##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period Ended March 31, 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
 
  Georgia
    
    58-1592285(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification Number)
 6655 Sugarloaf Parkway      Duluth, Georgia
    
    30097(Address of principal executive offices)
    
    (Zip Code)
 (678) 584-4000
 þ o
  o o þ
 o þ
  Outstanding at May 5, 2006Common Stock $.10 par value per share
    
    12,280,610 Shares




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##### 



INNOTRAC CORPORATION
 INDEX
 PagePart I. Financial InformationItem 1.
    
    Financial Statements:Condensed Consolidated Balance Sheets at March 31, 2006 (Unaudited) and December 31, 2005
    
    
    3Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2006 and 2005 (Unaudited)
    
    
    4Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2006 and 2005 (Unaudited)
    
    
    5Notes to Condensed Consolidated Financial Statements (Unaudited)
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11Item 3.
    
    Quantitative and Qualitative Disclosure About Market Risk
    
    
    18Item 4.
    
    Controls and Procedures
    
    
    18Part II. Other InformationItem 6.
    
    Exhibits
    
    
    19Signatures
    
    
    
    
    20EX-31.1 SECTION 302 CERTIFICATION OF THE CEOEX-31.2 SECTION 302 CERTIFICATION OF THE PRINCIPAL FINANCIAL OFFICEREX-32.1 SECTION 906 CERTIFICATION OF THE CEOEX-32.2 SECTION 906 CERTIFICATION OF THE PRINCIPAL FINANCIAL OFFICER
  1




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Part
I  Financial Information
 
 Item 1
 Financial Statements
  2




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INNOTRAC CORPORATION
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (in thousands, except share data)
 March 31, 2006
    
    
    December 31, 2005(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    1,171
    
    
    $
    2,068Accounts receivable (net of allowance for doubtful accounts of $2,776 at
March 31, 2006 and $2,791 at December 31, 2005)
    
    
    13,663
    
    
    
    12,745Inventory
    
    
    4,121
    
    
    
    4,676Prepaid expenses and other
    
    
    1,466
    
    
    
    1,383Total current assets
    
    
    20,421
    
    
    
    20,872Property and equipment:Rental equipment
    
    
    402
    
    
    
    427Computer software and equipment
    
    
    33,425
    
    
    
    30,514Furniture, fixtures and leasehold improvements
    
    
    5,137
    
    
    
    5,13338,964
    
    
    
    36,074Less accumulated depreciation and amortization
    
    
    (26,115
    )
    
    
    (25,320
    )12,849
    
    
    
    10,754Goodwill
    
    
    25,169
    
    
    
    25,169Other assets, net
    
    
    1,216
    
    
    
    1,177Total assets
    
    $
    59,655
    
    
    $
    57,972LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    4,178
    
    
    $
    6,707Line of credit
    
    
    4,071
    
    
    
    Accrued expenses and other
    
    
    4,399
    
    
    
    3,036Total current liabilities
    
    
    12,648
    
    
    
    9,743Noncurrent liabilities:Other noncurrent liabilities
    
    
    1,053
    
    
    
    1,038Total noncurrent liabilities
    
    
    1,053
    
    
    
    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
    
    
    65,952
    
    
    
    65,911Accumulated deficit
    
    
    (21,226
    )
    
    
    (19,948
    )Total shareholders equity
    
    
    45,954
    
    
    
    47,191Total liabilities and shareholders equity
    
    $
    59,655
    
    
    $
    57,972
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INNOTRAC CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 For the Three Months Ended March 31, 2006 and 2005
 (in thousands, except per share amounts)
 Three Months Ended March 31,2006
    
    
    2005(unaudited)
    
    
    (unaudited)Revenues
    
    $
    17,328
    
    
    $
    19,239Cost of revenues
    
    
    8,897
    
    
    
    9,953Selling, general and administrative expenses
    
    
    8,821
    
    
    
    8,255Depreciation and amortization
    
    
    821
    
    
    
    1,252Total operating expenses
    
    
    18,539
    
    
    
    19,460Operating (loss)
    
    
    (1,211
    )
    
    
    (221
    )Other expense:Interest expense
    
    
    67
    
    
    
    67Total other expense
    
    
    67
    
    
    
    67(Loss) before income taxes
    
    
    (1,278
    )
    
    
    (288
    )Income taxes
    
    
    
    
    
    
    Net (loss)
    
    $
    (1,278
    )
    
    $
    (288
    )(Loss) per share:Basic
    
    $
    (0.10
    )
    
    $
    (0.02
    )Diluted
    
    $
    (0.10
    )
    
    $
    (0.02
    )Weighted average shares outstanding:Basic
    
    
    12,281
    
    
    
    12,000Diluted
    
    
    12,281
    
    
    
    12,000
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INNOTRAC CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 For the Three Months Ended March 31, 2006 and 2005
 (in thousands)
 Three Months Ended March 31,2006
    
    
    2005(unaudited)
    
    
    (unaudited)Cash flows from operating activities:Net loss
    
    $
    (1,278
    )
    
