UNITED
          STATES
 SECURITIES
          AND EXCHANGE COMMISSION
 WASHINGTON,
          D.C. 20549
 
 FORM
          10-QSB
 
 QUARTERLY
          REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
 SECURITIES
          EXCHANGE ACT OF 1934
 
 FOR
          THE
          QUARTERLY PERIOD ENDED JUNE 30, 2006
 
 Commission
          File Number: #033-31067
 
 ITEC
          ENVIRONMENTAL GROUP, INC.
 (Exact
          name of small business issuer as specified in its charter)
 
 Delaware
 (State
          or
          other jurisdiction of incorporation or organization)
 
 31-1705310
 (IRS
          Employer Identification Number)
 
 5300
          Claus Road
 Riverbank,
          CA 95367
 (Address
          of principal executive offices)(Zip Code)
 
 (209)
          848-3900
 (Registrant's
          telephone no., including area code)
 
 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 is a shell company (as defined in
          Rule
          12b-2 of the Exchange Act). Yes o   No x
 
 The
          number of shares of the Company's common stock outstanding on July 31,
          2006:
          68,683,605
  
  ITEC
          ENVIRONMENTAL GROUP, INC.
 FORM
          10-QSB
  TABLE
          OF
          CONTENTS
 PART
                    I
                FINANCIAL
                    INFORMATION
                3Item
                    1
                Financial
                    Statements
                3Item
                    2
                Management's
                    Discussion and Analysis or Plan of Operation
                19Item
                    3
                Controls
                    and ProceduresPART
                    II
                OTHER
                    INFORMATION
                21Item
                    1
                Legal
                    Proceedings
                21Item
                    2
                Unregistered
                    Sales of Equity Securities and Use of Proceeds
                22Item
                    3
                Defaults
                    Upon Senior Securities
                22Item
                    4
                Submission
                    of Matters to a Vote of Security Holders
                22Item
                    5
                Other
                    Information
                22Item
                    6
                Exhibits
                22SIGNATURES
                
                23
  2
 PART
          I -
          FINANCIAL INFORMATION
 Item
          1.
          Financial Statements
 **ITEC
        Environmental Group, Inc. and Subsidiary**
 **Condensed
        Consolidated Balance Sheet**
 **(unaudited)**
  **June
                      30,**
                    **2006**Current
                  assetsCash
                  and cash equivalents
              
              $
              61,177Inventories
              
              
              41,210Prepaid
                  expenses and other current assets
              
              
              96,393Total
                  current assets
              
              
              198,780Property
                  and equipment, net
              
              
              3,279,684Notes
                  receivable - officer
              
              
              147,973Other
                  assets
              
              
              375,055Total
                  assets
              
              $
              4,001,492Current
                  liabilitiesAccounts
                  payable
              
              $
              851,525Accounts
                  payable - related party
              
              
              272,534Accrued
                  compensation and other amounts due officers
              
              
              964,773Accrued
                  liabilities
              
              
              507,671Current
                  portion of capital lease obligations
              
              
              7,790Notes
                  and convertible notes payable, net of $1,915,401 debt
                  discount
              
              
              1,754,581Current
                  portion of California Integrated Waste Management Board note
                  payable
              
              
              172,615Fair
                  value liability for convertible notes payable embedded
                  derivative
              
              
              2,790,747Fair
                  value liability for warrants
              
              
              5,980,535Loans
                  payable issued prior to 2004
              
              
              353,980Total
                  current liabilities
              
              
              13,656,751Capital
                  lease obligations, net of current portion
              
              
              11,377Note
                  payable to California Integrated Waste Management Board,
                  net
              
              
              1,799,411Total
                  liabilities
              
              
              15,467,539Commitments
                  and contingencies (Note 9)Stockholders'
                  DeficitPreferred
                      stock, $0.001 par value, 10,000,000 shares authorized , none
                      issued and
                      outstanding
              
              
              -Common
                    stock, $0.001 par value, 750,000,000 shares authorized, 68,683,605
                    shares
                    issued and outstanding
              
              
              68,684Additional
                  paid-in capital
              
              
              20,106,582Accumulated
                  deficit
              
              
              (31,641,313
              )Total
                  stockholders' deficit
              
              
              (11,466,047
              )Total
                  liabilities and stockholders' deficit
              
              $
              4,001,492See
                  accompanying notes to condensed consolidated financial
                  statements.


3


**ITEC
                  Environmental Group, Inc. and Subsidiary****Condensed
                  Consolidated Statements of Operations****(unaudited)**




Three
                  months ended June 30,
              
              Six
                  months ended June 30,2006
              
              2005
              
              2006
              
              2005Revenue
              
              $
              13,520
              
              $
              -
              
              $
              50,293
              
              $
              -Cost
                  of goods sold
              
              
              18,643
              
              
              -
              
              
              44,602
              
              
              -Gross
                  profit
              
              
              (5,123
              )
              
              -
              
              
              5,691
              
              
              -Operating
                  expensesTechnology
                  development
              
              
              422,711
              
              
              13,673
              
              
              708,190
              
              
              29,715Consulting
                  and legal fees
              
              
              1,206,368
              
              
              1,502,894
              
              
              2,217,947
              
              
              2,264,892General
                  and administrative
              
              
              238,863
              
              
              500,871
              
              
              538,280
              
              
              823,842Total
                  operating expenses
              
              
              1,867,942
              
              
              2,017,438
              
              
              3,464,417
              
              
              3,118,449Loss
                  from operations
              
              
              (1,873,065
              )
              
              (2,017,438
              )
              
              (3,458,726
              )
              
              (3,118,449
              )Other
                  expenseInterest
                  expense
              
              
              729,308
              
              
              101,338
              
              
              843,416
              
              
              116,390Loss
                  on conversion of notes payable for stock
              
              
              -
              
              
              156,140
              
              
              -
              
              
              156,140Change
                      in fair value liability of warrants and
                      derivatives
              
              
              986,080
              
              
              -
              
              
              1,952,767
              
              
              -Total
                  other expense
              
              
              1,715,388
              
              
              257,478
              
              
              2,796,183
              
              
              272,530Loss
                  before income taxes
              
              
              (3,588,453
              )
              
              (2,274,916
              )
              
              (6,254,909
              )
              
              (3,390,979
              )Provision
                  for income taxes
              
              
              -
              
              
              -
              
              
              -
              
              
              -Net
                  loss
              
              $
              (3,588,453
              )
              $
              (2,274,916
              )
              $
              (6,254,909
              )
              $
              (3,390,979
              )Net
                  loss per share, basic and diluted
              
              $
              (0.05
              )
              $
              (0.09
              )
              $
              (0.09
              )
              $
              (0.22
              )Weighted
                      average shares used in computing net loss per share, basic
                      and
                      diluted
              
              
              68,683,605
              
              
              24,427,954
              
              
              67,563,595
              
              
              15,711,856




See
        accompanying notes to condensed consolidated financial statements.


4


**ITEC
                  Environmental Group, Inc. and Subsidiary****Condensed
                  Consolidated Statements of Cash Flows****(unaudited)**




Six
                  months ended June 30,2006
              
              2005Cash
                  flows from operating activities:Net
                  loss
              
              $
              (6,254,909
              )
              $
              (3,390,979
              )Adjustments
                      to reconcile net loss to net cash used in operating
                      activities:Depreciation
                  and amortization
              
              
              181,473
              
              
              24,564Change
                  in fair value of warrants and derivatives
              
              
              1,952,770
              
              
              -Loss
                  on conversion of debt for common stock
              
              
              -
              
              
              156,140Issuance
                  of warrants or common stock for services or compensation
              
              
              590,606
              
              
              1,876,516Issuance
                  of warrants for services recorded as derivative
                  liabilities
              
              
              652,860
              
              
              -Amortization
                  of deferred stock-based consulting
              
              
              508,000
              
              
              433,622Amortization
                  of debt issue costs and discount
              
              
              525,590
              
              
              24,331Changes
                  in operating assets and liabilities:Inventory
              
              
              26,454
              
              
              -Other
                  assets
              
              
              (79,948
              )
              
              -Accounts
                  payable
              
              
              341,241
              
              
              385,518Accrued
                  liabilities
              
              
              6,531
              
              
              188,161Other
              
              
              -
              
              
              59,450Net
                  cash used by operating activities
              
              
              (1,549,332
              )
              
              (242,677
              )Cash
                  flows from investing activities:Purchase
                  of property, plant & equipment
              
              
              (655,612
              )
              
              -Net
                  cash used by investing activities
              
              
              (655,612
              )
              
              -Cash
                  flows from financing activities:Decrease
                  (increase) in restricted cash in escrow
              
              
              57,854
              
              
              (2,000,000
              )Proceeds
                  (payments on) from CIWMB notes payable
              
              
              (18,474
              )
              
              2,000,000Proceeds
                  from issuance of notes payable
              
              
              2,319,982
              
              
              306,000Payments
                  of debt issue costs
              
              
              (218,556
              )Principal
                  payments on capital lease obligations
              
              
              (3,550
              )
              
              (3,199
              )Proceeds
                  from notes payable - officers
              
              
              96,500
              
              
              -Payments
                  on notes payable - officers
              
              
              -
              
              
              (45,500
              )Net
                  cash provided by financing activities
              
              
              2,233,756
              
              
              257,301Net
                  increase in cash and cash equivalents
              
              
              28,812
              
              
              14,624Cash
                  and cash equivalents, beginning of period
              
              
              32,365
              
              
              5,366Cash
                  and cash equivalents, end of period
              
              $
              61,177
              
              $
              19,990**Supplemental
                  disclosures of cash flow information:**Cash
                  paid for interest
              
              $
              149,050
              
              $
              -Cash
                  paid for income taxes
              
              $
              -
              
              $
              -**Non-cash
                  investing and financing activities**Derivative
                  liabilities recorded as debt discount
              
              $
              2,319,982
              
              $
              -Warrants
                  issued recorded as deferred debt issue costs
              
              $
              240,769
              
              $
              -Conversion
                  of note and interest to convertible note
              
              $
              52,482
              
              $
              -Common stock issued for debt conversion note
              
              $
              -
              
              $
              110,000See
                  accompanying notes to condensed consolidated financial
                  statements.


5


**ITEC
      Environmental Group, Inc. and Subsidiary**


**Notes
      to Unaudited Condensed Consolidated Financial Statements**


**June
      30, 2006**




**Note
      1. Description of Business and Summary of Significant Accounting
      Policies**




Organization
      and Business - Itec
      Environmental Group, Inc. (“Itec” or the “Company”) was incorporated under the
      laws of the State of Delaware in March 2000. Itec was formed for the purpose
      of
      acquiring certain patented technology and the development of a worldwide market
      for its usage. The Company's subsidiary, ECO2 Environmental Systems, Inc.
      (“ECO2”), was incorporated under the laws of the State of Delaware in April
      2000. Unless the context indicates otherwise, all references herein to the
      Company include Itec and its wholly-owned subsidiary, ECO2.





The
      Company is engaged in activities to become a worldwide supplier of recycled
      plastics using its proprietary process and equipment and to form strategic
      alliances to become a supplier of recycling equipment outside of the United
      States. The Company has constructed its first recycling line at its Riverbank,
      California plant and in May 2006 commenced recycling operations.





Business
      risks and uncertainties - The
      Company operates in the evolving field of plastics materials recycling. New
      developments could both significantly and adversely affect existing and emerging
      technologies in the field. The Company's success in developing additional
      marketable products and processes and achieving a competitive position will
      depend on its ability to attract and retain qualified management personnel
      and
      to raise sufficient capital to meet its operating and development needs. While
      the Company is seeking financing through equity and loans, there can be no
      assurance that it will be successful in accomplishing its
      objectives.




