, which is available on our website at www.innotrac.com.




2




INNOTRAC CORPORATION


CONDENSED BALANCE SHEETS


(in thousands, except share data)


September 30, 2010


December 31, 2009(unaudited)ASSETSCurrent assets:Cash and cash equivalents

$
551


$
1,118Accounts receivable (net of allowance for doubtful accounts of $238 at September 30, 2010 and $172 at December 31, 2009)


11,584



14,521Inventories, net


3,663



3,093Prepaid expenses and other


1,271



1,693Total current assets


17,069



20,425Property and equipment:Rental equipment


144



163Computer software and equipment


38,789



38,094Furniture, fixtures and leasehold improvements


8,220



8,19347,153



46,450Less accumulated depreciation and amortization


(35,257
)


(32,733
)11,896



13,717Other assets, net


1,090



1,061Total assets

$
30,055


$
35,203LIABILITIES AND SHAREHOLDERS’ EQUITYCurrent liabilities:Accounts payable

$
4,194


$
5,309Line of credit


-



-Accrued salaries


618



1,746Accrued expenses and other


2,651



2,778Total current liabilities


7,463



9,833Noncurrent liabilities:Deferred compensation


708



675Equipment lease payable


191



370Other noncurrent liabilities


643



446Total noncurrent liabilities


1,542



1,491Commitments 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, 12,860,759 shares issued and 12,334,804 shares outstanding at September 30, 2010 12,600,759 shares issued and 12,334,804 shares outstanding at December 31, 2009


1,286



1,260Additional paid-in capital


66,578



66,528Accumulated deficit


(46,814
)


(43,909
)Total shareholders’ equity


21,050



23,879Total liabilities and shareholders’ equity

$
30,055


$
35,203




See notes to condensed financial statements.




3




Financial Statements-Continued




INNOTRAC CORPORATION


CONDENSED STATEMENTS OF OPERATIONS


For the Three Months Ended September 30, 2010 and 2009


(in thousands, except per share amounts)


Three Months Ended September 30,2010


2009(unaudited)


(unaudited)Service revenues

$
15,849


$
19,402Freight revenues


2,721



2,856Total revenues


18,570



22,258Cost of service revenues


7,040



8,625Freight expense


2,657



2,856Selling, general and administrative expenses


8,761



9,564Depreciation and amortization


882



1,082Total operating expenses


19,340



22,127Operating (loss) income


(770
)


131Other expense:Interest expense


51



42Total other expense


51



42(Loss) income before income taxes


(821
)


89Income taxes


-



167Net loss

$
(821
)

$
(78
)Loss per share:Basic

$
(0.06
)

$
(0.01
)Diluted

$
(0.06
)

$
(0.01
)Weighted average shares outstanding:Basic


12,861



12,601Diluted


12,861



12,601




See notes to condensed financial statements.




4





Financial Statements-Continued




INNOTRAC CORPORATION


CONDENSED STATEMENTS OF OPERATIONS


For the Nine Months Ended September 30, 2010 and 2009


(in thousands, except per share amounts)


Nine Months Ended September 30,2010


2009(unaudited)


(unaudited)Service revenues

$
47,216


$
68,109Freight revenues


9,162



10,515Total revenues


56,378



78,624Cost of service revenues


21,213



29,612Freight expense


9,017



10,401Selling, general and administrative expenses


26,308



31,142Depreciation and amortization


2,614



3,398Total operating expenses


59,152



74,553Operating (loss) income


(2,774
)


4,071Other expense:Interest expense


131



207Total other expense


131



207(Loss) Income before income taxes


(2,905
)


3,864Income taxes


-



167Net (loss) income

$
(2,905
)

$
3,697(Loss) income per share:Basic

$
(0.23
)

$
0.29Diluted

$
(0.23
)

$
0.29Weighted average shares outstanding:Basic


12,777



12,601Diluted


12,777



12,601




See notes to condensed financial statements.




5




Financial Statements-Continued




INNOTRAC CORPORATION


CONDENSED STATEMENTS OF CASH FLOWS


For the Nine Months Ended September 30, 2010 and 2009


(in thousands)


Nine Months Ended September 30,2010


2009(unaudited)


(unaudited)Cash flows from operating activities:Net (loss) income

$
(2,905
)

$
3,697Adjustments to reconcile net (loss) income to net cash provided by operating activities:Depreciation and amortization


2,614



3,398Provision for bad debts


87



41Loss on disposal of fixed assets


9



9Stock compensation expense-stock options


(2
)


10Stock compensation expense-restricted stock


78



56Deferred income taxes


-



167Decrease in other long-term assets


46



23Increase in other long-term liabilities


196



23Changes in operating assets and liabilities:Decrease in accounts receivable, gross


2,850



10,714(Increase) in inventory


(570
)


(690
)Decrease in prepaid expenses and other


451



69Decrease in accounts payable


(1,115
)


(4,695
)Decrease in accrued expenses and other


(1,241
)


(1,890
)Net cash provided by operating activities


498



10,932Cash flows from investing activities:Capital expenditures


(815
)


(845
)Net change in noncurrent assets and liabilities


(9
)


(34
)Net cash used in investing activities


(824
)


(879
)Cash flows used in financing activities:Net (repayments) under line of credit


-



(10,055
)Capital lease (payments) funding


(179
)


62Loan commitment fees


(62
)


(151
)Net cash used in financing activities


(241
)


(10,144
)Net (decrease) in cash and cash equivalents


(567
)


(91
)Cash and cash equivalents, beginning of period


1,118



1,056Cash and cash equivalents, end of period

$
551


$
965Supplemental cash flow disclosures:Cash paid for interest

$
85


$
165Non-cash investing and financing activities:Capital lease for computer equipment

$
-


$
560




See notes to condensed financial statements.




6


INNOTRAC CORPORATION


NOTES TO CONDENSED FINANCIAL STATEMENTS
 September 30, 2010 and 2009
 (Unaudited)


1.         SIGNIFICANT ACCOUNTING POLICIES




The accounting policies followed for quarterly financial reporting are the same as those disclosed in the Notes to Financial Statements included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2009.  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 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 in accordance with Accounting Standards Codification (“ASC”) topic No. 740 – 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 deferred tax asset as of December 31, 2009 and September 30, 2010 (see Note 4).




