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 employs sophisticated order processing and warehouse management technology and currently operates eight fulfillment centers and a call center in six cities spanning all time zones across the continental United States.

During the three months ended June 30, 2009, we completed the transfer of the DSL Fast Access portion of fulfillment services we provide AT&T to AT&T's in-house fulfillment house. We also completed the shut down and consolidation of our Reno, Nevada call center operation into our existing call center in Pueblo, Colorado. Additionally during the second quarter, we decided to close one of our less automated facilities in Romeoville, Illinois, the lease for which expires in November 30, 2009. The Romeoville facility was primarily used to provide services to two departing customers whose sales volumes were seasonally concentrated in the fourth quarter. At June 30, 2009, we recorded a $579,000 reserve for future costs related to the closing of the Romeoville facility and employee severance resulting from these events.

On July 5, 2009, the parent company of Smith and Hawken, Ltd. announced its decision to liquidate the operations of Smith and Hawken resulting in the Company ceasing to provide services to Smith and Hawken by a projected date of the end of 2009. One of our two facilities in Hebron, Kentucky was nearly exclusively used to provide fulfillment services for Smith and Hawken and as a result, unless we identify new clients to be serviced in that facility, we will close the facility in July 2010 at the end of its current lease term. Based on our current expectations regarding the terms of the liquidation plans and wind down of our services for Smith and Hawken, we do not currently expect the shut down costs of our operations and the facility, net of recoverable costs from the client, to be material. As Smith and Hawken's wind down plans become more developed, we expect to be better able to assess whether any reserve for future costs related to this event is needed.

The combined effect of the loss of the DSL fast access portion of AT&T fulfillment, the loss of the clients serviced from the Romeoville, Illinois facility and the expected loss of Smith and Hawken as a customer at the end of 2009 is projected to result in a significant reduction in our revenue and operating profit in 2010 unless we identify new business services to replace these lost clients. The combined revenue generated from the AT&T DSL fast access account, the Romeoville, Illinois customers and Smith and Hawken represented approximately $27.1 million or 25.9% of our total service revenue of $104.5 million for the year ended December 2008. The loss of the Romeoville clients business and partial loss of our AT&T business will cause a significant reduction in revenues and operating profit during the second half of 2009. This projected reduction in future revenue compared to our recently reported revenue will be evaluated on an ongoing basis to determine if any impairment in the carrying value of our equipment or goodwill is appropriate. In reaction to these events, we have already consolidated the call center operations and identified reductions in facility and general and administrative expenses which will result from closing the Romeoville and Smith and Hawken facilities to partially offset the reduced profit contribution in future periods. Additionally, we have increased our marketing staffing and will increase our business development efforts going forward in an effort to replace these lost accounts.

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

Our core service offerings include the following:

Fulfillment Services:
? sophisticated warehouse management technology ? automated shipping solutions ? real-time inventory tracking and order status ? purchasing and inventory management ? channel development
? zone skipping for shipment cost reduction ? product sourcing and procurement ? packaging solutions
? back-order management; and ? returns management.

Customer Support Services:

The Company is primarily focused on five diverse lines of business, or industry verticals. This is a result of a significant effort made by the Company to diversify both its industry concentration and client base over the past several years.

        Business Mix - Revenues



                                        Three Months Ended          Six Months Ended
                                             June 30,                   June 30,
     Business Line/Vertical              2009          2008         2009         2008
     eCommerce / Direct to Consumer         41.2 %       36.3 %        38.2 %      35.4 %
     Direct Marketing                       27.9         35.8          29.9        36.4
     Modems                                 19.0         18.6          20.8        18.4
     Business-to-Business ("B2B")            7.1          5.5           6.8         6.2
     Telecommunications                      4.8          3.8           4.3         3.6
                                           100.0 %      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, Smith & Hawken, Ltd., 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 call center or through direct electronic transmission from our clients. The orders are processed through one of our order management systems and then transmitted to one of our eight fulfillment centers located across the country and are shipped to the end consumer or retail store location, as applicable, typically within 24 hours of when the order is received. Inventory for our retail, eCommerce and direct marketing clients is held on a consignment basis, with minor exceptions, and includes items such as shoes, dresses, accessories, books, outdoor furniture, electronics, small appliances, home accessories, sporting goods and toys. Our revenues are sensitive to the number of orders and customer service calls received. Our client contracts do not guarantee volumes.

Telecommunications and Modems. The Company has historically been a major provider of fulfillment and customer support services to the telecommunications industry. In spite of a significant contraction and consolidation in this industry in the past several years, the Company continues to provide customer support services and fulfillment of consumer telephones and Digital Subscriber Line Modems ("Modems") for clients such as AT&T, Inc. and Qwest Communications International, Inc. and their customers. The consolidation in the telecommunications industry resulted in the acquisition of BellSouth by AT&T in December of 2006. On November 6, 2007, AT&T notified us that it intended to transition a portion of its fulfillment business in-house. That transition occurred at the end of the second quarter 2009. As a result, our telecommunications and modems verticals are projected to represent less than 10% of revenues for periods after June 30, 2009.