Basis
      of presentation and Going Concern - The
      accompanying unaudited condensed consolidated financial statements have been
      prepared in conformity with generally accepted accounting principles, which
      contemplate continuation of the Company as a going concern. The Company has
      reported recurring losses, cash used by operating activities and has a net
      working capital deficiency that raises substantial doubt about its ability
      to
      continue as a going concern. The Report of Independent Registered Public
      Accounting Firm included in the Company’s December 31, 2005 Annual Report on
      Form 10-KSB stated that these conditions, among others, raise substantial doubt
      about the Company’s ability to continue as a going concern. During the year
      ended December 31, 2005, the Company reported a net loss of approximately $15.3
      million and used cash in operating activities of approximately $1.4 million,
      and
      during the six months ended June 30, 2006 reported a net loss of approximately
      $6.3 million
      and used cash in operating activities of approximately $1.5 million and as
      of
      June 30, 2006, had a working capital deficiency of approximately
      $13.5 million
      and total stockholders' deficit of $10.5 million,
      which includes accumulated losses from inception of $31.6 million.




Company
      management intends to raise additional debt and/or equity financing to fund
      future capital expenditures, operations and to provide additional working
      capital, and in this regard has raised through June 30, 2006, approximately
      $2.3
      million pursuant to sales of securities in connection with its 2006 private
      placement as described in Note 5. However, there is no assurance that such
      financing will be obtained in sufficient amounts necessary to meet the Company's
      needs. In view of these matters, continuation as a going concern is dependent
      upon the Company's ability to meet its financing requirements, raise additional
      capital, and the success of its future operations or completion of a successful
      business combination.




The
      accompanying condensed consolidated financial statements do not include any
      adjustments to reflect the possible future effects on the recoverability and
      classification of assets or the amounts and classifications of liabilities
      that
      may result from the possible inability of the Company to continue as a going
      concern.




Use
      of
      estimates in the preparation of financial statements - The
      preparation of financial statements in conformity with generally accepted
      accounting principles 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 from those estimates. The more significant accounting
      estimates inherent in the preparation of the Company's financial statements
      include estimates as to the depreciable lives of property and equipment,
      valuation of inventories, valuation of equity related instruments and
      derivatives issued, and valuation allowance for deferred income tax
      assets.





Unaudited
      Interim Condensed Consolidated Financial Statements ***-*** The
      unaudited interim condensed consolidated financial statements have been prepared
      in accordance with the rules and regulations of the Securities and Exchange
      Commission with regard to interim financial information, and accordingly, do
      not
      include all of the information and notes to financial statements required by
      accounting principles generally accepted in the United States for complete
      financial statements. In the opinion of management, all adjustments, consisting
      of normal recurring adjustments, considered necessary to present fairly the
      Company’s financial position, results of operations and cash flows for the
      interim periods presented have been included. Results for the 2006 interim
      periods are not necessarily indicative of results to be expected for the year
      ending December 31, 2006 or for any other future period. These interim condensed
      consolidated financial statements should be read in conjunction with the
      Company’s audited annual financial statements and related notes thereto, which
      are included in the Company’s December 31, 2005 Annual Report on Form 10-KSB.


6


**ITEC
      Environmental Group, Inc. and Subsidiary**


**Notes
      to Unaudited Condensed Consolidated Financial Statements**


**June
      30, 2006**







Principles
      of Consolidation **-** The
      consolidated financial statements include the accounts of ITEC Environmental
      Group, Inc. and its wholly-owned subsidiary. All material intercompany balances
      and transactions have been eliminated in consolidation





Cash
      and cash equivalents - The
      Company considers deposits that can be redeemed on demand and investments that
      have original maturities of less than three months when purchased to be cash
      equivalents.




Restricted
      cash in escrow - In
      2005, the Company received cash from the California Integrated Waste Management
      Board pursuant to a $2,000,000 note payable, and received cash from an investor
      fund pursuant to $600,000 notes payable. Funds received from these borrowings
      were placed in escrow, with draws made by the Company upon satisfaction of
      certain conditions, including among others, presentation of invoices for
      purchases of authorized equipment to be financed. These funds were classified
      as
      Restricted Cash in Escrow as they were not otherwise available for use by the
      Company.




Inventories -
      Inventories are comprised of raw materials and recorded at cost determined
      on a
      first-in-first out basis.




Property
      and equipment -
      Property and equipment are recorded at cost less accumulated depreciation and
      amortization. Expenditures for major additions and improvements are capitalized,
      and minor maintenance, repairs and replacements are charged to expense as
      incurred. When property and equipment are retired or otherwise disposed of,
      the
      cost and accumulated depreciation are removed from the accounts and any
      resulting gain or loss is included in the results of operations. Depreciation
      and amortization are provided using the straight-line method over the estimated
      useful lives of the respective assets, which are 3 years for computer equipment
      and software and furniture and fixtures, 5 to 7 years for manufacturing
      equipment and 7 years for the recycling plant.




Contingencies -
      Certain conditions may exist as of the date financial statements are issued,
      which may result in a loss to the Company, but which will only be resolved
      when
      one or more future events occur or fail to occur. Company management and its
      legal counsel assess such contingent liabilities, and such assessment inherently
      involves an exercise of judgment. In assessing loss contingencies related to
      legal proceedings that are pending against the Company or unasserted claims
      that
      may result in such proceedings, the Company's legal counsel evaluates the
      perceived merits of any legal proceedings or unasserted claims as well as the
      perceived merits of the amount of relief sought or expected to be sought
      therein. If the assessment of a contingency indicates that it is probable that
      a
      liability has been incurred and the amount of the liability can be estimated,
      then the estimated liability would be accrued in the Company's financial
      statements. If the assessment indicates that a potentially material loss
      contingency is not probable but is reasonably possible, or is probable but
      cannot be estimated, then the nature of the contingent liability, together
      with
      an estimate of the range of possible loss if determinable would be
      disclosed.




Fair
      value of financial instruments - The
      Company measures its financial assets and liabilities in accordance with
      generally accepted accounting principles. For certain of the Company's financial
      instruments, including cash and cash equivalents, accounts payable and accrued
      liabilities, the carrying amounts approximate fair value due to their short
      maturities. Amounts recorded for notes payable also approximate fair value
      because current interest rates offered to the Company for debt of similar
      maturities are substantially the same **.**





Accounting
      for Derivatives - The
      Company evaluates its convertible debt, options, warrants or other contracts
      to
      determine if those contracts or embedded components of those contracts qualify
      as derivatives to be separately accounted for under Statement of Financial
      Accounting Standards 133 “Accounting for Derivative Instruments and Hedging
      Activities” and related interpretations including EITF 00-19 “Accounting for
      Derivative Financial Instruments Indexed to, and Potentially Settled in, a
      Company’s Own Stock”. The result of this accounting treatment is that the fair
      value of the derivative is marked-to-market each balance sheet date and recorded
      as a liability. In the event that the fair value is recorded as a liability,
      the
      change in fair value is recorded in the consolidated statement of operations
      as
      other income or expense. Upon conversion or exercise of a derivative instrument,
      the instrument is marked to fair value at the conversion date and then that
      fair
      value is reclassified to equity. Equity instruments that are initially
      classified as equity that become subject to reclassification under SFAS 133
      are
      reclassified to liability at the fair value of the instrument on the
      reclassification date.





Revenue
      recognition - The
      Company recognizes revenue when there is persuasive evidence of an arrangement,
      the product has been delivered or the services have been provided to the
      customer, the sales price is fixed or determinable, and collectibility is
      reasonably assured. The Company recognizes revenues from sales of recycled
      products upon delivery to customers. The Company will recognize revenues from
      sales of equipment or systems once configuration of such systems are completed
      and accepted by the customer.




7


**ITEC
      Environmental Group, Inc. and Subsidiary**


**Notes
      to Unaudited Condensed Consolidated Financial Statements**


**June
      30, 2006**




Income
      taxes - The
      Company accounts for income taxes in accordance with SFAS No. 109, “Accounting
      for Income Taxes,” which requires recognition of deferred tax assets and
      liabilities for expected future tax consequences of events that have been
      included in financial statements or tax returns. Under this method, deferred
      income taxes are recognized for the tax consequences in future years of
      differences between the tax bases of assets and liabilities and their financial
      reporting amounts at each period end based on enacted tax laws and statutory
      tax
      rates applicable to the periods in which the differences are expected to affect
      taxable income. Valuation allowances are established, when necessary, to reduce
      deferred tax assets to amounts expected to be realized. The provision for income
      taxes represents the tax payable for the period and change during the period
      in
      net deferred tax assets and liabilities.




Research
      and development cost -
      Research and development represent costs incurred in connection with the
      Company’s development of recycling processes, and such costs are expensed as
      incurred and included in technology development expenses.





Stock-based
      compensation - In
      December 2004, the Financial Accounting Standards Board (“FASB”) released a
      revision to Statement of Financial Accounting Standard (“SFAS”) No. 123,
      Accounting for Stock-Based Compensation (“FAS 123R”). FAS 123R sets forth the
      accounting for share-based payment transactions in which an enterprise receives
      employee services in exchange for (a) equity instruments of the enterprise
      or
      (b) liabilities that are based on the fair value of the enterprise's equity
      instruments or that may be settled by the issuance of such equity instruments.
      The statement eliminates the ability to account for share-based compensation
      transactions using APB Opinion No. 25, Accounting for Stock Issued to Employees,
      and generally requires instead that such transactions be accounted for using
      a
      fair-value-based method, which requires recording an expense over the requisite
      service period for the fair value of all options or warrants granted to
      employees and consultants. The Company adopted FAS 123R effective beginning
      January 1, 2005. The Company did not issue options or warrants to employees
      prior to 2005.





Basic
      and diluted net loss per share - Basic
      net loss per common share is computed by dividing net loss by the
      weighted-average number of common shares outstanding during the period. Diluted
      net loss per common share is determined using the weighted-average number of
      common shares outstanding during the period, adjusted for the dilutive effect
      of
      common stock equivalents, consisting of shares that might be issued upon
      exercise of common stock options, investment rights, warrants or
      convertible promissory notes. In periods where losses are reported, the
      weighted-average number of common shares outstanding excludes common stock
      equivalents, because their inclusion would be anti-dilutive. Computations of
      net
      loss per share for the interim periods ended June 30, 2005, exclude 9,307,370
      shares issuable upon exercise of outstanding warrants, 2,844,444 shares relating
      to common stock issuable upon conversion of convertible notes payable, and
      12,121 shares relating to common stock issuable upon exercise of outstanding
      warrants. Computations of net loss per share for the three and six months ended
      June 30, 2006, exclude 29,948,533 shares relating to common stock issuable
      upon
      conversion of convertible notes payable, 50,205,363 shares issuable upon exercise of outstanding and issuable warrants,
      and 19,458,403 shares issuable upon exercise of rights to purchase common
      stock. . These
      common stock equivalents could have the effect of decreasing diluted net income
      per share in future periods.




Concentrations -
      Financial instruments that potentially subject the Company to concentrations
      of
      credit risk consist principally of cash equivalents. At times, amounts of cash
      or cash equivalents in U.S. financial institutions exceed amounts insured by
      agencies of the U.S. Government.





The
      Company’s business is reliant on its licensing of technology from Honeywell
      International, Inc. See Note 4 for a discussion of this concentration and
      associated risks.




Development-stage
      company -
      Through December 31, 2005, the Company presented its consolidated financial
      statements in accordance with SFAS No. 7 “Accounting and Reporting by
      Development Stage Enterprises”. This statement specifies the guidelines for
      identifying an enterprise in the development stage and the standards of
      financial accounting and reporting for such an enterprise, which includes among
      other things, presentation of inception to date consolidated statements of
      operations and cash flows. During 2006, the Company commenced initial production
      activities at its recycling plant in Riverbank, and accordingly, it has been
      determined that the Company is no longer in the development stage for financial
      statement presentation purposes.





Reclassifications -
      Certain amounts in 2005 financial statements have been reclassified to conform
      to 2006 classifications.




Recent
      accounting pronouncements - In May
      2005, the FASB issued Statement of Financial Accounting Standards No. 154,
      “Accounting Changes and Error Corrections”, (SFAS 154”). SFAS 154 replaces APB
      Opinion No. 20, “Accounting Changes,” and SFAS No. 3, “Reporting Accounting
      Changes in Interim Financial Statements,” and changes the requirements for the
      accounting for and reporting of a change in accounting principle. The Company
      is
      required to adopt SFAS 154 in 2007. The Company's results of operations and
      financial condition will only be impacted by SFAS 154 if the Company implements
      changes in accounting principles that are addressed by the standard or correct
      accounting errors in future periods.