Revenue Recognition.  Innotrac derives its revenue primarily from two sources: (1) fulfillment operations and (2) the delivery of call center services integrated with our fulfillment operations.  Innotrac’s fulfillment services operations record revenue at the conclusion of the material selection, packaging and upon completion of the shipping process.  The shipping process is considered complete after transfer to an independent freight carrier and receipt of a bill of lading or shipping manifest from that carrier.  Innotrac’s call center service revenue is recognized according to written pricing agreements based on the number of calls, minutes or hourly rates when those calls and time rated services occur.  All other revenues are recognized as services are rendered.  As required by the consensus reached in ASC topic No. 605 – Revenue Recognition, 1)  revenues have been recorded net of the cost of the goods for all fee-for-service clients and 2)  the Company records reimbursements received from customers for out-of pocket expenses, primarily freight and postage fees, as revenue and the associated expense as cost of revenue.  For two clients we purchase their product from our client’s vendor under agreements that require our clients to buy the product back from us at original cost when we ship the product to our client’s end consumer or after a period of time if the product has not been shipped from our fulfillment centers.  The value of these products is repaid to us at the same amount as we paid for them and no service fees are generated on the products.  We net the value of the purchase against the reimbursement from our customer with a resulting zero value in our reported revenue and costs of revenue.




7




INNOTRAC CORPORATION
 NOTES TO CONDENSED FINANCIAL STATEMENTS
 September 30, 2010 and 2009
 (Unaudited)




Stock-Based Compensation Plans. In December 2004, the Financial Accounting Standards Board (“FASB”) issued an update to ASC topic No. 718 – Compensation – Stock Compensation, revising the required accounting for stock-based compensation.  The Company records compensation expense in the financial statements based on the fair value of all share based payments to employees, including grants of employee stock options.  The expense is recognized over the period during which an employee is required to provide services in exchange for the award, which is usually the vesting period.  Additionally, compensation expense for the portion of awards for which the requisite service has not been rendered that are outstanding as of the required effective date shall be recognized as the requisite service is performed on or after the required effective date. Under the requirements of ASC topic No. 718 the Company recorded $1,000 and $4,000 in compensation expense on stock options for the three months ended September 30, 2010 and 2009, respectively.  For the nine months ended September 30, the Company recorded ($2,000) and $10,000 in 2010 and 2009, respectively.  As of September 30, 2010, approximately $3,000 of unrecognized compensation expense related to non-vested stock options is expected to be recognized over the following 7 months.  In addition, the Company issued 265,956 restricted shares on April 16, 2007 and 260,000 restricted shares on March 29, 2010.  As a result, the Company recorded $29,000 and $19,000 in compensation expense for restricted shares for the three months ended September 30, 2010 and 2009, respectively.  For the nine months ended September 30, the Company recorded $78,000 and $56,000 in compensation expense for the restricted shares in 2010 and 2009, respectively.




Fair Value Measurements. Effective January 1, 2008, the Company adopted ASC topic No. 820- Fair Value Measurements and Disclosures, for all financial and non-financial assets and liabilities accounted for at fair value on a recurring basis.  Effective January 1, 2009, the Company adopted ASC topic No. 820 for all non-financial assets and liabilities accounted for at fair value on a non-recurring basis.  ASC topic No. 820 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States of America, and expands disclosures about fair value measurements. There was no impact on the Company’s financial statements upon adoption.




The Company determined the fair values of certain financial instruments based on the fair value hierarchy established in ASC topic No. 820. ASC topic No. 820 requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value;




Level 1: quoted price (unadjusted) in active markets for identical assets




Level 2: inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the instrument




Level 3: inputs to the valuation methodology are unobservable for the asset or liability




ASC topic No. 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.




The carrying value of our debt instrument, on which we had no amounts advanced or outstanding at both September 30, 2010 and December 31, 2009, approximates fair value since our debt instrument consists of a revolving credit line, which under certain conditions can mature within one year of September 30, 2010.  The interest rate is equal to the market rate for such instruments of similar duration and credit quality.




8




INNOTRAC CORPORATION
 NOTES TO CONDENSED FINANCIAL STATEMENTS
 September 30, 2010 and 2009
 (Unaudited)




The carrying value of our Deferred Compensation – Rabbi Trust is a fully funded and fully invested plan which is adjusted to the market value, as reported by the independent plan administrator, of the investments as of each financial statement date with the offsetting change in value adjusted to the value of the liability to the employees who participate in the plan.


Fair Value Measurements Using

(in 000’s)Description

Quoted 
Prices in 
Active 
Markets 
for 
Identical 
Assets 
(Level 1)


Significant 
Other Observable 
Inputs 
(Level 2)


Significant 
Unobservable 
Inputs(Level 3)


TotalAs of December 31,2009Deferred Compensation – Rabbi Trust (1)

$
675


$
-


$
-


$
675Total

$
675


$
-


$
-


$
675As of September 30, 2010Deferred Compensation – Rabbi Trust (1)

$
708


$
-


$
-


$
708Total

$
708


$
-


$
-


$
708




(1)
This is an executive deferred compensation plan for certain employees, as designated by the Company’s Board of Directors.  The Company invests contributions to this plan in employee-directed marketable equity securities which are recorded at quoted market prices.   The contributions are fully invested in six different mutual funds having various growth, industry and geographic characteristics.




Change in Presentation.The presentation of the statement of cash flows for the nine months ended September 30, 2009 has been changed to conform to the presentation for the current year of 2010.  The portion of “Net change in noncurrent assets and liabilities” relating to operating activities was moved from investing activities to operating activities.




Recent Accounting Pronouncements.




In September 2006, the FASB issued ASC topic No. 820 - Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements. ASC topic No. 820 was effective for all financial and non-financial assets and liabilities accounted for at fair value on a recurring basis for fiscal years beginning after November 15, 2007, with earlier application encouraged.  There was no impact on the Company’s financial statements upon adoption on January 1, 2008.




9




INNOTRAC CORPORATION
 NOTES TO CONDENSED FINANCIAL STATEMENTS
 September 30, 2010 and 2009
 (Unaudited)




ASC topic No 820 does not apply to leasing transactions.  Subsequent to the original issuance of ASC topic No. 820, the FASB identified the effective date of the application of ASC topic No. 820 for all non-financial assets and liabilities accounted for at fair value on a non-recurring basis to fiscal years beginning after November 15, 2008.  There was no impact on the Company’s financial statements upon adoption on January 1, 2009.




In June 2008, the FASB issued  an update to ASC topic No. 260 – Earnings per Share, which requires all unvested stock awards which contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, to be included in the number of shares outstanding in basic and diluted EPS calculations.  ASC topic No. 260, as it relates to unvested stock awards which contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, became effective on January 1, 2009.  As a result, our 525,956 restricted shares which are unvested but carry a non-forfeitable right to cash dividends have been included in our earnings per share calculations for all periods presented in our financial statements.





