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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended: September 30, 2004

OR

Commission file number: 0-21395

ALLIN CORPORATION

(Exact name of registrant as specified in its charter)

381 Mansfield Avenue, Suite 400

Pittsburgh, Pennsylvania 15220-2751

(Address of principal executive offices, including zip code)

(412) 928-8800

(Registrant’s telephone number, including area code)

N/A

(Former Name, Former Address and Former Fiscal Year, if changed since last report)

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.    x  Yes    ¨  No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)    ¨  Yes    x  No

Shares Outstanding of the Registrant’s Common Stock

As of November 1, 2004

Common Stock, 6,967,339 Shares

Table of Contents

Allin Corporation

Form 10-Q

Index

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Forward-Looking Information

Certain matters in this Form 10-Q, including, without limitation, certain matters discussed under Part I,,Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are typically identified by the words “believes,” “expects,” “anticipates,” “intends,” “will,” “seek,” “continue,” “show improvement” and similar expressions. In addition, any statements that refer to expectations or other characterizations of future events or circumstances are forward-looking statements. Readers are cautioned that any such forward-looking statements are not guarantees of performance and that matters referred to in such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of Allin Corporation to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, risks and uncertainties discussed throughout Part I, Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations and under the caption “Risk Factors” included therein. Allin Corporation undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

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Part I - Financial Information

Item 1. - Financial Statements

ALLIN CORPORATION & SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

The accompanying notes are an integral part of these consolidated financial statements.

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ALLIN CORPORATION & SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

The accompanying notes are an integral part of these consolidated financial statements.

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ALLIN CORPORATION & SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share data)

(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

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ALLIN CORPORATION & SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

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Allin Corporation and Subsidiaries

Notes to Consolidated Financial Statements

1. Summary of Significant Accounting Policies

The information contained in these financial statements and notes for the three- and nine-month periods ended September 30, 2003 and 2004 should be read in conjunction with the audited financial statements and notes for the years ended December 31, 2002 and 2003, contained in the Annual Report on Form 10-K of Allin Corporation (the “Company”) for the year ended December 31, 2003. The accompanying unaudited Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States and the rules and regulations of the Securities and Exchange Commission. These interim statements do not include all of the information and footnotes required for complete financial statements. It is management’s opinion that all adjustments (including all normal recurring accruals) considered necessary for a fair presentation have been made. However, results for these interim periods are not necessarily indicative of results to be expected for the full year. See Notes 5 – Goodwill and Customer List, 6 - Income Taxes and 7 – Industry Segment Information for information concerning the Company’s basis of presentation and accounting policies regarding these matters. The Consolidated Balance Sheet as of December 31, 2003 has been derived from the audited financial statements as of that date, but does not include all of the information and footnotes required by United States generally accepted accounting principles for complete financial statements.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. It is the Company’s policy to consolidate all majority-owned subsidiaries and variable interest entities where the Company has control. The Company does not currently utilize or have interests in any variable interest entities. All significant intercompany accounts and transactions have been eliminated.

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ materially from those estimates.

Revenue Recognition

The Company recognizes revenue in accordance with the Securities and Exchange Commission’s Staff Accounting Bulletins 101, Revenue Recognition in Financial Statements, and 104, Revenue Recognition, American Institute of Certified Public Accountants Statements of Position 97-2, Software Revenue Recognition (“SOP 97-2”), and 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts (“SOP 81-1”), Accounting Research Bulletin No. 45, Long-Term Construction-Type Contracts (“ARB No. 45”), Emerging Issues Task Force Issue No. 00-21, Revenue Arrangements with Multiple Deliverables (“EITF No. 00-21), and other authoritative accounting literature. The Company’s revenue recognition policies are described below for each of the various revenue captions on the Company’s Consolidated Statements of Operations.

Consulting Services

Consulting services are provided by the Company’s Interactive Media, Technology Infrastructure and Collaborative Solutions Practice Areas. The Company’s policy is to recognize revenue when persuasive evidence of an arrangement exists, price is fixed or determinable, services have been rendered and collectibility is reasonably assured. Fees are time-based for the majority of consulting engagements and revenue is recognized as the services are performed. For consulting engagements performed on a fixed-price basis, the Company follows the contract accounting guidance of ARB No. 45 and SOP 81-1. Revenue is recognized on a proportional performance basis, utilizing the proportion of labor expended through the end of the period to expected total project labor.