8


**ITEC
      Environmental Group, Inc. and Subsidiary**


**Notes
      to Unaudited Condensed Consolidated Financial Statements**


**June
      30, 2006**




**Note
      2**  **Inventories**





Inventories
      at June 30, 2006 consist of the following:





Raw
                materials
            
            $
            41,210




**Note
      3. Property and Equipment**





Property
      and equipment at June 30, 2006 consist of the following:





Manufacturing
                tools
            
            $
            23,361Office
                furniture and equipment
            
            
            57,690Recycling
                plant
            
            
            3,519,933Total
                property and equipment
            
            
            3,600,984Less
                accumulated depreciation and amortization
            
            
            (321,300
            )Property
                and equipment, net
            
            $
            3,279,684




During
      the three and six months ended June 30, 2006, the Company capitalized $0 and
      $43,408 of interest into the recycling plant during the construction
      period.





**Note
      4. Technology License**





In
      July
      2005, the Company and Honeywell International, Inc. (Honeywell) amended certain
      terms of the license agreement entered into by the parties in 2000, which,
      among
      other things, extended the agreement to be in effect for the life of the patent.
      Pursuant to terms of the Agreement, the Company obtained certain worldwide
      license rights to practice the methods and to make, use, and sell, the products
      which are covered by the proprietary rights, limited to the field of use of
      separating and recovering motor oil from high density polyethylene plastic.
      Under this amended Agreement, the Company is required to pay minimum annual
      royalties of $50,000 for 2006, $100,000 for 2007, $200,000 for 2008 and $300,000
      for 2009 and for years thereafter. The royalty provision was amended whereby
      the
      Company shall pay a royalty rate of $.005 per pound of recycled plastics sold
      in
      the United States which shall be due within 30 days of the close of the previous
      quarter. The first annual minimum payment was due in March 2006, which was
      accrued but unpaid as of June 30, 2006, and Company management has been engaged
      in discussions with Honeywell relating to payment modifications, which are
      expected to result in, among other things, deferral of the first annual minimum
      payment to 2007





Honeywell
      may terminate this agreement in the event of a bankruptcy filing or insolvency
      of the Company, an assignment for the benefit of creditors of the Company,
      the
      nationalization of the industry which encompasses any products or services,
      any
      suspension of payments under the terms of the agreement by government
      regulation, the Company's failure to commence manufacture, a substantial change
      in ownership of the Company (whether resulting from merger, acquisition,
      consolidation or otherwise), another company or person acquiring control of
      the
      Company, or the existence of a state of war between the United States and any
      country where the Company has a license to manufacture products or provide
      services. In addition, if either party to the agreement defaults for any reason
      in any of the obligations under the terms of the agreement, the other party
      will
      have the right to terminate the agreement by giving at least 60 days' written
      notice. Among other things, pursuant to terms of the agreement there are no
      rights to sub-license granted and the terms require the Company to observe
      all
      applicable United States and foreign laws, regulations, rules, and decrees
      with
      respect to the transfer of the proprietary rights and related technical data
      to
      foreign countries and failure to conform to such laws, regulations, rules and
      decrees may result in criminal liability.





**Note
      5.  Notes Payable**





Pursuant
      to terms of Business Loan Agreement, Security Agreements, and $2,000,000
      Promissory Note with the California Integrated Waste Management Board (“CIWMB”),
      in June 2005, the Company received into escrow  $1,990,000,
      after deduction of $10,000 for loan fees paid to CIWMB. The loan fee was
      recorded as a debt discount, which is amortized over the loan term. 
Approval for the loan was based on the Company's projection to build its first
      ECO2 Environmental System Plant and to divert post consumer plastic bottles
      as a
      result of the loan. The promissory note bears interest at 4.25% per annum,
      with
      interest only monthly payments during the first year,  and
      then
      principal and interest monthly payments of $22,548 starting in July 2006 until
      fully paid in May 2015. The promissory note is collateralized by equipment
      purchased for the recycling plant, a secondary security interest in all other
      machinery and equipment and other Company assets, and guaranteed by the
      Company's Chief Executive Officer. The Company made draws from cash in escrow
      upon meeting certain conditions, including presentation of equipment invoices.
      Minimum annual principal payments approximate $93,000 in 2006, $192,000 in
      2007,
      $200,000 in 2008, $209,000 in 2009, $219,000 in 2010 and $1,087,000 thereafter
      during 2011 through 2015.


9


**ITEC
      Environmental Group, Inc. and Subsidiary**


**Notes
      to Unaudited Condensed Consolidated Financial Statements**


**June
      30, 2006**








In
      January 2005, the Company issued for cash a 10% note payable for $50,000 due
      in
      July 2005. The proceeds were used for working capital. In June 2005, the Company
      issued 2,576,750 shares of its common stock upon conversion of the note payable.
      The Company recorded the excess of estimated fair value of the shares issued
      (based on the $0.115 per share quoted market price on the conversion date)
      of
      $156,140 as an increase in additional paid-in capital and as a loss on
      conversion of notes payable for common stock.




In
      April
      2005, the Company issued for cash a 10% note payable for $60,000 due in August
      2005, and convertible into shares of Company common stock at a per share price
      of the lesser of approximately $0.02, or 50% of the closing stock price on
      the
      date of conversion. The embedded conversion option qualified as a derivative
      pursuant to SFAS 133 since the conversion price is variable and the ability
      to
      have enough authorized common shares to fulfill its potential obligations under
      convertible debt contracts is not under the Company control. The fair value
      of
      the conversion option of $258,643 was computed using a Black-Scholes option
      pricing method with the following assumptions: contractual term of .5 years
      (due
      to its short term), volatility of 207% (based on historical volatility over
      the
      expected term), zero dividends and interest rate of 4.45%. The $258,643 was
      allocated $60,000 to debt discount, the maximum to be recorded, and $198,643
      to
      operations as a change in fair value of warrants and derivatives. The discount
      is amortized to interest expense over the term of the note. In June 2005, the
      note was converted into 3,029,100 shares of Company common stock in accordance
      with conversion terms and the then fair value liability of $166,669 was
      reclassified to equity. The full amount of the $60,000 debt discount was
      amortized to interest expense in 2005.





In
      August
      2005, the Company borrowed $33,400 on a short-term borrowing arrangement. The
      proceeds were used for working capital. In August 2005, the Company issued
      1,708,472 shares of its common stock upon conversion of the note payable, and
      recorded the excess of estimated fair value of the shares issued (based on
      the
      $.23 per share quoted market price on the conversion date) of $359,724 as an
      increase in additional paid-in capital and as a loss on conversion of notes
      payable for common stock.




In
      June
      2005, the Company issued for cash a 10% note payable for $128,000 due in October
      2005, and convertible into shares of Company common stock at the lesser of
      50%
      of the quoted trade price on the conversion date or $0.045 per share. The
      embedded conversion option qualified as a derivative pursuant to SFAS 133 since
      the conversion price is variable and the ability to have enough authorized
      common shares to fulfill its potential obligations under convertible debt
      contracts is not under the Company control. The fair value of the conversion
      option of $155,729 was computed using a Black-Scholes option pricing method
      with
      the following assumptions: contractual term of .33 years (due to its short
      term), volatility of 207% (based on historical volatility over the expected
      term), zero dividends and interest rate of 4.45%. The $155,729 was allocated
      $128,000 to debt discount, the maximum to be recorded, and $27,729 to operations
      as a change in fair value of warrants and derivatives. The discount was
      amortized to interest expense over the note term. The full amount of the
      $128,000 debt discount was amortized to interest expense in 2005. In October
      2005, the note was converted into 2,937,937 common shares and the then fair
      value liability of $310,050 was reclassified to equity.




In
      July
      2005, the Company issued for cash a 10% note payable for $250,000 due in October
      2005, and convertible into shares of Company common stock at the lesser of
      50%
      of the quoted trade price on the conversion date or $0.028 per share. The
      embedded conversion option qualified as a derivative pursuant to SFAS 133 since
      the conversion price is variable and the ability to have enough authorized
      common shares to fulfill its potential obligations under convertible debt
      contracts is not under the Company control. The fair value of the conversion
      option of $441,820 was computed using a Black-Scholes option pricing method
      with
      the following assumptions: contractual term of .33 years (due to its short
      term), volatility of 207% (based on historical volatility over the expected
      term), zero dividends and interest rate of 4.45%. The $441,820 was allocated
      $250,000 to debt discount, the maximum to be recorded, and $191,820 to
      operations as a change in fair value of warrants and derivatives. The discount
      was amortized to interest expense over the note term. The full amount of the
      $250,000 debt discount was amortized to interest expense in 2005. In November
      2005, the note was converted to 9,404,718 shares of Company common stock and
      the
      then fair value liability of $931,829 was reclassified to equity.





In
      July
      2005, the Company issued for cash a 10% note payable for $30,000 due in November
      2005, and convertible into shares of Company common stock at the lesser of
      50%
      of the quoted trade price on the conversion date or $0.035 per share. In
      addition, the Company issued to the lender warrants to purchase 300,000 shares
      of its common stock at a per share price of $0.25 per share. The embedded
      conversion option qualified as a derivative pursuant to SFAS 133 since the
      conversion price is variable and the ability to have enough authorized common
      shares to fulfill its potential obligations under convertible debt contracts
      is
      not under the Company control. The fair value of conversion option of $53,734
      was computed using a Black-Scholes option pricing method with the following
      assumptions: contractual term of .33 years (due to its short term), volatility
      of 207% (based on historical volatility over the expected term) , zero dividends
      and interest rate of 4.45%, and was allocated $30,000 to debt discount the
      maximum to be recorded, and $23,734 to operations as a change in fair value
      of
      warrants and derivatives. The discount is amortized to interest expense over
      the
      term of the note. The full amount of the $30,000 debt discount was amortized
      into interest expense in 2005. In November 2005, the note was converted to
      885,326 shares of Company common stock and the then fair value liability of
      $81,430 was reclassified to equity.


10


**ITEC
      Environmental Group, Inc. and Subsidiary**


**Notes
      to Unaudited Condensed Consolidated Financial Statements**


**June
      30, 2006**








In
      August
      2005, the Company received from The Elevation Fund, LLC (“The Elevation Fund” or
“Elevation”) cash of $600,000 in consideration for (i) a $600,000 promissory
      note, bearing interest at the greater of prime plus 5% or 10.75% (18% if there
      is an event of default) and due in 90 days or earlier in certain circumstances
      (the “Bridge Notes”), and (ii) cashless exercise warrants to purchase 8,500,000
      shares of the Company's common stock at an exercise price of $0.001 per share,
      immediately exercisable for ten years (the “Bridge Warrants”). The warrant value
      was recorded at approximately $352,000, the proportionate portion of the value
      of the warrant using a Black-Scholes option pricing method to the total of
      the
      warrant value and face amount of the note, as an increase in additional paid-in
      capital and as a debt discount to be amortized to interest expense over the
      term
      of the note. The full amount of the $352,000 debt discount was amortized into
      interest expense in 2005. The $20,000 origination fee to be paid directly to
      Elevation was also deferred as a debt discount and amortized to interest
      expense. The Bridge Notes are collateralized by a second position lien in all
      Company equipment and a blanket lien on all other assets. In April 2006, the
      Company received notice from Elevation that the Company defaulted on the loan,
      accrued interest and fees on November 1, 2005, and notified the Company that
      interest is accruing at the default rate of 18% since November 1, 2005 and
      that
      accrued fees accrue interest at the default rate of 18% since August 1, 2005.
      In
      addition, Elevation notified the Company that it has declared all amounts due
      and payable and intends to exercise any and all remedies provided under the
      loan
      agreement, note and security agreement (including without limitation, collect,
      receive, appropriate and realize upon the Collateral (as such term is defined
      in
      the security agreement) and sell, lease, assign, transfer or otherwise dispose
      of such collateral in accordance with the terms of the security agreement)
      and
      any and all other remedies available at law or equity. In June 2006, the Company
      entered into a Forbearance Agreement with Elevation, which provides for, among
      other things, payments, comprised first of costs and expenses, then interest,
      fees and then to principal, of $8,500 upon execution of the Forbearance
      Agreement, $100,000 on June 26, 2006, $200,000 on July 26, 2006 and payment
      in
      full on August 15, 2006 (or sooner if the Company closes on $5 million of
      financing), and payment of legal costs and expenses. Until repaid, the notes
      continue to bear interest at 18%.