In May 2009, the FASB issued ASC topic No. 855 – Subsequent Events, which establishes general standards of accounting for, and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued.  ASC topic No. 855 identifies the period after a balance sheet date, the circumstances under which an entity should recognize events or transactions and the disclosures an entity should make regarding events which occur after the balance sheet date.  The Company immediately adopted ASC topic No. 855 which became effective for all interim or annual financial periods ending after June 15, 2009.




In June 2009, the FASB issued the Accounting Standards Codification (“ASC”) as the single source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities in preparation of financial statements in conformity with U.S. GAAP. The ASC supersedes existing FASB, American Institute of Certified Public Accountants (“AICPA”), Emerging Issues Task Force (“EITF”) and related literature. While the adoption of the ASC as of July 1, 2009 changes how we reference accounting standards, the adoption did not have an impact on our financial position, results of operations or cash flows.




2.         FINANCING OBLIGATIONS




The Company has a revolving credit facility with Wachovia Bank, (the “Credit Facility”) which has a maximum borrowing limit of $15.0 million.  The Credit Facility is used to fund the Company’s capital expenditures, operational working capital and seasonal working capital needs.  The Credit Facility was renewed on March 27, 2009 when the Company entered into a Fourth Amended and Restated Loan and Security Agreement  (the “2009 Credit Agreement”) with Wachovia Bank, National Association (the “Bank”) setting forth the new terms of the Credit Facility including a maturity date of June 30, 2012.  The 2009 Credit Facility maintains a security interest in all of the Company’s assets.  There was no outstanding balance as of September 30, 2010 under the Credit Facility.




Interest on borrowings pursuant to the 2009 Credit Agreement is payable monthly at specified rates of either, at the Company’s option, the Base Rate (as defined in the 2009 Credit Agreement) plus between 2.00% and 2.50%, or the LIBOR Rate (as defined in the 2009 Credit Agreement) plus between 3.00% and 3.50%, in each case with the applicable margin depending on the Company’s Average Excess Availability (as defined in the 2009 Credit Agreement).  The Company will pay a specified fee on undrawn amounts under the Credit Facility.  After an event of default, all loans will bear interest at the otherwise applicable rate plus 2.00% per annum.




10




INNOTRAC CORPORATION
 NOTES TO CONDENSED FINANCIAL STATEMENTS
 September 30, 2010 and 2009
 (Unaudited)




On May 14, 2010, the Company entered into Amendment No. 1 (the “First Amendment”) to the Credit Facility with the Bank, to provide availability for certain accounts receivable and inventory which are currently excluded from collateral under the terms of the facility and to adjust 2010 and 2011 financial covenants under the Credit Facility for projected operating results.  The 2009 Credit Agreement, as amended by the First Amendment, contains financial, affirmative and negative covenants by the Company as are usual and customary for financings of this kind which can result in the acceleration of the maturity of amounts borrowed under the Credit Facility, including, without limitation, a change in ownership control covenant, a subjective material adverse change covenant and financial covenants establishing maximum annual Capital Expenditures, minimum Excess Availability, maximum monthly and cumulative loss covenants for 2010 and minimum Fixed Charge Coverage Ratio of between 0.35 to 1.35 for 2011 through maturity of the Credit Facility in June 2012 (as each of these terms is defined in the 2009 Credit Agreement and First Amendment).  The 2009 Credit Agreement as amended by the First Amendment also defines as an event of default any termination of the employment of the Chief Financial Officer of the Company, if the Company fails to fill such position with a replacement acceptable to the Bank within 150 days.  The provisions of the 2009 Credit Agreement require that the Company maintain a lockbox arrangement with the Bank, and allows the Bank to declare any outstanding borrowings to be immediately due and payable as a result of noncompliance with any of the covenants.  Accordingly, in the event of noncompliance, the Company’s payment obligations with respect to such borrowings could be accelerated.  Therefore, when the Company has a balance outstanding on its line of credit, that amount is classified as a current liability.  The Company was in compliance with all terms of the Credit Facility at September 30, 2010.




Although the maximum borrowing limit was $15.0 million at September 30, 2010, the Credit Facility limits borrowings to a specified percentage of eligible accounts receivable and inventory, which totaled $9.9 million at September 30, 2010.  Additionally, the terms of the Credit Facility provide that the amount borrowed and outstanding at any time combined with certain reserves for rental payments, letters of credit outstanding and general reserves be subtracted from the Credit Facility limit or the value of the total collateral to arrive at an amount of unused availability to borrow.  The total collateral under the Credit Facility at September 30, 2010 amounted to $9.9 million.  There were no borrowings outstanding under the Credit Facility at September 30, 2010 and the value of reserves and letters of credit at that date totaled $4.1 million.  As a result, the Company had $5.9 million of borrowing availability under the Credit Facility at September 30, 2010.




On May 29, 2009, the Company entered into a $758,000 three year financing agreement for the purchase of computer equipment.  The lease was recorded as a capital lease at June 30, 2009 with the first installment under the lease due in July 2009 and payable monthly. For the three months ended September 30, 2010, the Company repaid $60,000 of principal outstanding and $7,000 of interest expense related to the capital lease.  For the nine months ended September 30, 2010, the Company repaid $179,000 of principal outstanding and $22,000 of interest expense related to the capital lease.




For the three months ended September 30, 2010, we recorded interest expense of $8,000 on the Credit Facility at a weighted average interest rate of 3.31%.  The rate of interest being charged on the Credit Facility at September 30, 2010 was 3.26%.  For the three months ended September 30, 2009, we recorded interest expense of $1,000 on the Credit Facility at a weighted average interest rate of 3.64%.  The Company also incurred unused Credit Facility fees of approximately $17,000 and $18,000 for the three months ended September 30, 2010 and 2009 respectively, which unused Credit Facility fees are included in the total interest expense of $51,000 and $42,000 for the three months ended September 30, 2010 and 2009 respectively.




11




INNOTRAC CORPORATION
 NOTES TO CONDENSED FINANCIAL STATEMENTS
 September 30, 2010 and 2009
 (Unaudited)




For the nine months ended September 30, 2010, we recorded interest expense of $11,000 on the revolving credit agreement at a weighted average interest rate of 3.27%.  For the nine months ended September 30, 2009, we recorded interest expense of $92,000 at a weighted average rate of 3.17% on the revolving credit agreement.  The Company also incurred unused revolving credit facility fees of approximately $51,000 and $41,000 for the nine months ended September 30, 2010 and 2009, respectively.  Additionally, the Company reported total interest expense of $131,000 and $207,000 the nine months ended September 30, 2010 and 2009, respectively.






