INNOTRAC CORP - FORM 10-Q - November 16, 2009

Attached files

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EX-31.1 - EXHIBIT 31.1 - INNOTRAC CORP	ex31-1.htm
EX-32.2 - EXHIBIT 32.2 - INNOTRAC CORP	ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - INNOTRAC CORP	ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - INNOTRAC CORP	ex31-2.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2009

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

SECURITIES ACT OF 1934

For the transition period from ____ to ___

Commission file number

000-23740

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

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

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

Registrant’s telephone number, including area code:

(678) 584-4000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No 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 o No 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 o
	Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12-b-2 of the Act) Yes o No x

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


	Outstanding at November 6, 2009

Common Stock $.10 par value per share	12,334,804 Shares

INNOTRAC CORPORATION

INDEX


			Page

Part I. Financial Information

	Item 1.	Financial Statements:	2

		Condensed Balance Sheets at September 30, 2009 (Unaudited) and December 31, 2008	3

		Condensed Statements of Operations for the Three Months Ended September 30, 2009 and 2008 (Unaudited)	4

		Condensed Statements of Operations for the Nine Months Ended September 30, 2009 and 2008 (Unaudited)	5

		Condensed Statements of Cash Flows for the Nine Months Ended September 30, 2009 and 2008 (Unaudited)	6

		Notes to Condensed Financial Statements (Unaudited)	7

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14

	Item 3.	Quantitative and Qualitative Disclosures About Market Risks	24

	Item 4.	Controls and Procedures	24

Part II. Other Information

	Item 6.	Exhibits	25

Signatures			26

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, 2009 are not necessarily indicative of the results for the entire year ending December 31, 2009. These financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s 2008 Annual Report on Form 10-K, which is available on our website at www.innotrac.com.

INNOTRAC CORPORATION

CONDENSED BALANCE SHEETS

(in thousands, except share data)


		ASSETS	September 30, 2009			December 31, 2008
			(unaudited)

Current assets:
Cash and cash equivalents			$	965		$	1,056
Accounts receivable (net of allowance for doubtful accounts of $234 at September 30, 2009 and $271 at December 31, 2008)				15,038			25,793
Inventories, net				2,545			1,855
Prepaid expenses and other				1,228			1,262
Total current assets				19,776			29,966

Property and equipment:
Rental equipment				185			207
Computer software and equipment				42,352			41,388
Furniture, fixtures and leasehold improvements				9,080			9,061
				51,617			50,656
Less accumulated depreciation and amortization				(37,726	)		(34,814	)
				13,891			15,842

Goodwill				25,169			25,169
Other assets, net				1,053			822

Total assets			$	59,889		$	71,799


	LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities:
Accounts payable			$	4,564		$	9,259
Line of credit				—			10,055
Accrued salaries				1,304			2,111
Accrued expenses and other				2,298			3,142
Total current liabilities				8,166			24,567

Noncurrent liabilities:
Equipment lease payable				434			—
Deferred compensation				652			547
Other noncurrent liabilities				228			206
Deferred income taxes - noncurrent				167			—
Total noncurrent liabilities				1,481			753

Commitments and contingencies (see Note 5)				—			—

Shareholders’ equity:
Preferred stock: 10,000,000 shares authorized, $0.10 par value, no shares issued or outstanding				—			—
Common stock: 50,000,000 shares authorized, $0.10 par value, 12,600,759 shares issued and 12,334,804 shares outstanding				1,260			1,260
Additional paid-in capital				66,505			66,439
Accumulated deficit				(17,523	)		(21,220	)
Total shareholders’ equity				50,242			46,479

Total liabilities and shareholders’ equity			$	59,889		$	71,799

See notes to condensed financial statements.

Financial Statements-Continued

INNOTRAC CORPORATION

CONDENSED STATEMENTS OF OPERATIONS

For the Three Months Ended September 30, 2009 and 2008

(in thousands, except per share amounts)


	Three Months Ended September 30,
	2009			2008
	(unaudited)			(unaudited)

Service revenues	$	19,402		$	25,138
Freight revenues		2,856			6,863
Total revenues		22,258			32,001


Cost of service revenues		8,625			11,532
Freight expense		2,856			6,757
Selling, general and administrative expenses		9,564			11,419
Depreciation and amortization		1,082			1,106
Total operating expenses		22,127			30,814
Operating income		131			1,187

Other expense:
Interest expense		42			358
Total other expense		42			358
Income before income taxes		89			829
Income taxes		167			—

Net (loss) income	$	(78	)	$	829

(Loss) income per share:

Basic	$	(0.01	)	$	0.07

Diluted	$	(0.01	)	$	0.07

Weighted average shares outstanding:

Basic		12,601			12,598

Diluted		12,601			12,620

See notes to condensed financial statements.