Additionally
      in August 2005, the Company received from another investor (“Investor”) cash of
      $100,000 in consideration for (i) a $100,000 Bridge Note, and (ii) Bridge
      Warrants for 1,418,439 shares of Company common stock. The warrant value was
      recorded at $65,156 as an increase in additional paid-in capital and as a debt
      discount and was amortized to interest expense over the note term . The full
      amount of debt discount was amortized to interest expense in 2005. In April
      2006
      the Company received notice from the Investor that the Company has defaulted
      on
      the loan in December 2005. The notification states that interest is accruing
      at
      the default rate of 18% since December 2005 and declares that all unpaid amounts
      of principal and interest are immediately due and payable. In addition the
      Lender further reserves all other rights pursuant to the loan agreement and
      promissory note including the rights to collect all costs and expenses of
      collection. In May 2006, the Company entered into a Forbearance Agreement with
      the Investor and other note holders as described in the following paragraph,
      which provides for, among other things, payments, comprised first of costs
      and
      expenses, then interest, fees and then to principal, of $7,500 upon execution
      of
      the Forbearance Agreement, $100,000 on June 26, 2006, $200,000 on July 26,
      2006
      and payment in full on August 15, 2006 (or sooner if the Company closes on
      $5
      million of financing), and payment of $7,500 for legal costs and expenses.
      Until
      repaid, the notes continue to bear interest at 18%.





Additionally,
      in 2005, the Company received from other investors (the “Lenders”) cash of
      $650,000 in consideration for promissory notes totaling $650,000, bearing
      interest at 10% (18% if there is an event of default), due in 120 days or
      earlier in certain circumstances (the “Lenders Notes”), and convertible into
      shares of the Company's common stock at a per share price of the lesser of
      75%
      of (i) $.13, or (ii) the price of the common stock of the Company on the Over
      The Counter Bulletin Board on the day the Lenders elect to convert. The embedded
      conversion option qualified as a derivative pursuant to SFAS 133 since the
      conversion price is variable and the ability to have enough authorized common
      shares to fulfill its potential obligations under convertible debt contracts
      is
      not under the Company control. The fair value of the conversion options of
      $832,928 was computed using a Black-Scholes option pricing method with the
      following assumptions: contractual term of .33 years (due to its short term),
      volatility of 207% (based on historical volatility over the expected term),
      zero
      dividends and interest rate of 4.45%, and was allocated $635,644 to debt
      discount, the maximum to be recorded, and $197,284 to operations as a change
      in
      fair value of warrants and derivatives. The discount was amortized to interest
      expense over the note term. The full amount of the $600,000 debt discount was
      amortized to interest expense in 2005. At December 31, 2005 the fair value
      liability has been marked down to $159,033 using the Black-Scholes option
      pricing method with the following assumptions: contractual term of .01 years
      (due to its short term), volatility of 207% (based on historical volatility
      over
      the expected term), zero dividends and interest rate of 4.45%. In April 2006,
      the Company received notice from a representative of some of the Lenders
      representing $500,000 of these notes that the Company defaulted on the loans
      principal in 2005. The notification states that interest is accruing at the
      default rate of 18% since December 2005 and declares that all unpaid amounts
      of
      principal and interest are immediately due and payable with such interest
      continuing to accrue until the notes are paid in full. In addition, the Lenders
      further reserve all other rights pursuant to the loan agreements and promissory
      notes including the rights to collect all costs and expenses of collection.
      In
      May 2006, the Company entered into a Forbearance Agreement with the notifying
      Lenders and the Investor as described in the previous paragraph, which provides
      for, among other things, payments, comprised first of costs and expenses, then
      interest, fees and then to principal, of $7,500 upon execution of the
      Forbearance Agreement, $100,000 on June 26, 2006, $200,000 on July 26, 2006
      and
      payment in full on August 15, 2006 (or sooner if the Company closes on $5
      million of financing), and payment of $7,500 legal costs and expenses. Until
      repaid, the notes continue to bear interest at 18%.


11


**ITEC
      Environmental Group, Inc. and Subsidiary**


**Notes
      to Unaudited Condensed Consolidated Financial Statements**


**June
      30, 2006**




Bridge
      Notes are convertible in whole or in part into securities offered by the Company
      in its private placement offering of debentures and warrants (the “Private
      Placement”) on the same terms as such securities are sold to the other investors
      in the Private Placement, and in this regard the Company has granted the lender
      the right to invest up to the Bridge Notes amount on the same terms as are
      offered to other investors in the Private Placement. The Company has agreed
      to
      prepare and, as soon as practicable, but in no event later than 75 days
      following the closing date of the Private Placement (the “Filing Deadline”),
      file with the Securities and Exchange Commission (the “SEC”) a registration
      statement on Form SB-2 covering the resale of all shares of common stock
      underlying the Bridge Warrants, and has further agreed to use its reasonable
      best efforts to have such registration statement declared effective by the
      SEC
      as soon as practicable, but in no event later than the date which is 180 days
      following the closing date of the Private Placement (the “Effectiveness
      Deadline”). In the event the registration statement required to be filed is not
      filed by the Filing Deadline, the Company shall issue to the lender additional
      cashless warrants to purchase shares of the Company's common stock (“Additional
      Warrants”) in an amount equal to 10% of the number of shares underlying the
      Bridge Warrant issued to the lender for each 30 day period (or a portion
      thereof) during which time such registration statement has not been filed with
      the SEC, which Additional Warrants shall be issued on the first day of each
      30
      day period commencing on the Filing Deadline. In addition, in the event the
      registration statement required to be filed is not declared effective by the
      SEC
      by the Effectiveness Deadline, the Company shall issue to the Lender Additional
      Warrants in an amount equal to 10% of the number of shares underlying the
      Warrant issued to the Lender for each 30 day period (or portion thereof) during
      which time such registration statement has not been declared effective by the
      SEC, which Additional Warrants shall be issued on the first day of each 30
      day
      period and commencing on the Effectiveness Deadline. The exercise price for
      the
      Additional Warrants issued shall be the same as the exercise price of the
      warrants that are issued in the Private Placement. Due to the contingent nature
      of the conversion rights and related registration rights and penalties, the
      Company does not consider this debt convertible until the contingency, which
      is
      under control of the Company, occurs, whereupon the Company will evaluate
      whether this debt has an embedded derivative subject to separate accounting
      pursuant to SFAS 133 or any beneficial conversion value.





During
      2006, the Company has received subscriptions and related funds into escrow
      pursuant to a private placement memorandum in which $2.5 million, which can
      be
      increased to $5 million, of bridge financing is to be raised through the
      offering of a minimum of 20 Units for $25,000 per unit. Each Unit consists
      of a
      $25,000 junior secured subordinated convertible debenture (the “Private
      Placement Notes”), bearing interest at 10% with principal and accrued interest
      due 12 months from issuance (“maturity date”), convertible into shares of the
      Company’s common stock at a price of $0.0975 per share, and a warrant, with a
      cashless exercise provision, to purchase 75,000 shares of restricted common
      stock of the Company, exercisable for approximately 10 years (expires April
      2015) at an exercise price of $0.06 per share. The conversion price of the
      debentures and exercise price of the warrant are subject to anti-dilution
      downward adjustments in the event the Company sells common stock or securities
      convertible into common stock at a price below the conversion or exercise
      prices, and subject to other adjustments as described below relating to the
      registration rights. The security is subordinated only to the security interest
      granted to CIWMB. The shares underlying the debentures and warrants are subject
      to piggy back registration rights. In addition, a registration statement must
      be
      filed within 30 days after an investor elects to convert all or any portion
      of
      the debenture. If the registration statement is not filed within that time
      the
      investor shall be paid 10% of the shares of common stock into which the
      debenture converts in additional cashless exercise warrants at an exercise
      price
      of $.06 per share for each 30 days beyond the initial 30 day period. If the
      registration statement is not effective within 180 days after filing, the
      investor will get paid 10% of the shares of common stock into which the
      debenture converts in additional cashless exercise warrants at an exercise
      price
      of $.06 for each 30 days beyond the initial 150 day period. Should the
      Securities and Exchange Commission fail to declare a registration statement
      effective on or before May 1, 2007 or should such registration statement
      thereafter cease to be effective, then the conversion price shall decrease
      by
      $.03 upon the occurrence of every 30-day period thereafter (or part thereof)
      that the registration statement shall not be declared or remain effective,
      provided, however, that in no event shall the aggregate reduction in conversion
      price be greater than $.0975. Through June 30, 2006, subscription proceeds
      for
      $2,267,500 of Private Placement Notes had been received into escrow and the
      Company received approximately $1.6 million from the escrow account, 
$100,000 was disbursed from escrow for debt service and approximately $563,000
      was disbursed from escrow for payments on the Company’s behalf for legal and
      other professional fees, and as a result the Company has recorded convertible
      notes payable of $2,267,500 and 6,802,500 of warrants. Inasmuch as the offering
      has not closed and the debentures and warrants have not been issued. At June
      30,
      2006, approximately $22,000 of subscription funds had been received in escrow,
      but not disbursed to the Company, which is included in other current assets.
      In
      April 2006, one holder of Lender Notes converted notes of $50,000 plus accrued
      interest into a subscription unit comprised of a $52,482 Private Placement
      Note
      and 150,000 warrants, and the Company also issued 2 subscription units,
      comprised of $50,000 of notes and 150,000 warrants, to a consultant for services
      to be provided pursuant to a one-year consulting agreement The embedded
      conversion option in the debenture qualifies as a derivative under FASB
      Statement 133 and related interpretations since the debenture conversion price
      is variable, and thus the debenture instrument is separated into a debt
      instrument and embedded option instrument for financial statement purposes
      and
      the embedded option instrument is recorded as a liability at fair value and
      marked to fair value at each reporting date through statement of operations
      as
      other income or expense. Due to the authorized shares issue this causes under
      EITF 00-19, the warrants are also classified as a warrant liability and marked
      to fair value through the statement of operations. At the debt issuance dates
      the total fair value liability recorded for the embedded conversion options
      and
      warrants was approximately $3,434,000 and at June 30, 2006, the total fair
      value
      liability recorded approximated $3,398,000 for securities sold through that
      date. The fair value of the embedded conversion option and warrant was computed
      using a Black-Scholes option pricing method with the following assumptions:
      contractual term of 1year (due to its short term) and contractual term of 10
      years (since no historical basis yet exists), respectively, volatility of
      approximately 207% and 300% (based on historical volatility over the expected
      term), respectively, zero dividends and interest rate of 4.8%. The value of
      the
      embedded conversion feature was allocated $2,320,000 to debt discount, the
      maximum to be recorded, and the remaining $892,000 and $1,114,000 to operations
      for the three and six months ended June 30, 2006, respectively, as a change
      in
      fair value of warrants and derivatives. The discount is amortized to interest
      expense over the term of the note, and during the three and six months ended
      June 30, 2006, $359,000 and $405,000 was amortized to interest
      expense.