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Allin Corporation and Subsidiaries

Notes to Consolidated Financial Statements – (Continued)

Interactive Media consulting projects are frequently part of related arrangements, including computer hardware and equipment for interactive television systems, software, services, and post-contract support (“PCS”). SOP 97-2 specifies that if an arrangement to deliver software or a software system, either alone or together with other products or services, requires significant production, modification, or customization of software, the entire arrangement should be accounted for in conformity with the contract accounting guidance of ARB No. 45 and SOP 81-1. Interactive Media’s arrangements involve significant software modification, including the installation of customized software applications previously developed for the customer. Revenue for fixed-price service-based arrangements associated with these projects is recognized on the percentage of completion method of contract accounting, based on the proportion of labor expended through the end of the period to expected total project labor. Interactive Media arrangements frequently include PCS for a ninety-day period following system installation. A portion of the contract value is allocated to the PCS based on the proportion of expected PCS-related labor to expected total project labor and, in accordance with SOP 97-2, revenue is recognized for PCS over the period when services are performed.

The Company’s practice areas perform consulting projects where the Company may recommend that the customer implement technology products in order to facilitate the Company’s technology-based solutions. Under some of these arrangements, the Company will also sell the recommended technology products to the customer. When consulting services are part of multiple-deliverable arrangements, revenue from services and product sales are recognized separately based on SOP 97-2 and EITF No. 00-21.

Integration Services

Integration services include projects conducted by the Interactive Media Practice Area that are part of related arrangements, including computer hardware and equipment for interactive television systems, software and services. The Company follows the contract accounting guidance of ARB No. 45 and SOP 81-1, as specified by SOP 97-2, in accounting for revenue derived under these arrangements that involve significant software modification. The Company’s recognition method for revenue for systems integration projects is based on the size and expected duration of the project. For projects in excess of $250,000 of revenue and expected to be of greater than 90 days duration, revenue is recognized based on percentage of completion. The proportion of labor incurred to expected total project labor is utilized as a quantitative factor in determining the percentage of completion recognized for projects when the proportion of total project costs incurred to expected total project costs is not representative of actual project completion status. For projects with expected revenue of $250,000 or less, or expected duration of 90 days or less, revenue is recognized upon completion of the project. Interactive Media arrangements do not include rights for software, hardware or equipment upgrades.

Outsourced Services

The Company recognizes revenue for its outsourced services operations in a similar manner as discussed above for time-based practice area consulting services.

Information System Product Sales

Information system product sales arise from both stand-alone product sales and as part of multiple-deliverable arrangements. Revenue for stand-alone product sales is recognized when the price has been determined, delivery has occurred and collectibility is reasonably assured. Some sales are associated with consulting projects where the Company recommends that the customer implement certain technology products in order to facilitate the Company’s technology-based solution. Where information system product sales are part of these multiple-deliverable arrangements, revenue from product sales and consulting services are recognized separately based on SOP 97-2 and EITF No. 00-21.

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Notes to Consolidated Financial Statements – (Continued)

Revenue and cost of sales for the Company’s information system product sales are reported on a gross basis, in accordance with the guidelines of Emerging Issues Task Force Issue No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent, based primarily on the Company’s assumption of primary responsibility for fulfillment of the sales, sole latitude in establishing prices, collection risk on amounts billed to customers and inventory risk. Amounts billed to customers for shipping charges are recorded as revenue and associated shipping costs are recorded as cost of sales.

Other Services

Other services include activities peripheral to the Company’s operations such as website hosting and archival fees, contractual commissions and placement fees. The Company recognizes revenue when persuasive evidence of an arrangement exists, the price is fixed or determinable, services have been rendered and collectibility is reasonably assured.