    $
    (288
    )Adjustments to reconcile net loss to net cash (used in) provided by
operating activities:Depreciation and amortization
    
    
    821
    
    
    
    1,252Provision for bad debts
    
    
    (1
    )
    
    
    (522
    )Amortization of deferred compensation
    
    
    41
    
    
    
    Changes in operating assets and liabilities:(Increase) decrease in accounts receivable, gross
    
    
    (917
    )
    
    
    1,344Decrease (increase) in inventory
    
    
    555
    
    
    
    (766
    )(Increase) decrease in prepaid expenses and other
    
    
    (122
    )
    
    
    316Decrease in accounts payable
    
    
    (2,529
    )
    
    
    (463
    )Increase in accrued expenses and other
    
    
    1,378
    
    
    
    879Net cash (used in) provided by operating activities
    
    
    (2,052
    )
    
    
    1,752Cash flows from investing activity:Capital expenditures
    
    
    (2,916
    )
    
    
    (290
    )Net cash used in investing activities
    
    
    (2,916
    )
    
    
    (290
    )Cash flows from financing activities:Net borrowings (repayments) under line of credit
    
    
    4,071
    
    
    
    (869
    )Repayment of capital lease and other obligations
    
    
    
    
    
    
    (18
    )Exercise of employee stock options
    
    
    
    
    
    
    258Net cash provided by (used in) financing activities
    
    
    4,071
    
    
    
    (629
    )Net
(decrease) increase in cash and cash equivalents
    
    
    (897
    )
    
    
    833Cash and cash equivalents, beginning of period
    
    
    2,068
    
    
    
    1,377Cash and cash equivalents, end of period
    
    $
    1,171
    
    
    $
    2,210Supplemental cash flow disclosures:Cash paid for interest
    
    $
    54
    
    
    $
    60
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INNOTRAC CORPORATION
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 March 31, 2006 and 2005
 (Unaudited)
 1.
    
    SIGNIFICANT ACCOUNTING POLICIESThe 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 March 31, 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 $41,000 in compensation expense
for the
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INNOTRAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006 and 2005
(Unaudited)
 three months ended March 31, 2006. As of March 31, 2006, approximately $154,000 of
unrecognized compensation expense related to non-vested stock options is expected to be
recognized over the following 45 months.For the three months ended March 31, 2005, had compensation cost for stock options 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 EndedMarch 31, 2005Net loss
    
    $
    (288
    )Pro forma net loss
    
    $
    (398
    )Basic and diluted net loss per share
    
    $
    (0.02
    )Basic and diluted pro forma net
loss per share
    
    $
    (0.03
    )
 Under the fair value based method, compensation cost, net of tax would have been $110,000 for
the three months ended March 31, 2005. During the three months ended March 31, 2005, options
representing 61,000 shares were exercised.The fair value of each option was estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions:
 Three months endedMarch 31,
    
    March 31,2006
    
    2005Risk-free interest rate
    
    
    4.72
    %
    
    
    4.50
    %Expected dividend yield
    
    
    0
    %
    
    
    0
    %Expected lives
    
    2.1 Years
    
    2.2 YearsExpected volatility
    
    
    71.9
    %
    
    
    74.0
    %
 2.
    
    FINANCING OBLIGATIONSThe 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 $12.7 million at March 31, 2006. At March 31, 2006
the Company had $4.1 million outstanding and $5.0 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 restrictive
fixed charge coverage
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INNOTRAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006 and 2005
(Unaudited)
 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 require the Company to maintain a minimum fixed charge ratio of
between 0.70 and 1.00 to 1.00, depending on the particular fiscal quarter, for each of the
Companys quarters through the end of its fiscal year 2006, and a ratio of 1.15 to 1.00
thereafter. The Company was in compliance at March 31, 2006 with a fixed charge ratio of 0.82
to 1.00. Compliance with the fixed charge coverage ratio covenant is determined on a
quarterly basis.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 the three months ended March 31,
2006 and 2005, the Company incurred interest expense related to the line of credit of
approximately $41,000 and $52,000, respectively, resulting in a weighted average interest rate
of 6.68% and 4.76%, respectively. The Company also incurred unused revolving credit facility
fees of approximately $14,000 and $13,000 during the three months ended March 31, 2006 and
2005, respectively.3.
    
    EARNINGS PER SHAREThe 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 MonthsEnded March 31,2006
    
    2005Diluted earnings per share:Weighted average shares outstanding
    
    
    12,281
    
    
    
    12,000Employee and director stock options
and unvested restricted shares
    
    
    
    
    
    
    Weighted average shares assuming
dilution
    
    
    12,281
    
    
    
    12,000
 Options outstanding to purchase 1.7 million shares and 1.5 million shares of the Companys
common stock for the three months ended March 31, 2006 and 2005, respectively, were not
included in the computation of diluted EPS because their effect was anti-dilutive.
 4.
    