12


**ITEC
      Environmental Group, Inc. and Subsidiary**


**Notes
      to Unaudited Condensed Consolidated Financial Statements**


**June
      30, 2006**




Notes
      and
      convertible notes payable outstanding at June 30, 2006 consists of the
      following:




Notes
                PayableBridge
                Notes
            
            $
            700,000Convertible
                notes payableLenders
                Notes
            
            
            600,000Private
                Placement Notes
            
            
            2,369,982Total
                notes and convertible notes payable
            
            
            3,669,982Debt
                discount, net of amortization
            
            
            (1,915,401
            )Notes
                and convertible notes payable, net
            
            $
            1,754,581








CIWMB
      Note payable outstanding at June 30, 2006 consists of the
      following:





CIWMB
                Note
            
            $
            1,981,026Debt
                discount
            
            
            (9,000
            )1,972,026Less
                current portion
            
            
            172,615Long
                term portion, net
            
            $
            1,799,411




**Note
      6. Common Stock, Stock Warrants and Other Rights to Purchase Common
      Stock**





Common
      Stock Issued for Services and Settlement





In
      2004,
      Itec executed an agreement with an investment advisor whereby the Company issued
      a 24% note payable for $500,000. The Company put in escrow with a law firm
      303,030 shares of the Company's common stock (“escrowed shares”) and twenty (20)
      advance notices of not less than $25,000 each. The law firm released these
      advance notices to the holder commencing in April 2004, all of which were
      released. At the option of the note holder, interest was payable by the Company
      either in common stock or cash. During 2005, the Company issued an additional
      3,000,000 shares of common stock for services. Such shares were valued at
      $330,000 based on the quoted trading price of $.11 per share on the grant date.
      In July 2005, the Company entered into a settlement and release agreement with
      the investment advisor pursuant to which, among other things, the Company paid
      $90,353 and received 1,342,692 shares of it's common stock back from escrow,
      valued at $120,843, which were the remaining amount of the 3,000,000 shares
      issued in 2005. All amounts due and payable between the companies were
      considered fully-settled, and the note payable and agreement were cancelled
      and
      terminated. In connection with this settlement, the Company recorded a gain
      on
      forgiveness of debt of approximately $292,000 in 2005, which included a decrease
      in additional paid-in capital of approximately $121,000, the fair value of
      shares cancelled.





During
      2005, the Company issued 17,207,634 shares, valued at $2,390,154 based on quoted
      trade prices at the grant dates ranging from $.07 to $.24 per share and
      averaging approximately $.14 per share, to consultants for services. The value
      was recognized over the respective terms of the agreements resulting in deferred
      stock based consulting expense of approximately $365,000 at December 31, 2005
      and was fully amortized at June 30, 2006.


13


**ITEC
      Environmental Group, Inc. and Subsidiary**


**Notes
      to Unaudited Condensed Consolidated Financial Statements**


**June
      30, 2006**





The
      Company has an agreement with a related party for legal services whereby the
      related party is periodically issued vested non-forfeitable common shares of
      the
      Company and any proceeds from the sale of such shares by the related party
      are
      credited against invoice amounts due to that related party for legal services.
      The agreement has no stated term. Due to the contingent nature of the proceeds
      and the unstated term of the legal service agreement, the fair value of shares
      issued has been expensed when issued. The related party invoices are accrued
      to
      accounts payable, periodically paid in cash and accounts payable is credited
      for
      any proceeds in the period the proceeds are received by the related party and
      reported to the Company. During 2005 the Company issued 9,957,692 common shares
      pursuant to the legal services agreement. The shares were valued at the quoted
      trading prices on the respective grant dates which ranged from $.09 to $.23
      per
      share or an average of approximately $.16 per share, resulting in an expense
      of
      $1,635,000. During 2005, the Company also recognized approximately $1.2 million
      of stock based legal expenses relating to this same services provider that
      had
      been deferred. During the six months ended June 30, 2006, the Company issued
      2,802,925 shares of its common stock and recorded legal expense of approximately
      $336,000, which was determined based on the $0.12 per share quoted trading
      price
      on date of issuance. There were no reported stock sale proceeds during the
      six
      months ended June 30, 2006.





During
      2005, pursuant to the “safe harbor” private offering exemption provided by Rule
      506 of Regulation D under Section 4(2) and of the Securities Act of 1933 (the
      “Securities Act”), the Company issued 2,737,220 shares of its common stock (and
      certain registration rights) to an investment banker as retainer for certain
      corporate finance and investment banking services being provided pursuant to
      the
      corporate finance representation agreement between the parties entered into
      in
      2005. The agreement was for a period of one year, extendable to two years upon
      completion of a successful financing. In the event of a consummated transaction,
      the Company will pay the investment banker fees ranging from 2% to 8% of amounts
      raised and issued to the investment banker varying amounts of securities issued
      in the financing, depending of the type of securities and nature of transaction.
      The shares were valued at $246,350 based on a $.09 quoted trade price on the
      grant date. The $246,350 was deferred and amortized over the service term
      resulting in a deferred expense of $143,000 at December 31, 2005 and was fully
      amortized in 2006.





In
      October 2005, the Company issued 744,542 shares of its common stock to an
      investment banker as consideration for services provided pursuant to terms
      of a
      corporate finance representation agreement in connection with Company borrowings
      in August 2005, and recorded deferred debt issue costs asset of $74,466, based
      on the $.10 quoted trade price at the grant date. Additionally, the Company
      has
      recorded additional deferred debt issue costs of $135,000 relating to warrants
      issued to the investment banker and another consultant for services provided
      in
      connection with the borrowing transaction. Warrants are for the purchase of
      900,000 shares of common stock at a per share price of $0.001 for a term of
      5
      years (850,000 warrants) and 10 years (50,000 warrants). The full amount of
      debt
      issue costs was amortized to interest expense in 2005.





During
      the six months ended June 30, 2006, the Company issued 2,802,925 shares of
      its
      common stock to a consultant providing investor advisory services to the Company
      and recorded consulting expense of approximately $336,000, which was determined
      based on the $0.12 per share quoted trading price on date of
      issuance.




Common
      Stock Issued for Cash





In
      November 2005, pursuant to the “safe harbor” private offering exemption provided
      by Rule 506 of Regulation D under Section 4(2) and of the Securities Act, the
      Company received cash for working capital purposes of $175,000 and issued to
      an
      investor 1,029,411 shares of its common stock and the right to purchase an
      additional 7,794,117 shares (“option shares”) of common stock at $0.17 per share
      pursuant to terms of a Common Stock Purchase Agreement, Investor Rights
      Agreement, Covenant to Adjust and First Right of Refusal Agreement.
      Additionally, in November 2005, pursuant to the “safe harbor” private offering
      exemption provided by Rule 506 of Regulation D under Section 4(2) and of the
      Securities Act, the Company received cash for working capital purposes of
      $167,000 and issued 1,192,857 shares of its common stock and the right to
      purchase an additional 9,521,429 shares of common stock at $0.14 per share
      pursuant to terms of a Common Stock Purchase Agreement, Investor Rights
      Agreement, Covenant to Adjust and First Right of Refusal Agreement.
      Additionally, in December 2005, pursuant to the “safe harbor” private offering
      exemption provided by Rule 506 of Regulation D under Section 4(2) and of the
      Securities Act of 1933, the Company received cash for working capital purposes
      of $50,000 and issued 357,143 shares of its common stock and the right to
      purchase an additional 2,142,857 shares of common stock at $.14 per share
      pursuant to terms of a Common Stock Purchase Agreement, Investor Rights
      Agreement, Covenant to Adjust and First Right of Refusal Agreement. Additional
      investment rights a re
      exercisable for a 60 day period after certain events.. The
      Covenant to adjust required a decrease in the original purchase price if certain
      “efficiency” conditions, as defined in the agreement were not met. The Shares
      purchase prices were subject to reduction to a minimum $.11 per share for the
      $.17 shares and $0.08 per share for the $.14 shares, conditional upon when
      certain recycling volume and purity specifications were met (the “Efficiency”
conditions) .The reduction in purchase price was payable, at the investors
      option, in cash or additional shares of common stock. The $164,571 maximum
      redemption values of the above shares was classified as temporary
      equity at December 31, 2005. In January 2006 the Company issued additional
      shares at the investors election of 198,810 and 416,666 shares, based on a
      reduced purchase price of $.12 (for the $.14 purchase price shares), and 137,255
      shares for a reduced purchase price of $.15 (for the $.17 purchase price shares)
      and the covenant to adjust was amended to eliminate any further adjustments
      to
      the original purchase price, and the temporary equity was reclassified to
      permanent equity in 2006. The investor rights agreement contains registration
      rights on the issued shares and option shares which require the Company to
      prepare and file a registration statement and use its best efforts to cause
      such
      registration statement to become effective and keep it effective for 90 days
      including filing any required amendments.


14


**ITEC
      Environmental Group, Inc. and Subsidiary**


**Notes
      to Unaudited Condensed Consolidated Financial Statements**


**June
      30, 2006**




Stock
      Options





The
      Company has adopted an incentive stock option plan (the “Plan”) under which
      options granted are intended to qualify as “incentive stock options” under the
      Internal Revenue Code of 1986, as amended. Pursuant to the Plan, options to
      purchase up to 275 shares of the Company's common stock may be granted to
      employees of the Company. The Plan is administered by the Board of Directors
      which is empowered to determine the terms and conditions of each option subject
      to the limitation that the exercise price can not be less than market value
      of
      the common stock on the date of grant (110% of the market value in the case
      of
      options granted to an employee who owns 10% or more of the Company's outstanding
      common stock) and no option can have a term in excess of 10 years (5 years
      in
      the case of options granted to an employee who owns 10% or more of the Company's
      outstanding common stock). As of June 30, 2006, no Plan options have been
      granted.




Effective
      pursuant to resolution of the Board of Directors in 2005, the Company adopted
      a
      2005 Stock Plan to provide a source for the issuance of common stock of Itec
      in
      connection with compensatory programs sponsored by the Company and any other
      circumstances deemed by the Board of Directors as such a special situation.
      The
      number of shares available for granting awards under the Plan is 15,000,000
      shares. The Plan is eligible to any employee of the Company, any individual
      who
      is a member of the board of directors of the Company or any individual
      performing services for the Company as a Non-employee Contractor and any
      individual who has accepted an offer of employment with the Company. Unless
      the
      Board of Directors determines otherwise, shares of non-vested Stock awarded
      to a
      Participant will be forfeited if the Participant terminates employment or
      service for any reason other than death, disability, retirement or involuntary
      termination.




Stock
      Warrants





Warrants have
      been granted at prices that are equal to, or more or less than, the current
      fair value of the Company's common stock at the date of grant. All warrants
      granted to date are fully vested, have cashless exercise rights and there
      were no defined terms for any underlying services. Therefore they were expensed
      at the grant date. The fair value of warrants issued during 2005 was estimated
      using the Black-Scholes option-pricing model with the following assumptions:
      a
      dividend yield of 0%; expected volatility of 200% to 427% (based on historical
      volatility over the expected term); risk-free interest rates of 3.6 to 4.6%;
      and
      contractual terms of
      5 and
      10 years (since no historical basis yet exists). The fair value of warrants
      issued during 2006 was estimated using the Black-Scholes option-pricing model
      with the following assumptions: a dividend yield of 0%; expected volatility
      of
      300% (based on historical volatility over the expected term); risk-free interest
      rates of 4.8%; and contractual terms of 10
      years (since no historical basis exists). The weighted-average fair value of
      warrants granted approximated $0.12 during 2005, and $0.13 during the six months
      ended June 30, 2006.





In
      February 2006, in connection with and upon their resignation, the Company
      granted cashless exercise warrants to purchase 500,000 shares of the Company’s
      common stock to each of two directors of the Company, having an exercise price
      of $0.12 and expiring in 10 years. The Company recorded $120,000, the fair
      value
      as determined utilizing the Black-Scholes valuation model, as general and
      administrative expense since there is no vesting requirement.





During
      the six months ended June 30, 2006 the Company’s CEO assigned to service
      providers of the Company approximately 3.2 million of his warrants
      .





In
      connection with sales of Private Placement units comprised of Private Placement
      Notes and warrants as disclosed in Note 5, during the six months ended June
      30,
      2006, the Company received subscription proceeds relating to approximately
      6,952,500 warrants. These warrants are excisable at $0.06 per share for 10
      years
      and include cashless exercise terms. Additionally, in connection with sales
      of
      Private Placement units, pursuant to terms of an agreement with an investment
      advisor, the Company has agreed to issue warrants based on securities sold
      and
      common shares convertible or exercisable into, and in this regard has recorded
      debt issue costs of approximately $241,000 based on the fair value of
      approximately 1,667,000 warrants exercisable at $0.0975 per share for one-year
      and 487,000 warrants exercisable at $0.06 per share for ten-years.