3.
EARNINGS PER SHARE




The following table shows the shares (in thousands) used in computing diluted earnings per share (“EPS”) in accordance with ASC topic No. 260 – Earnings per Share:




Three Months

Ended September 30,


Nine Months

Ended September 30,2010


2009


2010


2009Diluted earnings per share:Weighted average shares (including 525,956 participating securities at  September 30, 2010 and 265,956 participating securities at September 30, 2009)


12,861



12,601



12,777



12,601Employee and director stock options


-



-



-



-Weighted average shares assumingdilution


12,861



12,601



12,777



12,601




Options outstanding to purchase 936,000 shares of the Company’s common stock for the three and nine months ended September 30, 2010 and 1.2 million shares for the three and nine months ended September 30, 2009 were not included in the computation of diluted EPS because their effect was anti-dilutive.  On January 1, 2009 the Company adopted an update to ASC topic No. 260, which requires the inclusion of all unvested stock awards which contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, in the number of shares outstanding in our basic and diluted EPS calculations.   As a result, we have included 525,956 restricted shares, 265,956 issued on April 16, 2007 and 260,000 issued on March 29, 2010, in our calculation of basic and diluted EPS for current and prior periods.  Under the terms of their issuance, as defined in shareholder approved compensation plans, the restricted shares have immediate voting rights but vesting of the shares does not occur until the earlier of a change in control or in accordance with a schedule of 25% on each of the 7th, 8th, 9th and 10th anniversary of their respective issuance dates.




12




INNOTRAC CORPORATION
 NOTES TO CONDENSED FINANCIAL STATEMENTS
 September 30, 2010 and 2009
 (Unaudited)




4.         INCOME TAXES




Innotrac utilizes the liability method of accounting for income taxes in accordance with ASC topic No. 740 – 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, 2010 and December 31, 2009 was approximately $22.9 million and $22.1 million, respectively.  This deferred tax asset was generated primarily by net operating loss carryforwards created mainly by a special charge of $34.3 million recorded in 2000 and the net losses generated in 2002, 2003, 2005 and 2006.  Innotrac has a net operating loss carryforward of $46.7 million at December 31, 2009 that expires between 2020 and 2027.




Innotrac’s ability to generate the expected amounts of taxable income from future operations is dependent upon general economic conditions, competitive pressures on sales and margins and other factors beyond management’s control.  These factors, combined with tax 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 $21.4 million and $20.3 million has been recorded as of September 30, 2010 and December 31, 2009, respectively.  Income taxes associated with future taxable earnings will be offset by the utilization of the net operating loss carryforward resulting in a reduction in the valuation allowance.  For the three and nine months ended September 30, 2010, the deferred tax benefit of $336,000 and $1.0 million, respectively, 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.




In June 2006, the FASB issued an update to ASC topic No. 740 which clarifies the accounting for uncertainty intax positions. This update to ASC topic No. 740 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 to be realized upon ultimate settlement. The Company adopted ASC topic No. 740 effective January 1, 2007.  The Company had a gross deferred tax asset of approximately $22.1 million at December 31, 2009, which did not change significantly during the nine months ended September 30, 2010.  As discussed in Note 7 to the financial statements in the 2009 Form 10-K, the Company has a valuation allowance against the full amount of its net deferred tax asset.   The Company currently provides a valuation allowance against deferred tax assets when it is more likely than not that deferred tax assets will not be realized.  The Company has recognized tax benefits from all tax positions we have taken, and there has been no adjustment to any net operating loss carryforwards as a result of ASC topic No. 740 and there are no unrecognized tax benefits and no related ASC topic No. 740 tax liabilities at September 30, 2010.




The Company generally recognizes interest and/or penalties related to income tax matters in general and administrative expenses.  As of September 30, 2010, we have no accrued interest or penalties related to uncertain tax positions.




13




INNOTRAC CORPORATION
 NOTES TO CONDENSED FINANCIAL STATEMENTS
 September 30, 2010 and 2009
 (Unaudited)


5.         COMMITMENTS AND CONTINGENCIES




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




On February 5, 2010, an individual filed a complaint in the federal court of the Northern District of Alabama on behalf of himself and individuals similarly situated against AT&T, Inc. and Innotrac Corp.  The complaint alleges among other items that AT&T and the Company conspired to sell product in a manner which had not been authorized by the individual.  The Company believes that the claims enumerated against the Company are without merit.




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 3, 2004 regarding the potential Section 16(b) liability issues that provided for the Company’s recovery of $301,957 no later than March 3, 2006.  In December 2005, the United States District Court in Cleveland, Ohio appointed a receiver to identify and administer the assets of the IPOF Fund, L.P. and its general partner, David Dadante.  The Company informed the IPOF receiver of such agreement, but the likelihood of recovering such amount from the receiver is doubtful.  The Company has not recorded any estimated receivable from this settlement.  Additionally, the Federal Court has prohibited the financial institutions holding Company stock owned by the IPOF Fund L.P. and Mr. Dadante in margin accounts from selling any of these shares through December 1, 2010.  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, L.P. and as warranted by market conditions.  The receiver has indicated to the Company that he does not intend to direct any open market sales during this period except in circumstances in which he believes that there would be no material adverse impact on the market price for the Company’s shares.




7.
SUBSEQUENT EVENTS




In accordance with FASB ASC topic No. 855 – Subsequent Events, general standards are established for the accounting and disclosures of events that occurred after the balance sheet date but before financial statements are issued or are available to be issued.  For the three and nine months ended September 30, 2010, we evaluated, for potential recognition and disclosure, events that occurred through the date of the filing of our Quarterly Report on Form 10-Q for the three and nine months ended September 30, 2010, and determined no adjustment or additional disclosure is needed.




14




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




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 recent 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 in “Item 1A – Risk Factors” in our Annual Report on Form 10-K.  We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.




Overview




Innotrac Corporation (“Innotrac” or the “Company”), founded in 1984 and headquartered in Atlanta, Georgia, is a full-service fulfillment and logistics provider serving enterprise clients and world-class brands.  The Company provides order processing, order fulfillment and call center services to large corporations that outsource these functions.  In order to perform call center and fulfillment functions in-house, a company may be required to develop expensive, labor-intensive infrastructures, which may divert its resources and management’s focus from its principal or core business. By assuming responsibility for these tasks, Innotrac strives to improve the quality of the non-core operations of our clients and to reduce their overall operating costs.