    INCOME TAXESInnotrac utilizes the liability method of accounting for income taxes. Under the liability
method, deferred taxes are determined based on the difference between the financial and tax
basis of assets and liabilities using enacted tax rates in effect in the years in which the
differences are expected to reverse. A valuation allowance is recorded against deferred tax
assets if the Company considers it is more likely than not that deferred tax assets will not
be realized. Innotracs gross deferred tax asset as of March 31, 2006 and December 31, 2005
was approximately $16.2 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
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INNOTRAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006 and 2005
(Unaudited)
 managements control. These factors, combined with losses in recent years, create
uncertainty about the ultimate realization of the gross deferred tax asset in future years.
Therefore, a valuation allowance of approximately $12.6 million and $12.2 million has been
recorded as of March 31, 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 three months ended March 31,
2006, the deferred tax benefit of $431,000 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 CONTINGENCIESShareholder 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 March 31, 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 is subject to various legal proceedings and claims that arise
in the ordinary course of business. There are no material pending legal proceedings to which
the Company is a party.Employment Commitment. In June 1999, in conjunction with the opening of a new call center
facility, the Company entered into an employment commitment agreement with the City of Pueblo,
Colorado, whereby the Company received cash incentives of $968,000. These funds were
accounted for as a reduction in the basis of the assets acquired. In return for this
consideration, the Company is obligated to employ a minimum number of full-time employees at
its Pueblo facility, measured on a quarterly basis. This obligation, which became effective
June 2002, will continue through June 2009. In the event that the number of full-time
employees fails to meet the minimum requirement, the Company will incur a quarterly penalty of
$96.30 for each employee less than the minimum required amount. During the three months ended
March 31, 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
$9,000 and $5,000, respectively.
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INNOTRAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006 and 2005
(Unaudited)
 6.
    
    RELATED PARTY TRANSACTIONIn 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, Mr. 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.
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Item 2 -
 MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  Overview
    
    
    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.
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MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  Business Mix
 Three Months EndedMarch 31,Business Line/Vertical
    
    2006
    
    2005Telecommunications
    
    
    8.7
    %
    
    
    13.3
    %Modems
    
    
    26.7
    
    
    
    19.9Retail/Catalog
    
    
    28.3
    
    
    
    26.5Direct Marketing
    
    
    20.8
    
    
    
    27.8Business-to-Business (B2B)
    
    
    15.5
    
    
    
    12.5100.0
    %
    
    
    100.0
    %
 Telecommunications and Modems
 Retail, Catalog and Direct Marketing.
 12




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MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  Business-to-Business.
 Results of Operations
  13




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MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  Three MonthsEnded March 31,2006
    
    2005Revenues
    
    
    100.0
    %
    
    
    100.0
    %Cost of revenues
    
    
    51.4
    
    
    
    51.7Selling, general and administrative expenses
    
    
    50.9
    
    
    
    42.9Depreciation and amortization
    
    
    4.7
    
    
    
    6.5Operating (loss)
    
    
    (7.0
    )
    
    
    (1.1
    )Other expense, net
    
    
    0.4
    
    
    
    0.4(Loss) before income taxes
    
    
    (7.4
    )
    
    
    (1.5
    )Income tax benefit
    
    
    
    
    
    
    Net (loss)
    
    
    (7.4
    )%
    
    
    (1.5
    )%
 Three Months Ended March 31, 2006 Compared to Three Months Ended March 31, 2005
 Revenues.
 Cost of Revenues.
 Selling, General and Administrative Expenses.
 Interest Expense.
 Income Taxes.
 14




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MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  Liquidity and Capital Resources
        15




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MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 borrowings of $4.1 million in 2006. Additionally, during 2005, the Company generated cash of
$258,000 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 doing so again in 2006. The Company may need to
raise additional funds in order to take advantage of unanticipated opportunities 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.Critical Accounting PoliciesCritical 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 March 31, 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.Accounting for Income Taxes.Innotrac utilizes the liability method of accounting for income
taxes. Under the liability method, deferred taxes are determined based on the difference between
the financial and tax basis of assets and liabilities using enacted tax rates in effect in the
years in which the differences are expected to reverse. A valuation allowance is recorded against
deferred tax assets if the Company considers it more likely than not that deferred tax assets will
not be realized. Innotracs gross deferred tax asset as of March 31, 2006 and December 31, 2005
was approximately $16.2 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 $12.6 million and $12.2 million has been
recorded as of March 31, 2006 and December 31,
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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  Accounting Estimates.
 Recent Accounting Pronouncements
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##### Table of Contents



Item 3  Quantitative and Qualitative Disclosure About Market Risks
  
 Item 4
 Controls and Procedures
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##### Table of Contents



Part
II  Other Information
 
 Item 6
 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.
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##### Table of Contents



SIGNATURES
  INNOTRAC
CORPORATION
(Registrant)Date: May 15, 2006
    
    By:
    
    /s/ Scott D. DorfmanScott D. DorfmanPresident, Chief Executive Officer and Chairmanof the Board (Principal Executive Officer)Date: May 15, 2006
    
    
    
    /s/ Christine A. HerrenChristine A. HerrenSenior Director and Controller (PrincipalFinancial Officer and Principal
Accounting Officer)
 20