2. SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation. The financial statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements include the accounts of the Company and its majority owned subsidiary. On April 11, 2011 the Company completed the formation of Innotrac Europe GmbH ("Innotrac Europe"), a joint venture between Innotrac and PVS Fulfillment-Service GmbH ("PVS") in Neckarsulm, Germany. Innotrac has a 50.1% ownership stake in the joint venture. All significant intercompany transactions and balances have been eliminated in consolidation.

Foreign Currency Translation. The financial statements of foreign subsidiaries have been translated into U.S. Dollars in accordance with Accounting Standards Codification ("ACS") topic No. 830-30 - Translation of Financial Statements. The financial position and results of operations of the Company's foreign subsidiary are measured using the foreign subsidiary's local currency as the functional currency. Revenue and expenses of the subsidiary have been translated into U.S. Dollars at the average exchange rate prevailing during the period. Assets and liabilities have been translated at the rates of exchange on the balance sheet date. The resulting translation gain and loss adjustments are recorded directly as a separate component of stockholders' equity, unless there is a sale or complete liquidation of the underlying foreign investment. Foreign currency translation adjustments were immaterial during the year ended December 31, 2011.

Gains and losses that result from foreign currency transactions are included in the "other expense (income)" line in the consolidated statements of operations. For the year ended December 31, 2011, we incurred an immaterial amount of net foreign currency transaction gains and losses.

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.

Customer Concentration. Except for one major client, from whom 26% of total revenues were derived in 2011 and 25% of total revenues were derived in 2010, and two other smaller clients who represented 12% and 10% of total revenues in 2011 and 9% and 9% of total revenues in 2010, no other single customer provided more than 10% of revenues during these years. As of December 31, 2011, these three clients represented approximately 20%, 11% and 14% of total accounts receivable. As of December 31, 2010 these three clients represented approximately 10%, 8% and 11% of total accounts receivable. For the years ended December 31, 2011 and 2010, our ten largest customers represented 77% and 79% of our total revenues, respectively.

Cash and Cash Equivalents. The Company considers all short-term, highly liquid investments with an original maturity of three months or less to be cash equivalents. The Company maintains its cash balances in financial institutions. These balances may, at times, exceed federally insured limits. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash balances.

Reserve for Uncollectible Accounts. The Company makes estimates each reporting period associated with its reserve for uncollectible accounts. These estimates are based on the aging of the receivables and known specific facts and circumstances.

Fair Value Measurements. The Company accounts for fair value in accordance with ASC topic No. 820 – Fair Value Measurements and Disclosures for all financial and non-financial assets and liabilities accounted for at fair value on a recurring basis. 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.

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 or liabilities that the Company has the ability to access at the measurement date.

Level 2: inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly.

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 cash, accounts receivable, accounts payable and other debt instruments approximates fair value since our debt instrument consists of a revolving credit line, which under certain conditions can mature within one year of December 31, 2011, 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.

	As of December 31, 2011
	Fair Value Measurements Using (in 000's)
Description	Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)	Total
Deferred Compensation plan assets held in Rabbi Trust (1)	$ 735	$ -	$ -	$ 735

Total	$ 735	$ -	$ -	$ 735

	As of December 31, 2010
	Fair Value Measurements Using (in 000's)
Description	Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)	Total
Deferred Compensation plan assets held in Rabbi Trust (1)	$ 758	$ -	$ -	$ 758
Total	$ 758	$ -	$ -	$ 758

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

There were no significant transfers into and out of each level of the fair value hierarchy for assets measured at fair value for the year ended December 31, 2011.

All transfers, if any, are recognized by the Company at the end of each reporting period.

Transfers between Levels 1 and 2 generally relate to whether a market becomes active or inactive. Transfers between Levels 2 and 3 generally relate to whether significant relevant observable inputs are available for the fair value measurement in their entirety.

Inventories. Inventories are stated at the lower of cost or market, with cost determined by the first-in, first-out method. Substantially all inventory at December 31, 2011 and 2010 is for the account of a single client who has indemnified the Company from substantially all risk associated with such inventory.