Financial Statements-Continued

INNOTRAC CORPORATION

CONDENSED STATEMENTS OF OPERATIONS

For the Nine Months Ended September 30, 2009 and 2008

(in thousands, except per share amounts)


	Nine Months Ended September 30,
	2009		2008
	(unaudited)		(unaudited)

Service revenues	$	68,109	$	74,028
Freight revenues		10,515		20,213
Total revenues		78,624		94,241

Cost of service revenues		29,612		34,190
Freight expense		10,401		20,022
Selling, general and administrative expenses		31,142		33,081
Depreciation and amortization		3,398		3,178
Total operating expenses		74,553		90,471
Operating income		4,071		3,770

Other expense:
Interest expense		207		1,084
Total other expense		207		1,084
Income before income taxes		3,864		2,686
Income taxes		167		—

Net income	$	3,697	$	2,686

Income per share:

Basic	$	0.29	$	0.21

Diluted	$	0.29	$	0.21

Weighted average shares outstanding:

Basic		12,601		12,590

Diluted		12,601		12,612

See notes to condensed financial statements.

Financial Statements-Continued

INNOTRAC CORPORATION

CONDENSED STATEMENTS OF CASH FLOWS

For the Nine Months Ended September 30, 2009 and 2008

(in thousands)


	Nine Months Ended September 30,
	2009			2008
	(unaudited)			(unaudited)

Cash flows from operating activities:
Net income	$	3,697		$	2,686
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		3,398			3,178
Loss on disposal of fixed assets		9			—
Provision for bad debts		41			—
Stock compensation expense-stock options		10			59
Stock compensation expense-restricted stock		56			56
Deferred income taxes		167			—
Changes in operating assets and liabilities:
Decrease in accounts receivable, gross		10,714			3,246
Increase in inventory		(690	)		(610	)
Decrease (increase) in prepaid expenses and other		69			(101	)
Decrease in accounts payable		(4,695	)		(6,499	)
(Decrease) increase in accrued expenses and other		(1,890	)		1,868
Net cash provided by operating activities		10,886			3,883

Cash flows from investing activities:
Capital expenditures		(845	)		(2,381	)
Net change in noncurrent assets and liabilities		12			51
Net cash used in investing activities		(833	)		(2,330	)


Cash flows used in financing activities:
Net (repayments) borrowings under line of credit		(10,055	)		2,946
Repayment of proceeds from term loan		—			(5,000	)
Issuance of stock, net		—			42
Capital lease funding		62			—
Loan commitment fees		(151	)		—
Net cash used in financing activities		(10,144	)		(2,012	)

Net decrease in cash and cash equivalents		(91	)		(459	)
Cash and cash equivalents, beginning of period		1,056			1,079
Cash and cash equivalents, end of period	$	965		$	620

Supplemental cash flow disclosures:

Cash paid for interest	$	165		$	1,012
Non-cash investing and financing activities:
Capital lease obligation for computer equipment purchased	$	560		$	—

See notes to condensed financial statements.

INNOTRAC CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

September 30, 2009 and 2008

(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, 2008. 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. 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, 2008 and September 30, 2009. For the three months ended September 30, 2009 a deferred tax liability and tax expense of approximately $167,000 associated with the amortization of goodwill was recorded (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 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.

	Stock-Based Compensation Plans. In December 2004, the FASB issued an update to ASC topic No. 718 revising the required accounting for stock-based compensation. ASC topic No. 718 as revised requires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense in the financial statements based on their fair values. That expense will be recognized over the period during which an employee is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period). The Company adopted this update to ASC topic No. 718 effective January 1, 2006 using the prospective application method. Under this update, ASC topic No. 718 applies to new awards and to awards modified, repurchased or cancelled after the effective date. Additionally, compensation expense for the portion of awards for which the requisite service has not been rendered that are outstanding as of the required effective date shall be recognized as the requisite service is performed on or after the required effective date. Under the requirements of the update to ASC topic No. 718 the Company recorded $4,000 and $13,000 in compensation expense on stock options for the three months ended September 30, 2009 and 2008, respectively. For the nine months ended September 30, the Company recorded $10,000 and $59,000 in 2009 and 2008, respectively. As of September 30, 2009, approximately $15,000 of unrecognized compensation expense related to non-vested stock options is expected to be recognized over the following 19 months.

INNOTRAC CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

September 30, 2009 and 2008

(Unaudited)

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

	Nine months ended
	September 30, 2009	September 30, 2008
Risk-free interest rate	3.4%	3.7%
Expected dividend yield	0%	0%
Expected lives	2.2 Years	2.2 Years
Expected volatility	83.8%	76.0%

	Fair Value Measurements. Effective January 1, 2008, the Company adopted ASC topic No. 820 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 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, 2009, and because of its short term nature. The interest rate is equal to the market rate for such instruments of similar duration and credit quality.