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 become a smaller percentage of our total revenues throughout the rest of 2009.

Results of Operations

The following table sets forth unaudited summary operating data, expressed as a percentage of revenues, for the three and six months ended June 30, 2009 and 2008. 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.

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

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

                                                       Three Months Ended            Six Months Ended
                                                            June 30,                     June 30,
                                                       2009           2008          2009          2008

Service revenues                                          87.2 %        79.3 %         86.4 %       78.5 %
Freight revenues                                          12.8          20.7           13.6         21.5
Total Revenues                                           100.0 %       100.0 %        100.0 %      100.0 %

Cost of service revenues                                  37.4          35.8           37.2         36.4
Cost of freight expense                                   12.7          20.4           13.4         21.3
Selling, general and administrative expenses              39.0          35.8           38.3         34.8
Depreciation and amortization                              4.0           3.4            4.1          3.3
Operating income (loss)                                    6.9           4.6            7.0          4.2
Other expense, net                                        (0.2 )        (1.2 )         (0.3 )       (1.2 )
Income (loss) before income taxes                          6.7           3.4            6.7          3.0
Income tax benefit                                           -             -              -            -
Net income (loss)                                          6.7 %         3.4 %          6.7 %        3.0 %

Three Months Ended June 30, 2009 Compared to Three Months Ended June 30, 2008

Service Revenues. Net service revenues increased 2.7% to $24.1 million for the three months ended June 30, 2009 from $23.4 million for the three months ended June 30, 2008. This increase was primarily attributable to a $1.2 million increase in revenues from our eCommerce vertical due to increased volumes from existing clients, a $195,000 increase in revenue from our Telecom vertical offset by a $559,000 decrease in revenue from our direct marketing vertical and a $177,000 reduction in revenue from our DSL clients due to reduced volumes resulting from the transition of a portion of the AT&T fulfillment business to AT&T's in-house fulfillment as previously discussed.

Freight Revenues. The Company's freight revenues decreased 42.1% to $3.5 million for the three months ended June 30, 2009 from $6.1 million for the three months ended June 30, 2008. The $2.6 million decrease in freight revenues is primarily attributable to the transition of Company owned freight accounts to client owned freight accounts. This transition to client owned accounts has no material impact on our operating profitability due to pricing practices for direct freight costs.

Cost of Service Revenues. Cost of service revenues decreased 2.2% to $10.3 million for the three months ended June 30, 2009, compared to $10.6 million for the three months ended June 30, 2008. The cost of service revenue decrease was primarily due to the decrease in labor costs associated with the combined effect of increased employee rosters resulting from decreasing the use of higher cost temporary labor services and operating efficiencies resulting from adjusting labor shifts to correspond with client volumes and fulfillment equipment installed during 2008. As a result of these operating improvements, cost of service revenues as a percent of service revenues decreased by 2.2% to 42.9% from 45.1% for the three months ended June 30, 2009 and 2008 respectively.

Freight Expense. The Company's freight expense decreased 42.0% to $3.5 million for the three months ended June 30, 2009 compared to $6.0 million for the three months ended June 30, 2008 due to the decrease in freight revenue for the reason listed above.

Selling, General and Administrative Expenses. S,G&A expenses for the three months ended June 30, 2009 increased slightly to $10.8 million, or 39.0% of total revenues, compared to $10.6 million, or 35.8% of total revenues, for the same period in 2008. The increase in S,G&A expenses as a percentage of revenue in 2009 as compared to 2008 was primarily attributable to the decrease in freight revenue. SG&A expenses as a percentage of service revenue remained relatively flat at 44.8% for the three months ended June 30, 2009 compared to 45.2% for the three months ended June 30, 2008. During the three months ended June 30, 2009, a $579,000 combined reserve was recorded for the costs associated with the Romeoville facility that will be closed at the termination of the Romeoville lease in November 2009 and employee severance costs associated with the transition of a portion of the AT&T fulfillment business to in-house fulfillment. Offsetting this increase in SG&A expenses were reductions in sales commission expense of $193,000 related to client accounts no longer eligible for sales commission, a $197,000 reduction in facility management and equipment maintenance costs resulting from adjusting these costs to changes in client volumes and $121,000 of cost savings in travel and information technology costs.

Interest Expense. Interest expense for the three months ended June 30, 2009 and 2008 was $59,000 and $353,000, respectively. The decrease was related to the September 26, 2008 repayment of the $5.0 million term loan which was outstanding in the second quarter of 2008 and a reduction in draws against the Credit Facility in 2009.

Income Taxes. The Company's effective tax rate for the three months ended June 30, 2009 and 2008 was 0%. At December 31, 2003, a valuation allowance was recorded against the Company's net deferred tax assets as losses in recent years created uncertainty about the realization of tax benefits in future years. Income taxes associated with income for the three months ended June 30, 2009 and 2008 were offset by a corresponding decrease of the valuation allowance resulting in an effective tax rate of 0% for the three months ended June 30, 2009 and 2008 respectively.

Six Months Ended June 30, 2009 Compared to Six Months Ended June 30, 2008

Service revenues. Net service revenues decreased slightly 0.4% to $48.7 million for the six months ended June 30, 2009 from $48.9 million for the six months ended June 30, 2008. This decrease was primarily attributable to a $804,000 decrease in our direct marketing vertical resulting from decreased volume from existing clients and the loss of a client, a $586,000 decrease in our B2B vertical due to the loss of a client, offset by a $719,000 increase in our eCommerce vertical resulting from increased volume from existing clients, a $266,000 increase in revenues from our DSL clients due to increased volumes from existing clients offset slightly by the transition of a portion of the AT&T fulfillment business to in-house during the last half of June 2009, and by a $218,000 increase in revenues from our telecom vertical resulting from increased volumes.

Freight Revenues. The Company's freight revenues decreased 42.6% to $7.7 million for the six months ended June 30, 2009 from $13.4 million for the six months ended June 30, 2008. The decrease in freight revenues of $5.7 million is primarily attributable to the transition of Company owned freight accounts to client owned freight accounts. This transition to client owned accounts has no material impact on our operating profitability due to pricing practices for direct freight costs.

Cost of service revenues. Cost of service revenues decreased 7.4% to $21.0 million for the six months ended June 30, 2009, compared to $22.7 million for the six months ended June 30, 2008. The cost of service revenue decrease was primarily due to the decrease in labor costs associated with the combined effect of increased employee rosters resulting from decreasing the use of higher cost temporary labor services and operating efficiencies resulting from adjusting labor shifts to correspond with client volumes and fulfillment equipment installed during 2008. As a result of these operating improvements, the cost of service revenues as a percent of service revenues decreased by 3.2% to 43.1% from 46.3% for the three months ended June 30, 2009 and 2008 respectively.

Freight Expense. The Company's freight expense decreased 43.1% to $7.5 million for the six months ended June 30, 2009 compared to $13.3 million for the six months ended June 30, 2008 due to the decrease in freight revenue for the reason listed above.

Selling, General and Administrative Expenses. S,G&A expenses for the six months ended June 30, 2009 decreased slightly to $21.6 million, or 38.3% of total revenues, compared to $21.7 million, or 34.8% of total revenues, for the same period in 2008. The increase in S,G&A expenses as a percentage of revenue in 2009 as compared to 2008 was primarily attributable to the decrease in freight revenue. SG&A expenses as a percentage of service revenue remained unchanged at 44.3% for both the six months ended June 30, 2009 and 2008. During the six months ended June 30, 2009, a $579,000 reserve was recorded for the costs associated with the Romeoville facility that will be closed at the termination of the Romeoville lease in November 2009 and employee severance costs associated with the transition of a portion of the AT&T fulfillment business to in-house fulfillment. Offsetting this increase in SG&A expenses is a $268,000 reduction in facility management and equipment maintenance costs resulting from adjusting these costs to changes in client volume, reduced sales commission expense of $198,000 related to client accounts no longer eligible for sales commission and cost savings of $153,000 in travel and information technology costs.

Interest Expense. Interest expense for the six months ended June 30, 2009 and June 30, 2008 was $165,000 and $726,000, respectively. The decrease was related to the interest and amortization of loan costs for the loans outstanding under the $5.0 million term loan which was outstanding in the second quarter of 2008 before being repaid on September 26, 2008 and a reduction in draws against the Credit Facility in 2009.

Income Taxes. The Company's effective tax rate for the six months ended June 30, 2009 and 2008 was 0%. At December 31, 2003, a valuation allowance was recorded against the Company's net deferred tax assets as losses in recent years created uncertainty about the realization of tax benefits in future years. Income taxes associated with income for the six months ended June 30, 2009 and 2008 were offset by a corresponding decrease of the valuation allowance resulting in an effective tax rate of 0% for the six months ended June 30, 2009 and 2008 respectively.

Liquidity and Capital Resources

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 June 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 2006 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.

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.

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 $13.5 million at June 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 June 30, 2009 amounted to $13.5 million. At June 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 $10.4 million of borrowing availability under the Credit Facility at June 30, 2009.

During the three months ended June 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 June 30, 2009, we recorded interest expense of $36,000 on the Credit Facility at a weighted average interest rate of 3.62%. The rate of interest being charged on the Credit Facility at June 30, 2009 was 3.56%. For the three months ended June 30, 2008, we recorded interest expense of $57,000 on the Credit Facility at a weighted average interest rate of 4.05% and $190,000 of interest expense on the Second Lien Credit Agreement at a constant rate of 15.0 % for the period. Our weighted average interest rate for the three . . .