The Company employs sophisticated order processing and warehouse management technology and operates seven fulfillment centers and one call center in six cities spanning all time zones across the continental United States.




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




Our core service offerings include the following:




Fulfillment Services:


●sophisticated warehouse management technology


●automated shipping solutions


●real-time inventory tracking and order status


●purchasing and inventory management


●   channel development


●zone skipping for shipment cost reduction


●product sourcing and procurement


●packaging solutions


●back-order management; and


●returns management.




15


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




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.




The Company is primarily focused on four 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 – Revenues




Three Months Ended

September 30,


Nine Months Ended

September 30,Business Line/Vertical

2010


2009


2010


2009eCommerce / Direct to Consumer


51.2
%


49.6
%


48.6
%


43.9
%Direct Marketing


29.2



27.8



32.6



26.8Modems & Telecommunications


17.1



19.5



16.0



23.6Business-to-Business (“B2B”)


2.5



3.1



2.8



5.7100.0
%


100.0
%


100.0
%


100.0
%




eCommerce/Direct-to-Consumer and Direct Marketing.  The Company provides a variety of fulfillment and customer support services for a significant number of eCommerce, retail and direct marketing clients, including such companies as Target.com, a Division of Target Corporation, Ann Taylor Retail, Inc., The North Face, Spanx, Microsoft, Inc., Product Partners and Thane International.  We take orders for our retail, eCommerce and direct marketing clients via the Internet, through customer service representatives at our Pueblo and Reno call centers or through direct electronic transmission from our clients.  The orders are processed through one of our order management systems and then transmitted to one of our seven 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, eCommerce and direct marketing clients is held on a consignment basis, with minor exceptions, and includes items such as shoes, dresses, accessories, books, 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 our revenues attributable to our eCommerce/Direct-to-Consumer and Direct marketing clients will increase during the remainder of 2010 with a possible increase in the relative percentage of the total depending on the comparable growth in our other business lines.




Telecommunications and Modems.The Company has historically been a major provider of fulfillment and customer support services to the telecommunications industry.  The consolidation in that industry over the last several years has resulted in a heavy concentration of volume in a few companies and accordingly concentration of the service providers to the telecommunication industry.  We completed the transition of the DSL fast access modem fulfillment services we provided AT&T to its in-house fulfillment organization.  We continue to provide other fulfillment and technology services for AT&T and other customers in the telecommunications industry.




16




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




Near the end of the second quarter ended June 30, 2010, we began shipping direct line telephones under a contract with AT&T.  Under this new program, the Company owns inventory until delivery to the customer with payment for the inventory occurring pursuant to a five month installment sale agreement.  Revenues generated under this program are based on the invoiced value of the telephone plus shipping to the end consumer.  Cost of revenues for this program includes the combined cost of the telephone, warehouse order fulfillment costs and shipping.  In this quarterly report for the nine months ended September 30, 2010, revenues and costs of revenue are reported in service revenue, freight revenue, cost of service revenue and cost of freight revenue.  Revenues from this line of business represented less than 2% of total revenues of the Company for the three months ended September 30, 2010 and less than 1% of total revenues for the nine months ended September 30, 2010.




Business-to-Business.  The Company also provides fulfillment and customer support services for business-to-business (“B2B”) clients, including NAPA and The Walt Disney Company.  We have not concentrated efforts to grow our client base in this area, and due to the combination of the recent loss of a client and current economic conditions, we expect this vertical of our business to remain a small percentage of our total revenues throughout the rest of 2010.




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, 2010 and 2009.  The data has been prepared on the same basis as the annual financial statements.  In the opinion of management, it reflects normal and recurring adjustments necessary for a fair presentation of the information for the periods presented.  Operating results for any period are not necessarily indicative of results for any future period.




The financial information provided below has been rounded in order to simplify its presentation.  However, the percentages below are calculated using the detailed information contained in the condensed financial statements.




Three Months Ended

September 30,


Nine Months Ended

September 30,2010

2009


2010


2009Service revenues


85.3
%


87.2
%


83.7
%


86.6
%Freight revenues


14.7



12.8



16.3



13.4Total Revenues


100.0
%


100.0
%


100.0
%


100.0
%Cost of service revenues


37.9



38.7



37.6



37.7Cost of freight expense


14.3



12.8



16.0



13.2Selling, general and administrative expenses


47.2



43.0



46.7



39.6Depreciation and amortization


4.7



4.9



4.6



4.3Operating  (loss) income


(4.1
)


0.6



(4.9
)


5.2Other expense, net


(0.3
)


(0.2
)


(0.2
)


(0.3
)(Loss) income before income taxes


(4.4
)


0.4



(5.1
)


4.9Income tax (expense)


-



(0.8
)


-



(0.2
)Net  (loss) income


(4.4
)%


(0.4
)%


(5.1
)%


4.7
%




17


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




Three Months Ended September 30, 2010 Compared to Three Months Ended September 30, 2009




Service Revenues. Net service revenues decreased 18.3% to $15.8 million for the three months ended September 30, 2010 from $19.4 million for the three months ended September 30, 2009.  This decrease was primarily attributable to i) a $1.4 million decrease in revenue from our eCommerce vertical due to the loss of the Smith & Hawken business when its parent decided to liquidate its operations in October 2009, the loss of clients serviced in the Romeoville facility, which was closed in October 2009 and net reductions in volumes from existing clients; ii) a $800,000 decrease in revenue from our direct marketing clients mainly resulting from reduced volumes from existing clients due to the negative economic conditions partially offset by revenue from the addition of a new client;  iii) a $600,000 decrease in revenue from our DSL-Modem clients due to the transition of a portion of the AT&T fulfillment business to AT&T’s in-house fulfillment organization and reduced volumes from existing clients; iv) a $500,000 reduction in revenue from our Telecom clients due to AT&T discontinuing consumer phone sales, which was partially offset by the new program that began near the end of the second quarter ended June 30, 2010 as discussed above; and v) a $100,000 reduction in revenue from our B2B clients due to the loss of a client that was being serviced out of our Romeoville, Illinois facility and reduced volumes from existing clients.




Freight Revenues.The Company’s freight revenues decreased 4.7% to $2.7 million for the three months ended September 30, 2010 from $2.9 million for the three months ended September 30, 2009.  The $135,000 decrease in freight revenues is primarily attributable reduced volumes from existing B2B and direct marketing clients offset by freight revenue from the addition of a new client.  Changes between reporting periods in freight revenue have no material impact on our operating profitability due to pricing practices for direct freight costs.