Earnings Per Share

Earnings per share (“EPS”) of common stock have been computed in accordance with Financial Accounting Standards Board Statement No. 128, Earnings Per Share (“SFAS No. 128”). The shares used in calculating basic and diluted EPS include the weighted average of the outstanding common shares of the Company. The Company’s outstanding stock options and warrants and the Company’s Series G convertible redeemable preferred stock are considered potentially dilutive securities under SFAS No. 128 and are included in the calculation of diluted EPS if the effect is dilutive. The Company’s Series D and F convertible redeemable preferred stock were also potentially dilutive securities prior to the expiration of their respective convertibility features in August 2003 and May 2004.

The Company’s convertible preferred stock and outstanding stock options and warrants were not included in the calculations of diluted EPS for the three-month period ended September 30, 2003 and the three- and nine-month periods ended September 30, 2004. Since the Company recognized net losses attributable to common shareholders in these periods, the effect of inclusion of the convertible preferred stock and outstanding stock options and warrants in the calculations would have been anti-dilutive. The additional shares that would have been included in the diluted EPS calculations related to the convertible preferred stock, if the effect was not anti-dilutive, were 5,158,435 for the three-month period ended September 30, 2003 and 4,285,714 and 4,567,883, respectively, for the three- and nine-month periods ended September 30, 2004. The average market prices of the Company’s common stock exceeded the exercise prices of 50,000, 55,000 and 60,000 outstanding options during the three-month period ended September 30, 2003 and the three- and nine-month periods ended September 30, 2004, respectively. This would have resulted in the inclusion of 10,451, 7,143 and 19,420 additional shares, respectively, in the calculations of diluted EPS for the three-month period ended September 30, 2003 and the three- and nine-month periods ended September 30, 2004, respectively, if the effect had not been anti-dilutive. The exercise prices of all other outstanding stock options and all outstanding warrants exceeded the average market prices of the Company’s common stock for these periods.

For the nine-month period ended September 30, 2003, a total of 4,285,714 additional shares were included in the calculation of diluted EPS for the effect of convertible preferred stock. An additional 1,136,048 shares would have been included for convertible preferred stock if the effect had not been anti-dilutive. The average market prices of the Company’s common stock exceeded the exercise prices of 45,000 outstanding options during the nine-month period ended September 30, 2003. This resulted in the inclusion of 7,054 additional shares in the calculation of diluted EPS for the period. The exercise prices of all other outstanding stock options and all outstanding warrants exceeded the average market prices of the Company’s common stock for this period.

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Allin Corporation and Subsidiaries

Notes to Consolidated Financial Statements – (Continued)

Accounts Receivable and Unbilled Receivables

The Company’s subsidiaries record accounts receivable based upon billing for services and products. Unbilled receivables are recorded when labor-based services have been provided prior to the end of the period and invoicing has not occurred. The Company evaluates the extension of credit to potential customers based on financial or other information and any special circumstances regarding the potential engagement. Payment for services or products is normally due within thirty days of billing, although alternate terms may be included in contracts or letters of engagement as agreed upon by the Company and the customer. Accounts receivable are not normally collateralized.

The Company does not routinely charge interest on past due accounts receivable. However, the Company will occasionally reach agreement with a customer on a payment plan for accounts receivable that includes interest charges if the Company believes this will facilitate collection. In these instances, interest income is recognized as payments are received. As of December 31, 2003 and September 30, 2004, the Company’s risk of loss for accounts receivable and unbilled receivables was limited to the amounts recorded on the Consolidated Balance Sheets as of those dates.

Allowances on accounts receivable are recorded when circumstances indicate collection is doubtful for particular accounts receivable or as a general reserve for all accounts receivable. Accounts receivable are written off if reasonable collection efforts prove unsuccessful. Bad debt expense is reflected in Other selling, general and administrative expenses on the Consolidated Statements of Operations when allowances on accounts receivable are increased or when accounts written off exceed available allowances.

As of September 30, 2004, two significant customers comprised 29% and 13%, respectively, of the Company’s accounts receivable. As of December 31, 2003, three significant customers comprised 18%, 17% and 13%, respectively, of the Company’s accounts receivable and two of the customers were affiliates of each other.