15


**ITEC
      Environmental Group, Inc. and Subsidiary**


**Notes
      to Unaudited Condensed Consolidated Financial Statements**


**June
      30, 2006**


In
        2005,
        pursuant to the terms of a common stock purchase agreements (see Stock Issued
        for Cash above), the Company issued additional investment rights (“Option
        Shares”) to purchase 9,521,429 common shares at $.17 per share, 7,794,117 common
        shares at $.14 per share and 2,142,857common shares at $.14 per share (for
        a
        total of 19,458,403 additional investment rights common shares). The additional
        investment rights are exercisable for a 60 day period after certain events.
        The
        Option Shares exercise prices were subject to reduction to $.11 per share
        for
        the $.17 options and $0.08 per share for the $.14 options, conditional upon
        when
        certain recycling volume and purity specifications are met (the “Efficiency”
conditions).  In January 2006 the Company reduced the purchase prices to
        $.12 and $.15 (for the $.14 and $.17 options, respectively) and the covenant
        to
        adjust was amended to eliminate further adjustments to the option shares
        purchase price. The investor rights agreement contain registration rights
        on the
        issued shares and option shares which require the Company to prepare and
        file a
        registration statement and use its best efforts to cause such registration
        statement to become effective and keep it effective for 90 days including
        filing
        any required amendments. Since this is a best efforts clause and there are
        no
        liquidating damages or penalties, the option shares qualify as equity pursuant
        to EITF 00-19 as the Company may issue unregistered shares upon exercise
        of the
        options and there is no cash penalty, and other criteria for equity
        classification are met. However, since there is an authorized shares issue
        derived from the variable conversion rate convertible debt, theses option
        shares
        are classified as liabilities at fair value. The fair value at the issuance
        date
        was recorded at $1,603,566 with a charge to operations to change in fair
        value
        liability of warrants and derivatives of approximately $1,212,000. The reduction
        in fair value credited to the change in fair value liability of warrants
        and
        derivatives from the issuance date through December 31, 2005 was $468,000
        resulting in a warrant liability of $1,136,000 at December 31, 2005. During
        the
        three and six months ended June 30, 2006, the Company recognized expense
        of
        approximately $291,000 and $244,000, respectively, relating to the increase
        in
        the fair value liability of such investment rights, which such fair value
        liability approximated $1,380,000 at June 30, 2006.





The
      Company has determined that pursuant to EITF 00-19, all of the Company’s
      warrants granted to non-employees are classified as liabilities. Since the
      Company has issued convertible debt with variable conversion terms, the ability
      to have enough authorized common shares to fulfill its potential obligations
      under convertible debt and warrant contracts is not under the Company control
      and accordingly the criteria for classification as equity instruments under
      EITF
      00-19 is not met. Accordingly, as of December 31, 2005 and June 30, 2006, the
      warrant liability recorded was approximately $3,446,000 and $5,981,000,
      respectively, which represents the fair value of outstanding warrants at those
      dates computed using the Black-Scholes option pricing method with the
      assumptions as discussed above. During the three and six months ended June
      30,
      2006, the Company recognized approximately $986,000 and approximately $2.0
      million, respectively, of expense relating to the change in fair value of
      warrants and embedded derivatives in convertible notes during the periods.
      Such
      amount is included in the accompanying statement of operations as the change
      in
      fair value liability of warrants and derivatives.





The
      following summarizes activity for stock warrants, not including additional
      investment rights discussed above, all of which are exercisable:


Outstanding
            
            Weighted
                average
              exercise
                priceBalance
                at December 31, 2005
            
            
            43,567,930
            
            $
            0.05Granted/Issuable
            
            
            11,094,803
            
            
            0.06Exercised
            
            
            -
            
            
            -Expired/
                Cancelled
            
            
            (4,457,370
            )
            
            0.06Balance
                at June 30, 2006
            
            
            50,205,363
            
            $
            0.06




Additional
      information regarding warrants outstanding as of June 30, 2006, is as
      follows:


Range
                  of exercise prices
              
              Shares
              
              Weighted
                  averageremaining life
              
              Weighted
                  averageexercise
                  price$
                  0.001
              
              
              10,828,439
              
              8.7
                  years
              
              $0.001$
                  0.02 - $ 0.05
              
              
              2,260,000
              
              4.8
                  years
              
              $0.04$
                  0.06
              
              
              32,639,175
              
              8.0
                  years
              
              $0.06$
                  0.09 - $ 0.13
              
              
              4,165,628
              
              4.0
                  years
              
              $0.10$
                  0.25
              
              
              300,000
              
              4.0
                  years
              
              $0.25$
                  29.70
              
              
              12,121
              
              1.3
                  years
              
              $29.70Total
              
              50,205,363
              
              8.2
                  years
              
              $0.06




**Note
      8.  Related Party Transactions**




In
      2000,
      the Company's Board of Directors approved and authorized the Company to make
      a
      loan of $250,000 to the Company's Chief Executive Officer. The loan is interest
      only for ten years with the total principal due at the end of ten years. As
      of
      June 30, 2006, a balance of $147,973, which remains unchanged since 2004, was
      due.


16


**ITEC
      Environmental Group, Inc. and Subsidiary**


**Notes
      to Unaudited Condensed Consolidated Financial Statements**


**June
      30, 2006**




The
      Company has received advances from its Chief Executive Officer primarily to
      accommodate working capital needs. Such advances are unsecured, bear interest
      at
      10% and due on demand. During 2006, additional advances of $96,500 were made
      and
      at June 30, 2006 advances payable were $103,100.




The
      Company has an agreement with its attorney, who is a related party principal
      stockholder and who became a director in 2006, for legal services whereby the
      attorney is periodically issued vested, non-forfeitable common shares of the
      Company and any proceeds from the sale of such shares by the related party
      are
      credited against invoice amounts due to that related party for legal services.
      The agreement has no stated term. Due to the contingent nature of the proceeds
      and the unstated term of the agreement, the fair values of shares granted are
      expensed on the grant date. Legal fee invoices are accrued to accounts
      payable, periodically paid in cash and the accounts payable and legal expenses
      are credited for proceeds received by the related party and reported to the
      Company. During 2005, the Company issued 9,957,692 common shares pursuant to
      the
      legal services agreement. The shares were valued at the quoted trading prices
      on
      the respective issue dates resulting in expense of approximately $1.6 million.
      During the six months ended June 30, 2006, the Company issued 2,802,925 shares
      of its common stock and recorded legal expense of approximately $336,000, which
      was determined based on the $0.12 per share quoted trading price on date of
      issuance. During 2005, the Company also recognized approximately $1.2 million
      of
      stock based legal expenses relating to this same services provider that had
      been
      deferred. The Company incurred legal  service fees of $530,000 to this
      related party legal services provider for the six months ended June 30, 2006
      of
      which $49,000 was recorded as deferred debt issue costs. Accounts payable to
      the
      related party for legal services was approximately $273,000 at June 30,
      2006.





**Note
      9. Commitments and Contingencies**




Legal
      Matters





In
      2006,
      a judgment was awarded against the Company relating to amounts owed as claimed
      by the plaintiff, and the Company paid the judgment award of approximately
      $70,000 in satisfaction of the judgment.





As
      described in Note 5, in April 2006 the Company received notice from holders
      of
      $1.2 million of Bridge Notes and Lenders Notes that the Company has defaulted
      on
      the loans principal in 2005. Also as described in Note 5, the Company entered
      into Forbearance Agreements with the note holders, which provides for, among
      other things, payments of $200,000 on June 26, 2006, $400,000 on July 26, 2006
      and payment in full on August 15, 2006 (or sooner if the Company closes on
      $5
      million of financing).





In
      May
      2006, a complaint was filed against the Company by Rose Waste Systems, Inc.
      (“plaintiff”). The proceeding is an action for monetary damages for, among other
      claims, the purchase price of certain
      plastic recycling processing equipment (the “equipment”) acquired by the Company
      from a third party vendor. The equipment is currently installed in the Company’s
      Riverbank plastic recycling facility (“Riverbank Plant”). The aggregate money
      damages for all claims made by plaintiff is approximately $250,000, plus costs,
      which may include attorney fees. In addition to monetary damages or in partial
      lieu thereof, plaintiff has demanded possession of the equipment. If plaintiff
      were to successfully obtain an order from the Court that plaintiff was entitled
      to possession of the installed equipment and if plaintiff recovered possession
      of the equipment, the Company would be incapable of operating the Riverbank
      Plant until such time as the equipment could be replaced and installed. The
      Company intends to vigorously defend this lawsuit and is advised by legal
      counsel that the claims made by plaintiff against the Company, at least as
      to
      the right in plaintiff to possess the equipment, are substantially without
      merit. Further, the Company is currently engaged in settlement discussions
      with
      plaintiff with a view towards negotiating a mutual settlement and release which
      will result in the dismissal of the action and the release and waiver of all
      claims against the Company.





Other
      Commitments and Contingencies





The
      Company leases space for its recycling plant, research and development and
      offices in Riverbank, California pursuant to a lease expiring in March 2009.
      Future minimum lease payments under the lease approximate $220,000 during 2006
      through 2008 and $37,000 in 2009.




In
      2005,
      pursuant to an arbitration award, the Company has been ordered to pay a former
      customer the sum of $150,000, plus fees and costs, for the return of a deposit
      previously paid to the Company. The Company recorded an additional accrued
      liability and expense during 2005 to provide for the full amount of the
      award.


17


**ITEC
      Environmental Group, Inc. and Subsidiary**


**Notes
      to Unaudited Condensed Consolidated Financial Statements**


**June
      30, 2006**





In
      February 2006, the Company entered into a six-month agreement with an
      investment advisor to act as placement agent in connection with a private
      placement of the Company’s securities, which such private placement has not yet
      occurred. The Company shall pay compensation of 7% of the gross proceeds of
      the
      proposed offering to be paid at closing and a warrant to purchase that number
      of
      shares of common stock of the Company equal to the aggregate of (a) 7% of the
      shares of common stock sold at a per share exercise price equal to the per
      share
      price of such shares in the offering, and (b) to the extent the securities
      are
      not common stock, 7% of the common stock acquirable upon exercise, exchange
      or
      conversion of such securities at a per share exercise price equal to the minimum
      per share price payable by an investor.





In
      March
      2006, the Company entered into an agreement with a financial advisor to act
      as
      an exclusive financial advisor for a term of six months. The agreement requires
      a retainer of $30,000 of which $15,000 is payable upon execution of agreement
      with remaining $15,000 payable 30 days from execution of agreement. The retainer
      will be credited against the following financing or acquisition fees (i) 7%
      of
      gross proceeds of any financing executed by the Company; (ii) a warrant to
      purchase a number of shares of common stock equal to 10% of shares sold in
      the
      financing with an exercise price equal to the offering price of the shares
      of
      common stock to be sold in the financing. (iii) an acquisition fee equal to
      3%
      of the transaction value payable in cash upon the closing of a transaction,
      subject to a minimum fee of $350,000.





In
      April
      2006 the Company executed a non-binding letter intent to acquire certain assets
      constituting the operations of two plastics recycling plants and to enter into
      a
      supply agreement with the seller for the seller to supply plastics to the two
      operations.





In
      2006,
      the Company entered into an arrangement with an investment advisor to act as
      placement agent in connection with the Private Placement of the Company’s
      securities for a term of six months. The Company shall pay compensation of
      8% of
      the gross proceeds of the proposed offering to be paid at closing of the
      proposed offering and a warrant to purchase that number of shares of common
      stock of the Company equal to the aggregate of (a) 8% of the shares of common
      stock sold at a per share exercise price equal to the per share price of such
      shares in the offering, and (b) to the extent the securities are not common
      stock, 8% of the common stock acquirable upon exercise, exchange or conversion
      of such securities at a per share exercise price equal to the minimum per share
      price payable by an investor. In connection with this arrangement, the Company
      paid fees of approximately $169,000 during the six months ended June 30, 2006,
      and recorded warrants issuable and
      in
      this regard has recorded debt issue costs of approximately $241,000 based on
      the
      fair value of approximately 1,667,000 warrants exercisable at $0.0975 per share
      for one-year and 487,000 warrants exercisable at $0.06 per share for ten-years.