Cost of Service Revenues. Cost of service revenues decreased 18.4% to $7.0 million for the three months ended September 30, 2010, compared to $8.6 million for the three months ended September 30, 2009.  The decrease in cost of service revenues was primarily due to reductions in labor costs as volumes and revenue decreased.  Cost of service revenues as a percent of service revenues decreased slightly to 37.9% from 38.7%.




Freight Expense.  The Company’s freight expense decreased 7.0% to $2.7 million for the three months ended September 30, 2010 compared to $2.9 million for the three months ended September 30, 2009 due to the decrease in freight revenue for the reasons listed above.




Selling, General and Administrative Expenses.S,G&A expenses for the three months ended September 30, 2010 decreased to $8.8 million, or 47.2% of total revenues, compared to $9.6 million, or 43.0% of total revenues, for the same period in 2009.  The decrease in S,G&A expenses primarily resulted from a $1.0 million decrease in facility, equipment, account services and fulfillment management expense as a result of closing the Romeoville facility, facility lease negotiations to reduce costs, and a $200,000 net increase in all other S,G&A costs.


Interest Expense.Interest expense for the three months ended September 30, 2010 and 2009 was $51,000 and $42,000, respectively.  The increase in interest expense was due to the Company having increased the amount of average debt outstanding on its Credit Facility to $966,000 during the three months ended September 30, 2010 from $104,000 during the same quarter in 2009, a result of more consistent use of the line during 2010 as compared to 2009.




18




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, 2010 and 2009 was 0% and 188%, respectively.  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.  The income tax benefit associated with our operating loss for the three months ended September 30, 2010 was offset by a corresponding increase of the valuation allowance resulting in an effective tax rate of 0% for the three months ended September 30, 2010.  Income taxes associated with income for the three months ended September 30, 2009 were offset by a corresponding decrease in the valuation allowance and tax expense of $167,000 for the three months ended September 30, 2009 related to the difference between financial and tax reporting of goodwill amortization was recorded.  At December 31, 2009, the Company recorded a 100% impairment of goodwill resulting in the reversal of the $167,000 tax expense.




Nine Months Ended September 30, 2010 Compared to Nine Months Ended September 30, 2009




Service Revenues. Net service revenues decreased 30.7% to $47.2 million for the nine months ended September 30, 2010 from $68.1 million for the nine months ended September 30, 2009.  This decrease was primarily attributable to i) a $8.0 million decrease in revenue from our DSL-Modem clients due to the transition of a portion of the AT&T fulfillment business to AT&T’s in-house fulfillment organization and reduced volumes from existing clients; ii) a $6.8 million decrease in revenue from our eCommerce vertical due to the loss of the Smith & Hawken business, the loss of clients serviced in the Romeoville facility, which was closed in October 2009 and a net reduction in volumes from existing clients; iii) a $3.1 million decrease in revenue from our direct marketing clients mainly resulting from reduced volumes from existing clients due to the negative economic conditions, offset by revenue from the addition of a new client; iv) a $1.8 million reduction in revenue from our B2B clients due to the loss of a client that was being serviced out of our Romeoville, Illinois facility and reduced volumes from existing clients; and v) a $1.2 million reduction in revenue from our Telecom clients due to AT&T discontinuing consumer phone sales, which was partially offset by the new program that began near the end of the second quarter ended June 30, 2010 discussed above.




Freight Revenues.The Company’s freight revenues decreased 12.9% to $9.2 million for the nine months ended September 30, 2010 from $10.5 million for the nine months ended September 30, 2009.  The $1.3 million decrease in freight revenues is primarily attributable to reduced volumes from existing B2B and direct marketing clients offset by freight revenue from the addition of a new direct marketing client.  Changes between reporting periods in freight revenue have no material impact on our operating profitability due to pricing practices for direct freight costs.




Cost of service revenues. Cost of service revenues decreased 28.4% to $21.2 million for the nine months ended September 30, 2010, compared to $29.6 million for the nine months ended September 30, 2009.  The decrease in cost of service revenues was primarily due to reductions in labor costs as volumes and revenue decreased.  Cost of service revenues as a percent of service revenues decreased slightly to 37.6% from 37.7%.




Freight Expense.  The Company’s freight expense decreased 13.3% to $9.0 million for the nine months ended September 30, 2010 compared to $10.4 million for the nine months ended September 30, 2009 due to the decrease in freight revenue for the reasons listed above.




Selling, General and Administrative Expenses.S,G&A expenses for the nine months ended September 30, 2010 decreased to $26.3 million, or 46.7% of total revenues, compared to $31.1 million, or 39.6% of total revenues, for the same period in 2009.  The decrease in S,G&A expenses primarily resulted from a $4.2 million decrease in facility, equipment, account services and fulfillment management expense as a result of closing the Romeoville facility, facility lease negotiations to reduce costs, and a $600,000 net reduction in other costs due to cost savings efforts offset by increased costs related to sales and marketing and worker’s compensation loss reserves. S,G&A expenses as a percentage of total revenue increased due to the decision to maintain facility and administrative capacity to support projected future growth in the face of the decreased service revenue described above.




19




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




Interest Expense.Interest expense for the nine months ended September 30, 2010 and September 30, 2009 was $131,000 and $207,000, respectively.  The decrease in interest expense was due to the Company having reduced the amount of average debt outstanding on its Credit Facility to $451,000 during the nine months ended September 30, 2010 from $3.8 million during the same period in 2009, a result of more consistent use of the line during 2009 as compared to 2010.




Income Taxes.The Company’s effective tax rate for the nine months ended September 30, 2010 and 2009 was 0% and 4.3%, respectively.  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.  The income tax benefit associated with our operating loss for the nine months ended September 30, 2010 was offset by a corresponding increase of the valuation allowance resulting in an effective tax rate of 0% for the nine months ended September 30, 2010.  Income taxes associated with income for the nine months ended September 30, 2009 were offset by a corresponding decrease in the valuation allowance and tax expense of $167,000 related to the difference between financial and tax reporting of goodwill amortization was recorded.  At December 31, 2009, the Company recorded a 100% impairment of goodwill resulting in the reversal of the $167,000 tax expense.




Liquidity and Capital Resources




The Company has a revolving credit facility with Wachovia Bank, (the “Credit Facility”) which has a maximum borrowing limit of $15.0 million.  The Credit Facility is used to fund the Company’s capital expenditures, operational working capital and seasonal working capital needs.  The Credit Facility was renewed on March 27, 2009  when the Company entered into a Fourth Amended and Restated Loan and Security Agreement  (the “2009 Credit Agreement”) with Wachovia Bank, National Association (the “Bank”) setting forth the new terms of the Credit Facility including a maturity date of June 30, 2012.   The 2009 Credit Facility maintains a security interest in all of the Company’s assets.  There was no outstanding balance as of September 30, 2010 under the Credit Facility.