INNOTRAC CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

September 30, 2009 and 2008

(Unaudited)


	We did not have any assets or liabilities measured at fair value on a recurring basis using quoted market prices in active markets (Level 1), significant other observable inputs (Level 2) or significant unobservable inputs (Level 3) during the period.

	In accordance with the provisions of ASC topic No. 350, the Company tests goodwill annually for impairment. The annual impairment test is based on fair value measurements using Level 3 inputs primarily consisting of estimated discounted cash flows expected to result from the use of the asset. Upon completion of its analysis for impairment as of January 1, 2009, no impairment was determined to exist at that time.

	Subsequent Events. Effective June 30, 2009, the Company adopted ASC topic No. 855 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.

	For the purposes of accounting and disclosure requirements, the Company evaluated subsequent events through November 16, 2009, the issuance date of the condensed financial statements, and noted there were no significant events that occurred subsequent to the balance sheet date but prior to issuance that would have a material impact on the condensed financial statements.

2.	FINANCING OBLIGATIONS

	The Company has a revolving credit facility (the “Credit Facility”) with Wachovia Bank, National Association (the “Bank”) 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 the Bank, setting forth the new terms of the Credit Facility including a maturity date of June 30, 2012. There was no outstanding balance on September 30, 2009 under the Credit Facility.

	The 2009 Credit Agreement continues the Bank’s security interest in all of the Company’s assets, but releases the Bank’s previously granted security interest in certain personal assets of Scott Dorfman, the Company’s Chairman, President and CEO, which were treated as additional collateral under the prior credit agreement.

	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.

INNOTRAC CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

September 30, 2009 and 2008

(Unaudited)


	The 2009 Credit Agreement 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 a minimum Fixed Charge Coverage Ratio of 1.35 to 1.00, maximum annual Capital Expenditures, and minimum Excess Availability (as each of these terms is defined in the 2009 Credit Agreement). The 2009 Credit Agreement 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 90 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 on its line of credit, it is classified as a current liability.

	Although the maximum borrowing limit is $15.0 million, the Credit Facility limits borrowings to a specified percentage of eligible accounts receivable and inventory, which totaled $12.6 million at September 30, 2009. 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, 2009 amounted to $12.6 million. At September 30, 2009, there were no borrowings outstanding under the Credit Facility, however, the value of reserves and letters of credit outstanding totaled $3.1 million. As a result, the Company had $9.5 million of borrowing availability under the Credit Facility at September 30, 2009.

	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.

	During the three and nine months ended September 30, 2008, the Company also had a $5.0 million second lien loan outstanding to a finance company (the “Second Lien Credit Agreement”). The $5.0 million second lien loan was outstanding from September 28, 2007 through September 26, 2008, and was entered into when we determined that the completion of capital expenditure projects in late 2007 and forecasted working capital requirements to support our seasonal volume increase during the fourth quarter of 2007 required additional short term funding. The 2007 seasonal working capital needs were significant as a result of our 48% growth in annual revenue to $121.8 million in 2007. The $5.0 million second lien loan was repaid on September 26, 2008 from a combination of funds generated by operating income and additional borrowing under the Credit Facility.

	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 rate of interest being charged on the Credit Facility at September 30, 2009 was 3.50%. For the three months ended September 30, 2008, we recorded interest expense of $53,000 on the Credit Facility at a weighted average interest rate of 4.08% and $195,000 of interest expense on the Second Lien Credit Agreement at a constant rate of 15.0% from July 1, 2008 to September 26, 2008. Our weighted average interest rate for the three months ended September 30, 2009 and 2008, including amounts borrowed under both the Credit Facility and the Second Lien Credit Agreement, was 3.64% and 9.56% respectively. The Company also incurred unused Credit Facility fees of approximately $18,000 and $5,000 for the three months ended September 30, 2009 and 2008, respectively. Additionally, the Company reported $12,000 and $104,000 of amortized loan costs as interest expense during the three months ended September 30, 2009 and 2008, respectively.