Costs and Estimated Gross Margins in Excess of Billings and Billings in Excess of Costs and Estimated Gross Margins

Costs and estimated gross margins in excess of billings and billings in excess of costs and estimated gross margins relate to Interactive Media Practice Area projects for which revenue and cost of sales are being recognized on a percentage of completion basis. For an individual project, costs and estimated gross margins in excess of billings consists of costs not yet recognized as cost of sales and estimated gross margins, net of amounts billed but not yet recognized as revenue. For an individual project, billings in excess of costs and estimated gross margins consists of amounts billed but not yet recognized as revenue, net of costs which have not yet been recognized as cost of sales and estimated gross margins associated with the project. Projects with costs and estimated gross margins in excess of billings are aggregated separately from projects with billings in excess of costs and estimated gross margins for presentation on the consolidated balance sheets.

Financial Instruments

As of September 30, 2004, the Company’s Consolidated Balance Sheet includes a note payable with a principal balance of $1,000,000 related to the acquisition of Allin Corporation of California (“Allin Consulting-California”). The principal balance of the note payable, which is due April 15, 2005, is recorded at the face value of the instrument. The Company accrues interest at fixed rates and makes quarterly interest payments.

Market Risk Sensitive Instruments

The Company currently has not invested in derivative or other market rate sensitive financial instruments.

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Allin Corporation and Subsidiaries

Notes to Consolidated Financial Statements – (Continued)

Stock-Based Compensation

The Company has adopted the disclosure-only provisions of Financial Accounting Standards Board Statement No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure (“SFAS No. 148”), which amends Financial Accounting Standards Board Statement No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”). Accordingly, no compensation expense has been recognized for the Company’s stock-based compensation plans. SFAS No. 148 amended SFAS No. 123 to provide alternate transition methods for adoption of the fair value based method of financial accounting and related reporting standards for stock-based employee compensation plans. SFAS No. 123 provides for adoption in the income statement or through footnote disclosure. The Company has elected to account for stock-based compensation plans under the intrinsic value method established by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), as permitted by SFAS No. 123. Had compensation costs for the Company’s Plans been determined consistent with SFAS No. 123, pro forma compensation cost, net income or loss and earnings (loss) per share would have been as follows:

Recently Issued Accounting Standards

In September 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 04-8, The Effect of Contingently Convertible Debt on Diluted Earnings per Share (“EITF No. 04-8”), that all issued securities with embedded conversion features that are contingently exercisable upon occurrence of a market price condition should be included in the calculation of diluted EPS regardless of whether the market price trigger has been met. This consensus also applies to instruments with embedded conversion features that are contingently exercisable upon the occurrence of a market price condition or the occurrence of another contingency. The Financial Accounting Standards Board is presently in the process of amending certain aspects of SFAS No. 128 and is expected to require that share settlement be assumed in the diluted EPS calculation for contracts that can be settled in stock or cash. The consensus in EITF No. 04-8 will become effective in the period when the proposed amendment to SFAS No. 128 becomes effective. The Company does not believe that EITF No. 04-8 will have a material effect on the Company’s diluted EPS calculation as the Company has not issued any securities with embedded conversion features that are contingently exercisable upon the occurrence of a market price condition or the occurrence of another contingency. The Company will evaluate the impact of any amendment to SFAS No. 128 once issued.

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Notes to Consolidated Financial Statements – (Continued)

Supplemental Disclosure of Cash Flow Information

Cash payments for income taxes were approximately $27,000 during the three-month period ended September 30, 2003. There were no cash payments for income taxes during the three-month period ended September 30, 2004. Cash payments for interest were approximately $18,000 and $19,000 during the three-month periods ended September 30, 2003 and 2004, respectively. Cash payments of dividends were approximately $89,000 and $90,000 during the three-month periods ended September 30, 2003 and 2004, respectively. Dividends of approximately $162,000 and $170,000 were accrued but unpaid during the three-month periods ended September 30, 2003 and 2004, respectively, on outstanding shares of the Company’s preferred stock.

Cash payments for income taxes were approximately $51,000 and $6,000 during the nine-month periods ended September 30, 2003 and 2004, respectively. Cash payments for interest were approximately $55,000 and $58,000 during the nine-month periods ended September 30, 2003 and 2004, respectively. Cash payments of dividends were approximately $266,000 during each of the nine-month periods ended September 30, 2003 and 2004. Dividends of approximately $328,000 and $350,000 were accrued but unpaid during the nine-month periods ended September 30, 2003 and 2004, respectively, on outstanding shares of the Company’s preferred stock.