Interest on borrowings pursuant to the 2009 Credit Agreement is payable monthly at specified rates of either, at the Company’s option, the Base Rate (as defined in the 2009 Credit Agreement) plus between 2.00% and 2.50%, or the LIBOR Rate (as defined in the 2009 Credit Agreement) plus between 3.00% and 3.50%, in each case with the applicable margin depending on the Company’s Average Excess Availability (as defined in the 2009 Credit Agreement).  The Company will pay a specified fee on undrawn amounts under the Credit Facility.  After an event of default, all loans will bear interest at the otherwise applicable rate plus 2.00% per annum.




On May 14, 2010, the Company entered into Amendment No. 1 (the “First Amendment”) to the Credit Facility to provide availability for certain accounts receivable and inventory which are currently excluded from collateral under the terms of the facility and to adjust 2010 and 2011 financial covenants under the Credit Facility for projected operating results.  The 2009 Credit Agreement, as amended by the First Amendment, contains financial, affirmative and negative covenants by the Company as are usual and customary for financings of this kind which can result in the acceleration of the maturity of amounts borrowed under the Credit Facility, including, without limitation, a change in ownership control covenant, a subjective material adverse change covenant and financial covenants establishing maximum annual Capital Expenditures, minimum Excess Availability, maximum monthly and cumulative loss covenants for 2010 and minimum Fixed Charge Coverage Ratio of between 0.35 to 1.35 for 2011 through maturity of the Credit Facility in June 2012 (as each of these terms is defined in the 2009 Credit Agreement and First Amendment).  The 2009 Credit Agreement as amended by the First Amendment also defines as an event of default any termination of the employment of the Chief Financial Officer of the Company, if the Company fails to fill such position with a replacement acceptable to the Bank within 150 days.  The provisions of the 2009 Credit Agreement require that the Company maintain a lockbox arrangement with the Bank, and allows the Bank to declare any outstanding borrowings to be immediately due and payable as a result of noncompliance with any of the covenants.  Accordingly, in the event of noncompliance, the Company’s payment obligations with respect to such borrowings could be accelerated.  Therefore, when the Company has a balance outstanding on its line of credit, that amount is classified as a current liability.  The Company was in compliance with all terms of the Credit Facility at September 30, 2010.




20




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




Under the terms of the Credit Facility, the maximum borrowing limit of $15.0 million is limited to borrowings at a specified percentage of eligible accounts receivable and inventory, which totaled $9.9 million at September 30, 2010.  Additionally, the terms of the Credit Facility provide that the amount borrowed and outstanding at any time combined with certain reserves for rental payments, letters of credit outstanding and general reserves be subtracted from the Credit Facility limit or the value of the total collateral to arrive at an amount of unused availability to borrow.  The total collateral under the Credit Facility at September 30, 2010 amounted to $9.9 million.  There were no borrowings outstanding under the Credit Facility at September 30, 2010 and the value of reserves and letters of credit outstanding at that date totaled $4.1 million.  As a result, the Company had $5.9 million of borrowing availability under the Credit Facility at September 30, 2010.




For the three months ended September 30, 2010, we recorded interest expense of $8,000 on the Credit Facility at a weighted average interest rate of 3.31%.  The rate of interest being charged on the Credit Facility at September 30, 2010 was 3.26%.  For the three months ended September 30, 2009, we recorded interest expense of $1,000 on the Credit Facility at a weighted average interest rate of 3.64%.    The Company also incurred unused Credit Facility fees of approximately $17,000 and $18,000 for the three months ended September 30, 2010 and 2009 respectively, which unused Credit Facility fees are included in the total interest expense of $51,000 and $42,000 for the three months ended September 30, 2010 and 2009 respectively.




For the nine months ended September 30, 2010, we recorded interest expense of $11,000 on the revolving credit agreement at a weighted average interest rate of 3.27%.  For the nine months ended September 30, 2009, we recorded interest expense of $92,000 at a weighted average rate of 3.17% on the revolving credit agreement.  The Company also incurred unused revolving credit facility fees of approximately $51,000 and $41,000 for the nine months ended September 30, 2010 and 2009, respectively.  Additionally, the Company reported total interest expense of $131,000 and $187,000 the nine months ended September 30, 2010 and 2009, respectively.




The presentation of the statement of cash flows for the nine months ended September 30, 2009 has been changed to conform to the presentation for the current year of 2010.  The portion of “Net change in noncurrent assets and liabilities” relating to operating activities was moved from investing activities to operating activities.




For the nine months ended September 30, 2010, the Company generated $498,000 positive cash flow from operations compared to generating $10.9 million positive cash flow from operations for the same nine month period in 2009.  The $10.4 million decrease for the nine months ended September 30, 2010 from the same period in 2009 was due to the combined result of generating a net loss of $2.9 million for the period compared to generating a net income of $3.7 million in the prior period, and the net effect of all working capital accounts providing $462,000 of cash during the nine months ended September 30, 2010 compared with the net effect of all working capital accounts providing $3.5 million of cash during the prior period.  The changes in working capital accounts for the nine months ended September 30, 2010 and 2009 resulted mainly from i) the combined effect of reductions in accounts receivable of $2.9 million in 2010 compared to $10.8 million in 2009 due to lower revenues;  offset by ii) reductions in accounts payable of $1.1 million in 2010 compared to $4.7 million in 2009 and reductions in accrued expenses of $1.2 million in 2010 compared to $1.9 million in 2009 primarily due to reduced freight and supply vendor payables impacted by reduced total revenues.  Additionally, non cash expenses for depreciation, which are included in net income, were $2.6 compared to $3.4 million for the nine months ended September 30, 2010 and 2009 respectively.




21




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




During the nine month period ended September 30, 2010 and 2009, net cash used in investing activities consisted mainly of capital expenditures and decreased to $815,000 at September 30, 2010 from $845,000 at September 30, 2009.




During the nine months ended September 30, 2010, there was $241,000 cash used by financing activities due to $62,000 of expenses related to the First Amendment to the Credit Facility with Wachovia Bank and $179,000 of capital lease payments.  For the same nine months ended September 30, 2009, there was $10.1 million of cash used to repay outstanding advances on the Credit Facility.  Additionally, during the nine month period ended September 30, 2009, the Company incurred $151,000 of loan commitment fees as a result of the renewal of the Credit Facility with Wachovia Bank in March 2009 offset by $62,000 of advances under the capital lease entered into in May 2009.





The Company estimates that its cash and financing needs through the rest of 2010 will be met by cash flows from operations and availability under the Credit Facility.




Critical Accounting Policies




Critical accounting policies are those policies that can have a significant impact on the presentation of our financial position and results of operations and demand the most significant use of subjective estimates and management judgment.  Because of the uncertainty inherent in such estimates, actual results may differ from these estimates.  Specific risks inherent in our application of these critical policies are described below.  For all of these policies, we caution that future events rarely develop exactly as forecasted, and the best estimates routinely require adjustment.  These policies often require difficult judgments on complex matters that are often subject to multiple sources of authoritative guidance.  Additional information concerning our accounting policies can be found in Note 1 to the condensed financial statements in this Form 10-Q and Note 2 to the financial statements appearing in our Annual Report on Form 10-K for the year ended December 31, 2009.  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 ASC topic No. 350 - Business Combinations and Reorganizations.  Under ASC topic No. 350, goodwill impairment may exist if the net book value of a reporting unit exceeds its estimated fair value.  At December 31, 2009, in accordance with ASC topic No. 350, the Company determined that the carrying value of its goodwill should be $0 resulting in a non-cash impairment charge of $25.2 million at December 31, 2009.




Accounting for Income Taxes.Innotrac utilizes the liability method of accounting for income taxes in accordance with ASC topic No. 740 – 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, 2010 and December 31, 2009 was approximately $22.9 million and $22.1 million, respectively.  This deferred tax asset was generated primarily by net operating loss carryforwards created primarily by the special charge of $34.3 million recorded in 2000 and the net losses generated in 2002, 2003, 2005 and 2006.  Innotrac has a net operating loss carryforward of $46.7 million at December 31, 2009 that expires between 2020 and 2027.




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




Innotrac’s ability to generate the expected amounts of taxable income from future operations is dependent upon general economic conditions, competitive pressures on sales and margins and other factors beyond management’s control.  These factors, combined with losses in recent years, create uncertainty about the ultimate realization of the gross deferred tax asset in future years.  Therefore, a valuation allowance of approximately $21.4 million and $20.3 million has been recorded as of September 30, 2010 and December 31, 2009, respectively.  Income taxes and income tax benefits associated with future earnings and losses will be offset by the utilization of or increases in the net operating loss carryforward resulting in a reduction in or increase in the valuation allowance respectively.  For the nine months ended September 30, 2010, the deferred tax benefit of $1.0 million 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 September 2006, the FASB issued ASC topic No. 820 - Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements. ASC topic No. 820 was effective for all financial and non-financial assets and liabilities accounted for at fair value on a recurring basis for fiscal years beginning after November 15, 2007, with earlier application encouraged.  There was no impact on the Company’s financial statements upon adoption on January 1, 2008.




ASC topic No 820 does not apply to leasing transactions.  Subsequent to the original issuance of ASC topic No. 820, the FASB identified the effective date of the application of ASC topic No. 820 for all non-financial assets and liabilities accounted for at fair value on a non-recurring basis to fiscal years beginning after November 15, 2008.  There was no impact on the Company’s financial statements upon adoption on January 1, 2009.




In June 2008, the FASB issued  an update to ASC topic No. 260 – Earnings per Share, which requires all unvested stock awards which contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, to be included in the number of shares outstanding in basic and diluted EPS calculations.  ASC topic No. 260, as it relates to unvested stock awards which contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, became effective on January 1, 2009.  As a result, our 525,956 restricted shares which are unvested but carry a non-forfeitable right to cash dividends have been included in our earnings per share calculations for all periods presented in our financial statements.





In May 2009, the FASB issued ASC topic No. 855 – Subsequent Events, which establishes general standards of accounting for, and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued.  ASC topic No. 855 identifies the period after a balance sheet date, the circumstances under which an entity should recognize events or transactions and the disclosures an entity should make regarding events which occur after the balance sheet date.  The Company immediately adopted ASC topic No. 855 which became effective for all interim or annual financial periods ending after June 15, 2009.




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




In June 2009, the FASB issued the Accounting Standards Codification (“ASC”) as the single source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities in preparation of financial statements in conformity with U.S. GAAP. The ASC supersedes existing FASB, American Institute of Certified Public Accountants (“AICPA”), Emerging Issues Task Force (“EITF”) and related literature. While the adoption of the ASC as of July 1, 2009 changes how we reference accounting standards, the adoption did not have an impact on our financial position, results of operations or cash flows.




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Item 3 - Quantitative and Qualitative Disclosures About Market Risks




Management believes the Company’s exposure to market risks (investments, interest rates and foreign currency) is immaterial.  Innotrac holds no market risk sensitive instruments for trading purposes.  At present, the Company does not employ any derivative financial instruments, and does not currently plan to employ them in the future.  The Company does not transact any sales in foreign currency.  To the extent that the Company has borrowings outstanding under its Credit Facility, the Company will have market risk relating to the amount of borrowings due to variable interest rates under the credit facility.  All of the Company’s lease obligations are fixed in nature as noted in Note 5 to the Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2009, and the Company has no long-term purchase commitments.




Item 4 – Controls and Procedures




Evaluation of Disclosure Controls and Procedures




The Company’s management, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial (and Principal Accounting) Officer, carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) as of December 31, 2009.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s internal controls over financial reporting were effective as of the end of the period covered by this report.




Changes in Internal Control Over Financial Reporting




There were no material changes in the Company’s system of internal control over financial reporting during the period covered by this report.




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Part II – Other Information




Item 6 – Exhibits




Exhibits:




31.1*   Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d – 14(a).




31.2*   Certification of Principal Financial Officer Pursuant to Rule 13a-14(a)/15d – 14(a).




32.1*   Certification of Chief Executive Officer Pursuant to 18 U.S.C. § 1350.




32.2*   Certification of Principal Financial Officer Pursuant to 18 U.S.C. § 1350.




*   Filed herewith




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SIGNATURES




Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.




INNOTRAC CORPORATION(Registrant)Date: November 15, 2010
By:
/s/ Scott D. DorfmanScott D. DorfmanPresident, Chief Executive Officer and Chairman of the Board (Principal Executive Officer)Date: November 15, 2010
By:
/s/ George M. HareGeorge M. HareChief Financial Officer (Principal Financial Officer and Principal Accounting Officer)