INNOTRAC CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

September 30, 2009 and 2008

(Unaudited)


	For the nine months ended September 30, 2009, we recorded interest expense of $92,000 on the revolving credit agreement at a weighted average interest rate of 3.17%. For the nine months ended September 30, 2008, we recorded interest expense of $187,000 at a weighted average rate of 4.51% on the revolving credit agreement and $574,000 on the Second Lien Credit Agreement at a constant rate of 15% for the period. Our weighted average interest rate for the nine months ended September 30, 2008, including amounts borrowed under both the revolving credit agreement and the Second Lien Credit Agreement, was 9.39%. The Company also incurred unused revolving credit facility fees of approximately $41,000 and $14,000 for the nine months ended September 30, 2009 and 2008, respectively. Additionally, the Company reported $62,000 and $312,000 of amortized loan coasts as interest expense during the nine months ended September 30, 2009 and 2008, 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:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2009		2008		2009		2008
Diluted earnings per share:
Weighted average shares outstanding		12,601		12,598		12,601		12,590

Employee and director stock options		—		22		—		22
Weighted average shares assuming dilution		12,601		12,620		12,601		12,612

	Options outstanding to purchase 1.2 million shares of the Company’s common stock for both the three and nine months ended September 30, 2009 and 936,000 shares for the three months ended September 30, 2008 and 1.0 million shares for the nine months ended September 30, 2008 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 the 265,956 restricted shares issued on April 16, 2007 in our calculation of basic and diluted EPS for current and prior periods. These shares, which are not vested, were issued under the terms provided in the Executive Retention Plan which plan was ratified on June 5, 2005 at the Company’s 2005 annual meeting.

4.	INCOME TAXES

	Innotrac utilizes the liability method of accounting for income taxes in accordance with ASC topic No. 740. 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, 2009 and December 31, 2008 was approximately $17.3 million and $18.7 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 $48.3 million at December 31, 2008 that expires between 2020 and 2027.

INNOTRAC CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

September 30, 2009 and 2008

(Unaudited)


	Innotrac’s ability to generate the expected amounts of taxable income from future operations is dependent upon general economic conditions, competitive pressures on sales and margins and other factors beyond management’s control. These factors, combined with 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 $10.9 million and $12.4 million has been recorded as of September 30, 2009 and December 31, 2008, respectively, after taking into account the gross deferred tax asset noted above and prior goodwill amortization and other items giving rise to a gross deferred tax liability. The result after the valuation allowance is a deferred tax liability and expense of $167,000 associated with the amortization of goodwill for the quarter ended September 30, 2009. 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, but it is expected that future goodwill amortization will result in additional tax expense for the deferred tax liability resulting thereon. For the three months ended September 30, 2009, a deferred tax benefit of $44,000 was offset by a corresponding increase of the deferred tax asset valuation allowance. For the nine months ended September 30, 2009, a deferred tax expense of $1.5 million, was offset by a corresponding decrease of the deferred tax asset valuation allowance. When, and if, the Company can return to consistent profitability, and management determines that it 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 in tax 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 of being realized upon ultimate settlement. The Company adopted this update to ASC topic No. 740 effective January 1, 2007. The Company has a gross deferred tax asset of approximately $18.7 million at December 31, 2008, which is estimated to have been reduced by $1.4 million to $17.3 million due to taxable earnings recorded during the nine months ended September 30, 2009. As discussed in Note 6 to the financial statements in the 2008 Form 10-K, the Company had a valuation allowance against the full amount of its deferred tax asset. The Company currently provides a valuation allowance against deferred tax assets when it is more likely than not that deferred tax assets will not be realized. The Company has recognized tax benefits from all tax positions we have taken, and there has been no adjustment to any net operating loss carryforwards as a result of ASC topic No. 740 and there are no unrecognized tax benefits and no related ASC topic No. 740 tax liabilities at September 30, 2009.

	The Company generally recognizes interest and/or penalties related to income tax matters in general and administrative expenses. As of September 30, 2009, we have no accrued interest or penalties related to uncertain tax positions.

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.

INNOTRAC CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

September 30, 2009 and 2008

(Unaudited)

6.	RELATED PARTY TRANSACTION

	In early 2004, the Company learned that certain trading activity of the IPOF Fund L.P., an owner of more than 5% of the outstanding Common Stock, may have violated the short-swing profit rules under Section 16(b) of the Securities Exchange Act of 1934. The Company promptly conducted an investigation of the matter. IPOF Fund L.P. and its affiliates entered into a settlement agreement with the Company on March 4, 2004 regarding the potential Section 16(b) liability issues that provided for the Company’s recovery of $301,957 no later than March 3, 2006. In December 2005, the United States District Court in Cleveland, Ohio appointed a receiver to identify and administer the assets of the IPOF Fund, L.P. and its general partner, David Dadante. The Company informed the IPOF receiver of such agreement, but the likelihood of recovering such amount from the receiver is doubtful. The Company has not recorded any estimated receivable from this settlement. Additionally, the Federal Court has prohibited the financial institutions holding Company stock owned by the IPOF Fund L.P. and Mr. Dadante in margin accounts from selling any of these shares through December 4, 2009. 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.