2. Preferred Stock

The Company has the authority to issue 100,000 shares of preferred stock with a par value of $.01 per share. Of the authorized shares, 40,000 have been designated as Series A Convertible Redeemable Preferred Stock, 5,000 as Series B Redeemable Preferred Stock, 25,000 as Series C Redeemable Preferred Stock, 2,750 as Series D Convertible Redeemable Preferred Stock, 2,000 as Series E Convertible Redeemable Preferred Stock, 1,000 as Series F Convertible Redeemable Preferred Stock and 150 as Series G Convertible Redeemable Preferred Stock. As of September 30, 2004, the Company has outstanding 25,000, 2,750, 1,000 and 150 shares of Series C, D, F and G preferred stock, respectively. The Company will not issue any additional shares of any of its existing series of preferred stock. The order of liquidation preference of the series of the Company’s outstanding preferred stock, from senior to junior, is Series F, Series G, Series D and Series C.

3. Equity Transactions and Changes in Shareholders’ Equity

During the three months ended September 30, 2004, the Company awarded options to purchase 10,000 shares of the Company’s common stock under the Company’s 2000 Stock Plan. The grant price was $0.155 per share, which was the closing market price of the Company’s common stock on the grant date. These options to purchase common shares will fully vest on the first anniversary of the grant date. There was no compensation expense recognized in conjunction with the award of the options. There were no forfeitures of options during the three months ended September 30, 2004 under any of the Company’s stock plans. Options granted under the 1996, 1997, 1998 and 2000 Stock Plans to purchase 123,500, 222,850, 237,800 and 181,000 shares, respectively, of common stock remain outstanding as of September 30, 2004.

Information concerning changes to Series G preferred stock and additional paid-in-capital during the nine months ended September 30, 2004 is as follows:

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Notes to Consolidated Financial Statements – (Continued)

There were no changes to the other components of shareholders’ equity during this period other than the increase in accumulated deficit resulting from the net loss realized for the nine months ended September 30, 2004.

4. Revolving Credit Loan

On October 1, 1998, the Company and S&T Bank, a Pennsylvania banking association, entered into a Loan and Security Agreement, under which S&T Bank agreed to extend the Company a revolving credit loan. The original term of the revolving credit loan was one year and it has subsequently been renewed for six annual periods. The current expiration date of the revolving credit loan is September 30, 2005. Borrowings may be made under the S&T Loan Agreement for general working capital purposes. The maximum borrowing availability under the revolving credit loan is the lesser of $5,000,000 or 80% of the aggregate gross amount of eligible trade accounts receivable aged sixty days or less from the date of invoice. Accounts receivable qualifying for inclusion in the borrowing base are net of any prepayments, progress payments, deposits or retention and must not be subject to any prior assignment, claim, lien, or security interest.

As of September 30, 2004, maximum borrowing availability under the revolving credit loan was approximately $1,386,000. There was no outstanding balance as of September 30, 2004. Loans made under the revolving credit loan bear interest at the bank’s prime interest rate plus one percent. During the nine months ended September 30, 2004, the rate of interest on any outstanding borrowings under the revolving credit loan would have ranged from 5.00% to 5.75%. As of September 30, 2004,, the interest rate in effect was 5.75%.

The revolving credit loan includes provisions granting S&T Bank a security interest in certain assets of the Company including its accounts receivable, equipment, lease rights for real property, and inventory. The revolving credit loan also includes reporting requirements regarding annual audit reports, monthly financial reports, monthly accounts receivable and payable reports and weekly borrowing base certificates. The revolving credit loan also includes various covenants relating to matters affecting the Company including insurance coverage, financial accounting practices, audit rights, prohibited transactions, dividends and stock purchases. The covenants also include a cash flow to interest ratio of not less than 1.0 to 1.0. Cash flow is defined as operating income before depreciation, amortization and interest. The cash flow coverage ratio is measured for each of the Company’s fiscal quarters. The Company was not in compliance with the cash flow covenant for the fiscal quarter ended September 30, 2004. S&T Bank granted a waiver of the compliance requirement for this period. The Company is in compliance with all other covenants as of September 30, 2004.