In
      June
      2006, the Company entered into an agreement with a consultant to provide
      services on a non-exclusive basis to assist the Company in finding licensing
      and
      distribution agreements, equity capital, debt financing and joint venture
      partners. The initial term of the agreement is 90 days, but will be
      automatically extended for an additional five-year term from the funding date
      following the completion of debt funding pursuant to which the Company received
      no less than $30 million (the “Financing Amount”). As compensation the Company
      shall pay fees of 10% of the gross proceeds of funds raised and exercisable,
      five-year warrants to purchase that number of shares of common stock of the
      Company equal to 40% of all issued and outstanding stock of the Company at
      a per
      share price of $0.001. Should the Company accept an amount less than the
      Financing Amount, the consultant will be paid a fee of 10% of the lesser amount
      and proportionately less warrants depending on the funds raised. Additionally,
      the consultant will be paid fees based on revenues for licensing agreements,
      distribution agreements or joint ventures or other business relationships
      entered into by the Company with parties that were referred by the
      consultant.  No such transactions have yet occurred





As
      described in Note 4, t he
      first
      annual minimum payment of $50,000 was due to a licensor in March 2006, which
      was
      accrued but unpaid as of June 30, 2006, and Company management has been engaged
      in discussions with Honeywell relating to payment modifications, which are
      expected to result in, among other things, deferral of the first annual minimum
      payment to 2007 This
      non-payment may be considered an event of default allowing the licensor to
      terminate the license agreement with 60-days notice to the Company. This is
      a
      significant contingency since the licensed technology is a critical component
      of
      the Company’s operations.




**Note
      10. Subsequent Events**





In
      July
      2006, the Company entered into a loan agreement pursuant to which the Company
      received cash of $200,000 in consideration for a $200,000 promissory note
      bearing interest at 12% and due in one month from issuance and 600,000 ten-year
      warrants to purchase Company common stock at $0.12 per share. The note is
      convertible at the holder’s option into private placement
      securities.


18
  **ITEM
        2 . MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
        OPERATIONS**
 
 FORWARD
        LOOKING STATEMENTS CAUTIONARY
 
 This
        Item
        2. and June 30, 2006 Quarterly Report on Form 10-QSB may contain
        "forward-looking statements." In some cases, you can identify forward-looking
        statements by terminology such as "may," "will," "should," "could," "expects,"
        "plans," "intends," "anticipates," "believes," "estimates," "predicts,"
        "potential" or "continue" or the negative of such terms and other comparable
        terminology. These forward-looking statements include, without limitation,
        statements about our market opportunity, our strategies, competition, expected
        activities and expenditures as we pursue our business plan, and the adequacy
        of
        our available cash resources. Although we believe that the expectations
        reflected in any forward-looking statements are reasonable, we cannot guarantee
        future results, levels of activity, performance or achievements. Actual results
        may differ materially from the predictions discussed in these forward-looking
        statements. Changes in the circumstances upon which we base our predictions
        and/or forward-looking statements could materially affect our actual results.
        Additional factors that could materially affect these forward-looking statements
        and/or predictions include, among other things: (1) our limited operating
        history; (2) our ability to pay down existing debt; (3) our ability to retain
        the professional advisors necessary to guide us through our corporate
        restructuring; (4) the risks inherent in the investigation, involvement and
        acquisition of a new business opportunity; (5) unforeseen costs and expenses;
        (6) potential litigation with our shareholders, creditors and/or former or
        current investors; (7) the Company's ability to comply with federal, state
        and
        local government regulations; and (8) other factors over which we have little
        or
        no control.
  **Business** **** -
        Itec
        Environmental Group, Inc. and its subsidiary ECO2 Environmental Systems,
        Inc.,
        (together, the “Company”) is primarily engaged in activities to become a
        worldwide supplier of recycled plastics using its proprietary process and
        equipment and to form strategic alliances to become a supplier of recycling
        equipment outside of the United States. During 2005, the Company commenced
        construction of its first recycling line at its Riverbank, California plant
        and
        on May 31, 2006 announced that it has commenced recycling operations. After
        months of equipment and product testing as well as several successful trial
        runs
        of its patented Eco2(tm) plastic recycling system, the Riverbank plant has
        begun
        operating eight hours a day, five days a week, producing recycled PET flake.
        The
        Company expects to increase production to twenty-four hours a day, seven
        days
        per week over the next few months and add additional capacity, increasing
        daily
        production to approximately 25,000 pounds of recycled PET flake per day. Over
        the
        next year, Itec expects to acquire and install additional equipment that
        will
        improve output to 198,000 pounds of recycled PET flake per day. During this
        time, but dependent on customer demand, the Company anticipates the installation
        of a pellet production system to the end of the recycling system line . The
        processing of the PET flakes into pellets will increase the overall value
        of the
        recycled product and generate greater return on the recycled PET sold by
        the
        Company.
  In
        June
        2005, pursuant to terms of a 4.25% promissory note the Company received into
        an
        escrow account $1,990,000, after deduction of $10,000 for loan fees to the
        lender, from the California Integrated Waste Management Board (the “CIWMB”). The
        CIWMB makes low interest loans to local government agencies and private business
        entities within a Recycling Market Development Zone to increase diversion
        of
        nonhazardous solid waste from landfills and to promote market demand for
        secondary and post consumer materials. Approval for the loan was based on
        the
        Company's projection to build its first Eco2 Environmental System Plant and
        to
        divert post consumer plastic bottles as a result of the loan. Borrowing of
        CIWMB
        funds required, among other things, verification of matching funds, which
        co-funded equipment purchases. In August 2005, the Company received an
        investment and deposited funds sufficient to enable the Company to begin
        construction of its first Eco2 Environmental Recycling System Plant.
 
 We
        use
        patented technology and proprietary equipment to recycle plastic. We license
        environmental technology using a carbon dioxide cleaning process from Honeywell
        International, Inc.  The narrowest application of this environmental
        technology allows for the 100% recycling of plastic motor oil containers
        and the
        residual oil left inside each container.  By using the carbon dioxide
        cleaning process, the Company can focus on environmental protection and
        environmental safety by creating no chemical waste disposal in the oil recycling
        and plastic recycling process.
  The
        Company operates in the evolving field of plastics materials recycling. New
        developments could both significantly and adversely affect existing and emerging
        technologies in the field. The Company's success in developing additional
        marketable products and processes and achieving a competitive position will
        depend on its ability to attract and retain qualified management personnel
        and
        to raise sufficient capital to meet its operating and development needs.
 
 **Critical
        Accounting Policies and Estimates**  - The
        preparation of financial statements included in this Quarterly Report on
        Form
        10-QSB requires management to make estimates and assumptions that affect
        the
        reported amounts of assets and liabilities at the date of the financial
        statements and the reported amounts of revenues and expenses during the
        reporting period.  On an on-going basis, management evaluates its estimates
        and judgments. Management bases its estimates and judgments on historical
        experiences and on various other factors that are believed to be reasonable
        under the circumstances, the results of which form the basis for making
        judgments about the carrying value of assets and liabilities that are not
        readily apparent from other sources.  Actual results may differ from these
        estimates under different assumptions or conditions.  The more significant
        accounting estimates inherent in the preparation of the Company's financial
        statements include estimates as to the depreciable lives of property and
        equipment, valuation of equity related instruments and derivatives issued,
        and
        valuation allowance for deferred income tax assets. Our accounting policies
        are described in the notes to financial statements included in this Quarterly
        Report on Form 10-QSB and our December 31, 2005 Annual Report on Form 10-KSB.
        The more critical accounting policies are as described below.
  19
 Going
        concern presentation - The
        accompanying consolidated financial statements have been prepared in conformity
        with generally accepted accounting principles, which contemplate continuation
        of
        the Company as a going concern. The Company has incurred recurring losses
        from
        operations and has a net working capital deficiency and net capital deficiency
        that raises substantial doubt about its ability to continue as a going concern.
        The Report of Independent Registered Public Accounting Firm included in the
        Company’s December 31, 2005 Annual Report on Form 10-KSB stated that these
        conditions, among others, raise substantial doubt about the Company’s ability to
        continue as a going concern. Company management intends to raise additional
        debt
        and equity financing to fund future operations and to provide additional
        working
        capital. However, there is no assurance that such financing will be obtained
        in
        sufficient amounts necessary to meet the Company’s needs. The accompanying
        consolidated financial statements do not include any adjustments to reflect
        the
        possible future effects on the recoverability and classification of assets
        or
        the amounts and classifications of liabilities that may result from the outcome
        of this uncertainty.
 
 Accounting
        for Derivatives - The
        Company evaluates its convertible debt, options, warrants or other contracts
        to
        determine if those contracts or embedded components of those contracts qualify
        as derivatives to be separately accounted for under Statement of Financial
        Accounting Standards 133 “Accounting for Derivative Instruments and Hedging
        Activities” and related interpretations including EITF 00-19 “Accounting for
        Derivative Financial Instruments Indexed to, and Potentially Settled in,
        a
        Company’s Own Stock”. The result of this accounting treatment is that the fair
        value of the derivative is marked-to-market each balance sheet date and recorded
        as a liability. In the event that the fair value is recorded as a liability,
        the
        change in fair value is recorded in the consolidated statement of operations
        as
        other income or expense. Upon conversion or exercise of a derivative instrument,
        the instrument is marked to fair value at the conversion date and then that
        fair
        value is reclassified to equity. Equity instruments that are initially
        classified as equity that become subject to reclassification under SFAS 133
        are
        reclassified to liability at the fair value of the instrument on the
        reclassification date.
 
 Revenue
        recognition - The
        Company recognizes revenue when there is persuasive evidence of an arrangement,
        the product has been delivered or the services have been provided to the
        customer, the sales price is fixed or determinable, and collectibility is
        reasonably assured. The Company recognizes revenues from sales of recycled
        products upon delivery to customers. The Company will recognize revenues
        from
        sales of equipment or systems once configuration of such systems are completed
        and accepted by the customer.
  Income
        taxes - The
        Company utilizes SFAS No. 109, “Accounting for Income Taxes,” which 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 income taxes are recognized for
        the tax
        consequences in future years of differences between the tax bases of assets
        and
        liabilities and their financial reporting amounts at each period end based
        on
        enacted tax laws and statutory tax rates applicable to the periods in which
        the
        differences are expected to affect taxable income. Valuation allowances are
        established, when necessary, to reduce deferred tax assets to amounts expected
        to be realized. The provision for income taxes represents the tax payable
        for
        the period and change during the period in net deferred tax assets and
        liabilities.
  Stock-based
        compensation - The
        Company did not issue options or warrants to employees prior to 2005. Effective
        January 1, 2005, the Company accounts for all options and warrant grants
        to
        employees and consultants in accordance with SFAS 123R, which requires recording
        an expense over the requisite service period for the fair value of all options
        or warrants granted employees and consultants.
 
 **Results
        of Operations** - We
        had
        revenues of approximately $14,000 and $50,000 during the three and six months
        ended June 30, 2006 as compared to $0 in 2005. Revenues in 2006 are the result
        of commencing recycling operations and initial sales of recycled product.
        We
        expect revenues to continue to increase in future periods. The absence of
        revenues in 2005 was the result of a change in business strategy from the
        marketing of equipment and licensing of the System technology, to building
        our
        own plant for the recycling of plastic.
  Total
        operating expenses for the three and six months ended June 30, 2006 approximated
        $1.9 million and $3.5 million compared with $2.0 million and $3.1 million
        in the
        comparative prior year periods. Operating expenses decreased during the three
        months ended June 30, 2006 from the comparative prior year period due primarily
        to decreases in consulting and legal expenses and general and administrative
        costs, offset by increases in technology development expenses. Operating
        expenses for the six months ended June 30, 2006 increased over the comparable
        prior year period due primarily to an increase in technology and development
        expense. Consulting and legal expenses decreased during the three and six
        months
        ended June 30, 2006 from the comparative prior year periods, due primarily
        to
        issuances of warrants and common stock in 2005 for services valued at
        $1,877,000, as compared to $672,000 in 2006, offset by increases in amortization
        of previously deferred stock-based consulting of $508,000. These expenses
        are
        directly related to the use by the Company of legal and strategic business
        consultants, who have assisted in our redirection and recapitalization efforts,
        which have been paid through issuance of common stock and warrants.
  The
        Company recorded interest expense of $729,000 and $843,000 for the three
        and six
        months ended June 30, 2006, as compared to $101,000 and $116,000 for the
        comparative prior year periods. The increase is due to increased average
        borrowings during the 2006 period as compared to the comparative prior year
        period, and the inclusion of approximately $526,000 of debt issue costs and
        discount amortization relating to 2006 borrowings.
 