Property and Equipment. Property and equipment are stated at cost. Depreciation is determined using straight-line methods over the following estimated useful lives:

Computers and software 3-5 years

Machinery and equipment 5-7 years

Furniture and fixtures 7-10 years

Leasehold improvements are amortized using the straight-line method over the shorter of the service lives of the improvements or the remaining term of the lease. Depreciation and amortization expense for the years ended December 31, 2011 and 2010 for all property and equipment, including capital leases, was $3.4 million and $3.5 million respectively. Computers, machinery and equipment include capital leases of $1.3 million and $800,000 at December 31, 2011 and 2010, respectively. Accumulated depreciation includes $447,000 at December 31, 2011 and $274,000 at December 31, 2010 related to capital leases. Maintenance and repairs are expensed as incurred.

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. During the years ended December 31, 2011 and 2010, there was no impairment of long-lived assets.

Accounting for Income Taxes. Innotrac utilizes the liability method of accounting for income taxes in accordance with Accounting Standards Codification ("ASC") topic No. 740 – Income Taxes. Under the liability method, deferred taxes are determined based on the difference between the financial and tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. A valuation allowance is recorded against deferred tax assets if the Company considers it is more likely than not that deferred tax assets will not be realized. A full valuation allowance has been recorded against deferred tax assets at December 31, 2011 and 2010 (see Note 7).

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

Cost of Revenues. The primary components of cost of revenues include labor costs, telephone minute fees, and packaging material costs. Costs related to facilities, equipment, account services and information technology are included in selling, general and administrative expense along with other operating costs. As a result of the Company's policy to include facility, account services and information technology costs in selling, general and administrative expense, our gross margins may not be comparable to other fulfillment companies.

Stock-Based Compensation Plans. The Company accounts for stock based compensation according to the provisions of the Compensation – Stock Compensation topic of the ASC, which establishes accounting for stock-based awards exchanged for employee services. Accordingly, stock-based compensation cost is measured at grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the employee's requisite service period.

Earnings Per Share. Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding. In the computation of diluted earnings per share, the weighted average number of common shares outstanding is adjusted for the effect of all dilutive potential common stock equivalent shares.

Recent Accounting Pronouncements.

In May 2011, the FASB issued ASU 2011-04 to Topic 820 - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs which provides guidance for required disclosure on fair value measurements, including a consistent meaning of the term "fair value", thereby facilitating greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and International Financial Reporting Standards. The amendments are to be applied prospectively and are effective for fiscal years beginning after December 15, 2011. The Company plans to adopt these provisions in the first quarter of 2012. Adoption of these provisions is not expected to have a material impact on the Company's consolidated financial statements.

In June 2011, the FASB issued ASU 2011-05 to Topic 220 - Presentation of Comprehensive Income, to allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements, consisting of an income statement followed by a separate statement of other comprehensive income. Also, items that are reclassified from other comprehensive income to net income must be presented on the face of the financial statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity.

In December 2011, the FASB issued Accounting Standards Update 2011-12 ("ASU 2011-12") which defers certain provisions of ASU 2011-05. One provision of ASU 2011-05 required entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented (for both interim and annual financial statements). This requirement is indefinitely deferred under ASU 2011-12 and will be further deliberated by the FASB at a future date. During the deferral period, all entities are required to comply with existing requirements for reclassification adjustments in Accounting Standards Codification 220 ("ASC 220"), Comprehensive Income, which indicates that "[a]n entity may display reclassification adjustments on the face of the financial statement in which comprehensive income is reported, or it may disclose reclassification adjustments in the notes to the financial statements." The ASU 2011-05 and 2011-12 amendments are to be applied retrospectively and are effective for fiscal years beginning after December 15, 2011. The Company plans to adopt these provisions in the first quarter of 2012. Adoption of these provisions is not expected to have a material impact on the Company's consolidated financial statements.