5. Goodwill and Customer List

As of September 30, 2004, the Company’s Consolidated Balance Sheet includes goodwill associated with the 1996 acquisition of Allin Consulting-California and the 1998 acquisitions of Allin Consulting of Pennsylvania, Inc. (“Allin Consulting-Pennsylvania”) and MEGAbase, Inc., and a customer list associated with the acquisition of Allin Consulting-Pennsylvania. Upon acquisition, these intangible assets were valued in accordance with the then prevailing accounting standard, Accounting Principals Board Opinion No. 16, Accounting for Business Combinations. Information concerning these assets is as follows:

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Allin Corporation and Subsidiaries

Notes to Consolidated Financial Statements – (Continued)

The Company follows the requirements of Statements of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”), and No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”), regarding amortization and testing for the potential impairment of intangible assets. Under SFAS No. 142, goodwill and other separable intangible assets with indefinite lives are not amortized, but separable intangible assets that are deemed to have definite lives, such as the customer list, are amortized over their useful lives. SFAS No. 142 also sets forth guidance as to required annual testing for the potential impairment of goodwill. SFAS No. 144 sets forth standards for testing for the potential impairment of long-lived assets, including amortized intangible assets, such as the customer list.

Testing for potential impairment of goodwill involves an attribution of the recognized assets of the acquired businesses, including cash, accounts receivable, prepaid expenses, deferred tax assets, property and equipment, customer list and goodwill, net of accounts payable, accrued liabilities and deferred revenue, to reporting units. The reporting units utilized are the Company’s reported segments applicable to the acquired subsidiaries, Technology Infrastructure, Collaborative Solutions and Outsourced Services, further broken down geographically between Northern California-based and Pittsburgh-based operations. Recognized assets are attributed to reporting units in a manner consistent with that used for segment reporting. Management utilizes industry information for public technology consulting businesses to develop assumptions for appropriate revenue multiples for estimating the fair values of the reporting units. Estimated fair values are compared to the attributed recognized assets for each reporting unit, and an impairment loss is recognized to the extent that attributed assets exceed the estimated fair value of any reporting unit. The Company believes that key risk factors related to the potential impairment of goodwill would be a significant drop in valuation multiples or a significant drop in revenue for one or more of the reporting units.

To test for potential impairment of the customer list, the Company utilizes a cash flow model to estimate fair value. The critical estimates are the determination of the proportions of the overall cash flow of Allin Consulting-Pennsylvania to attribute to the acquired customer list in each period and the assumed growth of the overall business operations. Management utilizes historical information related to business derived from the customers included on the acquired list, future projections for the operations of Allin Consulting-Pennsylvania and industry information concerning expected growth in the technology consulting industry to develop estimates of future cash flows for Allin Consulting-Pennsylvania and the portions of the estimated cash flows to be attributed to the customer list. If the sum of the undiscounted cash flows attributable to the customer list exceeds the recognized value of the customer list, no impairment is indicated. If the sum of the undiscounted cash flows is less than the recognized value, an impairment loss is recognized for the difference between the recognized value and the sum of the discounted cash flows attributable to the customer list. Key risk factors related to the potential impairment of the customer list would be lowering of expected future growth rates for the technology consulting industry and the loss of key customers from the acquired list which may result in a significant decline in the proportion of Allin Consulting-Pennsylvania’s business attributed to the list.

During 2003, management elected to change the date of annual testing for impairment to December 31. Consequently, the Company performed two annual tests for 2003, as of January 1 and as of December 31. Management concluded that evaluation of risk factors and testing for potential impairment are more beneficial to financial reporting when done as of the end, rather than as of the beginning, of a fiscal period because this results in estimates and determinations based on more recent data. The Company will perform annual tests for 2004 as of December 31, unless events indicate more frequent tests are necessary. Key risk factors will continue to be monitored on an ongoing basis and testing for potential impairment of goodwill or the customer list will be performed on an interim basis if indicators of potential impairment arise.