 During
        the three and six months ended June 30, 2006, the Company recorded expense
        of
        approximately $986,000 and $2.0 million relating to the change in fair value
        liability of warrants and derivatives, as described in notes 5 and 6 in the
        accompanying condensed consolidated financial statements. There was no such
        similar expense during the three or six months ended June 30, 2005.
  Net
        loss
        increased to $3.6 million and $6.3 million for the three and six months ended
        June 30, 2006, compared with $2.3 million and $3.4 million for the three
        and six
        months ended June 30, 2005, due primarily to the 2006 change in fair value
        liability of warrants and derivatives.
  20
 At
        June
        30, 2006, the Company has net operating loss carry-forwards potentially
        available to offset future income taxes which expire through 2025.
 Realization is dependent on generating sufficient taxable income prior to
        expiration of the loss carry-forwards.  A change of greater than 50% of the
        Company ownership could significantly reduce the availability of these
        carryforwards.  The Company continues to provide a full valuation allowance
        to reduce its net deferred tax asset to zero, inasmuch as Company management
        has
        not determined that realization of deferred tax assets is more likely than
        not.
 
 **Liquidity
        and Capital Resources** - Historically,
        our cash needs have been satisfied primarily through proceeds from private
        placements of our equity securities and debt instruments including debt
        instruments convertible into our equity securities.  We expect to continue
        to be required to raise capital in the future, but cannot guarantee that
        such
        financing activities will be sufficient to fund our current and future projects
        and our ability to meet our cash and working capital needs.
  At
        June
        30, 2006, we had a working capital deficit of approximately $13.5 million
        (including fair value liabilities for warrants and embedded derivative of
        approximately $8.8 million), compared to a working capital deficit of $7.4
        million at December 31, 2005.  At June 30, 2006, we had total assets of
        approximately $4.0 million and a total stockholders’ deficit of approximately
        $11.5 million, compared with total assets of approximately $3.1 million and
        total stockholder's deficit of approximately $6.5 million at December 31,
        2005.
  During
        the six months ended June 30, 2006, cash used by operating activities increased
        to approximately $1.5 million from $243,000 during the comparative prior
        year
        period, due primarily to an increase in net loss.
 
 During
        the six months ended June 30, 2006, cash used by investing activities increased
        to approximately $656, 000 relating to capital expenditures on the recycling
        plant as compared to $0 during the comparative prior year period.
 
 During
        the six months ended June 30, 2006, cash provided by financing activities
        increased to approximately $2.2 million from $257,000 during the comparative
        prior year period. During 2006, the Company received net (of offering related
        costs) proceeds of approximately $2.0 million from sales of private placement
        units comprised of convertible promissory notes and warrants.
  At
        June
        30, 2006, the Company does not have sufficient cash to meet its needs for
        the
        next twelve months. However, the Company continues to be in the process of
        raising funds, and Company management anticipates being able to raise sufficient
        cash to meet the Company’s needs through 2006. There is no guarantee, however,
        that our efforts will result in raising cash in amounts sufficient to meet
        the
        Company’s needs.
  During
        2006, the Company has received subscriptions and related funds into escrow
        pursuant to a private placement memorandum in which $2.5 million, which can
        be
        increased to $5 million, of bridge financing is to be raised through the
        offering of a minimum of 20 Units for $25,000 per unit. Each Unit consists
        of a
        $25,000 junior secured subordinated convertible debenture (the “Private
        Placement Notes”), bearing interest at 10% with principal and accrued interest
        due 12 months from issuance (“maturity date”), convertible into shares of the
        Company’s common stock at a price of $0.0975 per share, and a warrant, with a
        cashless exercise provision, to purchase 75,000 shares of restricted common
        stock of the Company, exercisable for approximately 10 years (expires April
        2015) at an exercise price of $0.06 per share. Through June 30, 2006,
        subscription proceeds for approximately $2.3 million of Private Placement
        Notes
        had been received into escrow and the Company received approximately $1.6
        million from the escrow account, $100,000 was disbursed from escrow for debt
        service and approximately $563,000 was disbursed from escrow for payments
        on the
        Company’s behalf for legal and other professional fees, and as a result has
        recorded convertible notes payable of $2.3 million and 6,802,000 of warrants.
 
 **Off-Balance
        Sheet Arrangements** - We
        do not
        have any off balance sheet arrangements that have or are likely to have a
        material current or future effect on the Company's financial condition, or
        changes in financial condition, liquidity or capital resources or
        expenditures.
 
 **Recent
        accounting pronouncements** **** -
        In May
        2005, the FASB issued Statement of Financial Accounting Standards No. 154,
        “Accounting Changes and Error Corrections”, (SFAS 154”). SFAS 154 replaces APB
        Opinion No. 20, “Accounting Changes,” and SFAS No. 3, “Reporting Accounting
        Changes in Interim Financial Statements,” and changes the requirements for the
        accounting for and reporting of a change in accounting principle. The Company
        is
        required to adopt SFAS 154 in 2007. The Company's results of operations and
        financial condition will only be impacted by SFAS 154 if the Company implements
        changes in accounting principles that are addressed by the standard or correct
        accounting errors in future periods.
  Item
          3.
          Controls and Procedures
  Under
          the
          supervision and with the participation of our management, including the
          Chief
          Executive Officer and Chief Financial Officer, we have evaluated the
          effectiveness of our disclosure controls and procedures pursuant to Exchange
          Act
          Rule 13a-15(b) as of the end of the period covered by this report. Based
          on that
          evaluation, the Chief Executive Officer and Chief Financial Officer have
          concluded that these disclosure controls and procedures are effective.
          There
          were no changes in our internal controls over financial reporting during
          the
          quarter ended June 30, 2006 that have materially affected, or are reasonably
          likely to materially affect, our internal control over financial
          reporting.
 
 PART
        II -
        OTHER INFORMATION
 
 Item
        1.
        Legal Proceedings
 
 On
        or
        about May 17, 2006 a complaint was filed against registrant by Rose Waste
        Systems, Inc. (“plaintiff”) in the Superior Court of the State of California in
        and for Stanislaus County. The proceeding is an action for money damages
        for,
        among other claims not material here, the purchase price of certain plastic
        recycling processing equipment (the “equipment”) acquired by registrant from a
        third party vendor. The equipment is currently installed in registrant’s
        Riverbank plastic recycling facility (“Riverbank Plant”). The aggregate money
        damages for all claims made by plaintiff is approximately $249,706, plus
        costs
        which costs may include attorney fees.
 
 21
 In
        addition to money damages or in partial lieu thereof, plaintiff has demanded
        possession of the equipment by virtue of a purchase money security interest
        in
        the equipment plaintiff alleges has been perfected. If plaintiff were to
        successfully obtain an order from the Court that plaintiff was entitled to
        possession of the equipment installed at the Riverbank Plant and if plaintiff
        recovered possession of the equipment, registrant would be incapable of
        operating the Riverbank Plant until such time as the equipment could be replaced
        and installed.
 
 Registrant
        intends to vigorously defend this lawsuit and is advised by legal counsel
        that
        the claims made by plaintiff against registrant, at least as to the right
        in
        plaintiff to possess the equipment, are substantially without merit. Further,
        the registrant is currently engaged in settlement discussions with plaintiff
        with a view towards negotiating a mutual settlement and release which will
        result in the dismissal of the action and the release and waiver of all claims
        against the registrant.
 
 Other
        than as disclosed, the Company is not currently involved in any legal proceeding
        not previously reported that is not in the ordinary course of business or
        is
        material.
  Item
        2.
        Unregistered Sales of Equity Securities and Use of Proceeds
 
 Registrant
        has sold securities in reliance on an exemption from the registration
        requirements of the Securities Act of 1933 during the period covered by this
        report. Disclosure of such sales is included in Note 6 to the financial
        statements presented in Part I of this report on Form 10-QSB which is hereby
        incorporated herein by reference, to the extent not previously disclosed
        in any
        other prior report.
 
 Item
        3.
        Defaults Upon Senior Securities
 
 In
        June
        2006, the Company entered into Forbearance Agreements with Elevation Fund,
        LLC,
        and others (the “Holders”) holding approximately $1.2 million certain
        senior securities, which the registrant defaulted upon. The Forbearance
        Agreements by and between the registrant and the Holders provides for, among
        other things, payments, comprised first of costs and expenses, then interest,
        fees and then to principal, of $200,000 on June 26, 2006, $400,000 on July
        26,
        2006 and payment in full on August 15, 2006 (or sooner if the registrant
        closes
        on $5 million of financing), and payment of legal costs and expenses. Until
        repaid, the notes continue to bear interest at 18% .
        Additional disclosure regarding the defaults is included in Note 5 to the
        financial statements presented in Part I of this report on Form 10-QSB which
        is
        hereby incorporated herein by this reference.
  Item
        4.
        Submission of matters to a Vote of Securities Holders
 
 Not
        applicable.
  Item
        5.
        Other Information
 
 In
        July
        2006, registrant entered into a loan agreement with Ji Y. Baek pursuant to
        which
        the Company received cash of $200,000 in consideration for a $200,000 promissory
        note bearing interest at 12% and due in one month from issuance and 600,000
        warrants to purchase common stock of the registrant at $0.12 per share. The
        loan
        agreement is attached as Exhibit 10.1 to this report on Form 10-QSB and hereby
        incorporated herein by this reference.
 
 Item
        6.
        Exhibits
 
 [See
        Exhibit Index below after signatures]
 
 22
 
 SIGNATURES
 
 
 Pursuant
        to the requirements of the Securities Exchange Act of 1934, as amended, this
        report has been signed by the following persons on behalf of the Registrant
        in
        the capacities and on the dates indicated.
 
 ITEC
                  ENVIRONMENTAL GROUP, INC.August
                  11, 2006
              
              
              /s/
                  Gary M. De LaurentiisGary
                  M. De LaurentiisChairman
                  & Chief Executive Officer(Principal
                  Executive Officer)August
                  11, 2006
              
              
              /s/
                  Frederick W. Smith, Jr.Frederick
                  W. Smith, Jr.Chief
                  Financial Officer
 
 
 23
 EXHIBIT
        INDEX
 
 Exhibit
                  No.
              Description
              
              Location3.1(i)
              Amendment
                  to Restated Certificate of Incorporation
              
              Incorporated
                  by reference to Exhibit A to the DEFR14C filed by the Company on
                  November
                  30, 20043.2(i)
              Restated
                  Certificate of Incorporation
              
              Incorporated
                  by reference to Exhibit B to the DEF-14C filed by the Company on
                  September
                  9, 20023.3(i)
              Certificate
                  of Incorporation
              
              Incorporated
                  by reference to the Form S-18 Registration Statement filed by the
                  Company
                  File No. 33-31-673.4(ii)
              Bylaws
              
              Incorporated
                  by reference to Exhibit B to the DEF-14C filed by the Company on
                  September
                  9, 200210.1
              Loan
                  Agreement by and between Itec Environmental Group, Inc. and Ji
                  Y.
                  Baek
              
              Attached31.1
              Certification
                  of CEO pursuant to Section 302 of the Sarbanes-Oxley Act
              
              Attached31.2
              Certification
                  of CFO pursuant to Section 302 of the Sarbanes-Oxley Act
              
              Attached32
              Certification
                  of CEO and CFO pursuant to Section 906 of the Sarbanes-Oxley
                  Act
              
              Attached
 
 
 24