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Allin Corporation and Subsidiaries

Notes to Consolidated Financial Statements – (Continued)

The table below reflects the changes in the recognized value of goodwill since January 1, 2003:

The industry valuation multiple utilized in the January 1, 2003 annual test for goodwill represented a decrease of over 25% from the multiple used for the 2002 annual test, reflecting lower future growth expectations in the technology consulting industry at that time. Allin Consulting-Pennsylvania recorded losses of $27,000 due to impairment of goodwill related to the Outsourced Services and Technology Infrastructure reporting units during the first quarter of 2003. The industry valuation multiple utilized in the December 31, 2003 annual test represented an approximate 22% increase over the multiple used for the preceding 2003 interim test, based on then current industry information. Management believes the improvement in the industry valuation multiple reflected improving short-term growth expectations in the technology consulting industry as of late 2003. The estimated fair values of all reporting units exceeded the recognized assets attributed to the reporting units as of December 31, 2003, indicating no impairment of goodwill. Management will evaluate the potential indicators for impairment of goodwill during 2004 and will perform interim testing if deemed appropriate. The estimated useful life of the customer list extends through 2013, which was the final year in which expected cash flows were attributed to the customer list in the Company’s fair value estimates prepared during 2003. There has been no change to the estimated useful life of the customer list since January 1, 2003.

Annual testing for potential impairment of the customer list under SFAS No. 144 for the 2003 fiscal year was performed as of January 1, 2003, based on the method described above. The estimated fair value of the customer list exceeded the recognized value, indicating no impairment. Industry information utilized for the annual testing as of December 31, 2003 indicated lower long-term growth rates for the technology consulting industry than had been indicated in previous testing, despite an improvement in short-term prospects as of late 2003. Factors resulting in the lower long-term growth rate forecast included expectations that future growth in technology consulting would more closely correlate with expectations of overall economic conditions and competitive factors in the marketplace and be more dependent on economic return requirements than in the past, and the growing sourcing of business to offshore information technology enterprises, particularly for application development. The Company recorded a loss of approximately $349,000 in the quarter ended December 31, 2003 to reflect the impairment of the customer list and adjust the recognized value of the list to the estimated level of discounted cash flows attributable to the customer list. The adjustment to the carrying value of the customer list due to the impairment resulted in a reduction in amortization expense beginning in 2004. Information regarding aggregate amortization expense recorded during the three- and nine-month periods ended September 30, 2003 and 2004, and expected through December 31, 2009, follows.

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Notes to Consolidated Financial Statements – (Continued)

Amortization Expense

6. Income Taxes

The Company records current and deferred provisions for or benefits from income taxes and deferred tax assets and liabilities in accordance with the requirements of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (“SFAS No. 109”). SFAS No. 109 requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax bases using enacted tax rates expected to be in effect for the year in which the differences are expected to reverse. Valuation allowances will reduce deferred tax assets if there is material uncertainty as to the ultimate realization of the deferred tax benefits.

The Company’s results of operations in future periods are subject to a number of material risks, including risks arising from concentrations related to the operations of the Interactive Media Practice Area, where in recent periods revenue has resulted from a small number of large projects each year. Furthermore, these projects have been performed for a small number of customers concentrated in one industry. The Company’s Interactive Media revenue is expected to decline significantly in 2004 as compared to 2003 and may continue to decline in future periods if the Company fails to obtain additional projects from existing or new customers. Valuation allowances have been recorded based on the Company’s estimates of realizability.

The (benefit from) provision for income taxes is comprised of the following for the three-and nine-month periods ended September 30, 2003 and 2004:

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Allin Corporation and Subsidiaries

Notes to Consolidated Financial Statements – (Continued)

A reconciliation of income taxes computed at the federal statutory rate of 34% to the provision for (benefit from) income taxes reflected in the Consolidated Statements of Operations is as follows for the three- and nine-month periods ended September 30, 2003 and 2004:

The components of the deferred tax assets and liabilities, as of December 31, 2003 and September 30, 2004, are as follows:

As of September 30, 2004, the Company estimates its potentially realizable net operating loss carryforwards are approximately $20,747,000 and $18,756,000 for federal and state income tax purposes, respectively. The realization of the potential federal and state tax benefits related to net operating loss carryforwards, estimated to be approximately $7,054,000 and $954,000, respectively, as of September 30, 2004, depends on the Company’s ability to generate future taxable income. The net operating loss carryforwards are scheduled to expire at various times from 2004 through 2024. The Company files state income tax returns for California on a unitary basis. Tax returns for other states in which the Company or subsidiaries operate are filed on a single corporation basis, which may limit the Company’s ability to realize benefits related to net operating loss carryforwards.

Cash payments for income taxes were approximately $27,000 during the three-month period ended September 30, 2003. There were no cash payments for income taxes during the three-month period ended September 30, 2004. Cash payments for income taxes were approximately $51,000 and $6,000 during the nine-month periods ended September 30, 2003 and 2004, respectively.

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Notes to Consolidated Financial Statements – (Continued)

7. Industry Segment Information

The Company follows Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS No. 131”), as the basis for determining its segments. SFAS No. 131 requires use of a model for segment reporting called the “management approach”. The management approach is based on the way the chief operating decision maker organizes segments within a company for making decisions and assessing performance.

Basis for Determining Segments

The Company’s operations and management’s evaluations are primarily oriented around three practice areas meeting customer needs for interactive media and Microsoft-based technology services: Interactive Media, Technology Infrastructure and Collaborative Solutions. The operations of these practice areas comprise the substantial majority of the Company’s revenue and gross profit and are closely associated with its strategic focus of providing solutions-oriented consulting and systems integration services. The reportable segments related to these practice areas reflect aggregated practice area activity across the Company’s subsidiaries due to the similarity in nature of services, processes, types of customers and distribution methods for the practice areas.

Certain terminology regarding the Company’s operations was changed in 2004 as a result of management’s ongoing review of the Company’s business and direction. The Company now utilizes the term practice area to denote its core operating functions, whereas the term solution area had been previously used. Also, the practice area formerly known as E-Business was renamed Collaborative Solutions. Management believes Collaborative Solutions better reflects the broad scope of the practice area, including portals and information workflow solutions, business intelligence solutions and applications development and deployment. There were no changes in the personnel associated with or operations of the Collaborative Solutions Practice Area other than the name change.

The Company’s reported segments are the following: Collaborative Solutions Consulting, Technology Infrastructure Consulting, Interactive Media Consulting, Interactive Media Systems Integration, Outsourced Services, Information System Product Sales and Other Services. Revenue and gross profit for the three- and nine-month periods ended September 30, 2003 and assets as of December 31, 2003 reported for Collaborative Solutions Consulting were reported as E-Business Consulting in reports prior to June 30, 2004. There have been no changes to the amounts reported.

On the Company’s Consolidated Statements of Operations, the first three of the segments are aggregated and captioned as Consulting services while the segment Interactive Media Systems Integration corresponds with the Integration services caption. The Outsourced Services, Information System Product Sales and Other Services segments correspond with matching captions on the Consolidated Statements of Operations

The seven segments are consistent with the Company’s presentation of segment information prior to December 31, 2003. However, the Company no longer separates the segments into two groups, Solution Area Services and Ancillary Services & Product Sales, which were utilized in segment reporting through September 30, 2003. The Company no longer believes that separate groups enhance the usefulness of the segment information.

Measurement Method

The Company’s basis for measurement of segment revenue, gross profit and assets is consistent with that utilized for the Company’s Consolidated Statements of Operations and Consolidated Balance Sheets. There are no differences in measurement method.

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Allin Corporation and Subsidiaries

Notes to Consolidated Financial Statements – (Continued)

Revenue

Information on revenue derived from external customers is as follows:

Certain of the Company’s segments performed services for other segments. All revenue recorded for these services is eliminated in consolidation. Information on revenue from services for other segments is as follows:

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Notes to Consolidated Financial Statements – (Continued)

Gross Profit

Gross profit is the segment profitability measure that the Company’s management believes is determined in accordance with the measurement principles most consistent with those used in measuring the corresponding amounts in the Company’s consolidated financial statements. Revenue and cost of sales for services performed for other segments is eliminated in calculating gross profit. Information on gross profit is as follows: