UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549




FORM
10-Q




x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934




For
the Quarterly Period Ended September 30, 2009





o
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934




For
the transition period from __________ to __________





Commission
File Number: 000-25839





DOCUMENT
CAPTURE TECHNOLOGIES, INC.


(Exact
name of registrant as specified in its charter)




Delaware
            
            59-3134518(State
      or other jurisdiction of
            
            (I.R.S.Employerincorporation
      or organization)
            
            Identification
      Number)




1798
Technology Drive


Suite
178


San
Jose, California 95110


(Address
of principal executive offices, Zip code)





408-436-9888
ext. 207


(Registrant’s
telephone number, including area code)





Check
whether the issuer (1) filed all reports required to be filed by Section 13
or 15(d) of the Exchange Act during the preceding 12 months (or for such 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 large accelerated filer, an
accelerated filer, a non-accelerated filer, or smaller reporting
company.  See definitions of “large accelerated filer,” “accelerated
filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.





Large
accelerated filer  o    Accelerated
filer   o   Non-accelerated
filer  o    Smaller
Reporting Company  x




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





The
number of shares of Common Stock outstanding as of November 16, 2009 was
19,406,270.










SPECIAL
NOTE ON FORWARD LOOKING STATEMENTS





This
Quarterly Report on Form 10-Q, including "Management's Discussion and Analysis
of Financial Condition and Results of Operations" in Item 2 of Part I of this
report, includes forward-looking statements. These statements involve known and
unknown risks, uncertainties and other factors that may cause our actual
results, levels of activity, performance or achievements to be materially
different from any future results, levels of activity, performance, or
achievements expressed or implied by forward-looking statements.





In some
cases, you can identify forward-looking statements by terminology such as "may,"
"should," "expects," "plans," "anticipates," "believes," "estimates,"
"predicts," "potential," "proposed," "intended," or "continue" or the negative
of these terms or other comparable terminology. You should read statements that
contain these words carefully, because they discuss our expectations about our
future operating results or future financial condition, or state other
"forward-looking" information. There may be events in the future that we are not
able to accurately predict or control. Before you invest in our securities, you
should be aware that the occurrence of any of the events described in this
Quarterly Report could substantially harm our business, results of operations
and financial condition, and that upon the occurrence of any of these events,
the trading price of our securities could decline and you could lose all or part
of your investment. Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
growth rates, levels of activity, performance or achievements. We are under no
duty to update any of the forward-looking statements after the date of this
Quarterly Report to conform these statements to actual results.




- 2
-




DOCUMENT
CAPTURE TECHNOLOGIES, INC




FORM 10-Q




FOR
THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2009




INDEX





PagePART I – FINANCIAL
    INFORMATIONItem
      1
            Financial
      Statements
            4Item
      2
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            18Item
      4
            Controls
      and Procedures
            24PART II – OTHER INFORMATIONItem
      1
            Legal
      Proceedings
            26Item
      1A
            Risk
      Factors
            26Item
      2
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            26Item
      3
            Defaults
      Upon Senior Securities
            26Item
      4
            Submission
      of Matters to a Vote of Security Holders
            26Item
      5
            Other
      Information
            26Item
      6
            Exhibits
            27Signatures
            28





- 3
-




PART
I.  FINANCIAL INFORMATION





Item
1 - Financial Statements




DOCUMENT
CAPTURE TECHNOLOGIES, INC.


CONDENSED
CONSOLIDATED BALANCE SHEETS


(in
thousands)





September
      30,
            
            
            December
      31,2009
            
            
            2008ASSETS
            
            (unaudited)
            
            
            *Current assets:Cash
      and cash equivalents
            
            $
            257
            
            
            $
            405Trade
      receivables
            
            
            2,153
            
            
            
            1,366Inventories,
      net
            
            
            1,085
            
            
            
            1,353Income
      taxes receivable
            
            
            76
            
            
            
            -Prepaid
      expenses and other current assets
            
            
            218
            
            
            
            99Total
      current assets
            
            
            3,789
            
            
            
            3,223Restricted
      cash
            
            
            5
            
            
            
            -Fixed
      assets, net
            
            
            110
            
            
            
            98Total
      assets
            
            $
            3,904
            
            
            $
            3,321LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Line
      of credit
            
            $
            785
            
            
            $
            -Trade
      payables to related parties
            
            
            355
            
            
            
            393Trade
      payables and other accrued expenses
            
            
            427
            
            
            
            398Income
      taxes payable
            
            
            -
            
            
            
            75Deferred
      revenue and customer deposits
            
            
            102
            
            
            
            187Fair
      value of warrant liability
            
            
            -
            
            
            
            350Total
      current liabilities
            
            
            1,669
            
            
            
            1,403Liability
      under derivative contracts
            
            
            -
            
            
            
            9Total
      liabilities
            
            
            1,669
            
            
            
            1,412Commitments
      and contingencies (Note 11)Convertible
      preferred stock:Series
      B convertible preferred stock, $.001 par value, 2,000 authorized,
      0shares
      issued and outstanding at September 30, 2009 and December
      31,2008;
      liquidation value of $0 at September 30, 2009 and December
      31,2008
            
            
            -
            
            
            
            120Stockholders’
      equity:Common
      stock $.001par value, 50,000 authorized, 19,406 and 18,444
      sharesissued
      and outstanding at September 30, 2009 and December 31,
      2008,respectively
            
            
            19
            
            
            
            18Additional
      paid-in capital
            
            
            35,582
            
            
            
            34,602Accumulated
      deficit
            
            
            (33,366
            )
            
            
            (32,831
            )Total
      stockholders’ equity
            
            
            2,235
            
            
            
            1,789Total
      liabilities and stockholders’ equity
            
            $
            3,904
            
            
            $
            3,321









- 4
-




DOCUMENT
CAPTURE TECHNOLOGIES, INC.


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)


(in
thousands, except per share amounts)





Three
      Months Ended
              September
      30,
            
            
            Nine
      Months Ended
              September
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008Net
      sales
            
            $
            2,975
            
            
            $
            3,019
            
            
            $
            7,992
            
            
            $
            8,560Cost
      of sales
            
            
            1,847
            
            
            
            1,986
            
            
            
            4,908
            
            
            
            5,811Gross
      profit
            
            
            1,128
            
            
            
            1,033
            
            
            
            3,084
            
            
            
            2,749Operating
      expenses:Selling,
      general and administrative
            
            
            829
            
            
            
            836
            
            
            
            2,929
            
            
            
            2,308Research
      and development
            
            
            295
            
            
            
            166
            
            
            
            728
            
            
            
            539Total
      operating expenses
            
            
            1,124
            
            
            
            1,002
            
            
            
            3,657
            
            
            
            2,847Operating
      income (loss)
            
            
            4
            
            
            
            31
            
            
            
            (573
            )
            
            
            (98
            )Total
      other income (expense)
            
            
            (9
            )
            
            
            (581
            )
            
            
            (8
            )
            
            
            (173
            )Net
      income (loss) before income taxes
            
            
            (5
            )
            
            
            (550
            )
            
            
            (581
            )
            
            
            (271
            )Provision
      (benefit) for income taxes
            
            
            (76
            )
            
            
            -
            
            
            
            (76
            )
            
            
            2Net
      income (loss)
            
            
            71
            
            
            
            (550
            )
            
            
            (505
            )
            
            
            (273
            )Dividend
      on Series A and accretion of Series A and SeriesB
      preferred stock redemption value
            
            
            (5
            )
            
            
            (14
            )
            
            
            (30
            )
            
            
            (127
            )Deemed
      dividend on Series A preferred stock maturity andConversion
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (231
            )Net
      income (loss) available to common stockholders
            
            $
            66
            
            
            $
            (564
            )
            
            $
            (535
            )
            
            $
            (631
            )Basic
      income (loss) per common share
            
            $
            0.00
            
            
            $
            (0.03
            )
            
            $
            (0.03
            )
            
            $
            (0.04
            )Diluted
      income (loss) per common share
            
            $
            0.00
            
            
            $
            (0.03
            )
            
            $
            (0.03
            )
            
            $
            (0.04
            )Weighted
      average common shares outstanding
            
            
            18,750
            
            
            
            18,444
            
            
            
            18,562
            
            
            
            17,784Weighted
      average common shares outstanding,assuming
      dilution
            
            
            22,583
            
            
            
            18,444
            
            
            
            18,562
            
            
            
            17,784




- 5
-




DOCUMENT
CAPTURE TECHNOLOGIES, INC.


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)


(in
thousands)





Nine
      Months Ended
              September
      30,2009
            
            
            2008Operating
      activities:Net
      loss
            
            $
            (505
            )
            
            $
            (273
            )Adjustments
      to reconcile net loss to net cash provided (used) by
      operatingactivities:Depreciation
      expense
            
            
            46
            
            
            
            37Stock-based
      compensation cost – options
            
            
            410
            
            
            
            391Fair
      value of common stock and warrants issued for services
      rendered
            
            
            111
            
            
            
            69Change
      in allowance for slow-moving inventory
            
            
            (20
            )
            
            
            -Other
      non-cash income/expenses, net
            
            
            (4
            )
            
            
            75Changes
      in operating assets and liabilities:Trade
      receivables
            
            
            (787
            )
            
            
            1,323Inventories
            
            
            288
            
            
            
            377Prepaid
      expenses and other current assets
            
            
            (182
            )
            
            
            (73
            )Trade
      payables to related parties
            
            
            (38
            )
            
            
            (18
            )Trade
      payables and other current liabilities
            
            
            (46
            )
            
            
            (381
            )Deferred
      revenue and customer deposits
            
            
            (85
            )
            
            
            234Cash
      (used) provided by operating activities
            
            
            (812
            )
            
            
            1,761Investing
      activities:Cash
      proceeds from sale of assets
            
            
            -
            
            
            
            550Capital
      expenditures
            
            
            (58
            )
            
            
            (7
            )Cash
      (used) provided by investing activities
            
            
            (58
            )
            
            
            543Financing
      activities:Net
      advances(payments) on bank line of credit
            
            
            817
            
            
            
            (2,021
            )Deferred
      financing costs
            
            
            (20
            )
            
            
            -Payments on
      notes payable
            
            
            -
            
            
            
            (1,300
            )Cash paid
      upon the maturity of preferred stock
            
            
            (75
            )
            
            
            -Proceeds
      from exercise of employee stock options
            
            
            -
            
            
            
            8Cash
      provided (used) by financing activities
            
            
            722
            
            
            
            (3,313
            )Net
      decrease in cash and cash equivalents
            
            
            (148
            )
            
            
            (1,009
            )Cash
      and cash equivalents at beginning of period
            
            
            405
            
            
            
            1,770Cash
      and cash equivalents at end of period
            
            $
            257
            
            
            $
            761Supplemental
      disclosures of cash flow information:Non-cash
      investing and financing activities:Conversion
      of convertible preferred stock to common stock
            
            $
            75
            
            
            $
            1,341Conversion
      of warrants to common stock
            
            $
            350
            
            
            $
            -




- 6
-




Note
1 – Background and Basis of Presentation





Organization





Document
Capture Technologies, Inc. ("DCT" or "Company") develops, designs and delivers
various imaging technology solutions to all types and sizes of enterprises
including governmental agencies, large corporations, small corporations, small
office-home offices (“SOHO”), professional practices as well as consumers
(referred to herein collectively as “Enterprises”). DCT is a market-leader in
providing USB-powered scanning solutions to a wide variety of industries and
market applications. DCT’s patented and proprietary page-imaging devices
facilitate the way information is stored, shared and managed for both business
and personal use.





Syscan,
Inc., DCT’s wholly-owned subsidiary, was incorporated in California in 1995 to
develop and manufacture a new generation of contact image sensors (“CIS”) that
are complementary metal-oxide-silicon (“CMOS”) imaging sensor devices. During
the late 1990s, DCT established many technical milestones and was granted
numerous patents for its linear imaging technology. DCT’s patented CIS and
mobile imaging scanner technology provides high quality images at extremely low
power consumption levels allowing delivery of compact scanners in a form ideally
suited for laptop or desktop computer users who need a small, lightweight device
to scan or fax documents.





DCT’s
business model was developed around intellectual property (“IP”) driven products
sold primarily to original equipment manufacturers (“OEM”), private label brands
and value added resellers (“VAR”).  These products can be found in a
variety of applications including, but not limited to, the
following:





·
            Document
      and information management;




·
            Identification
      card scanners;




·
            Passport
      security scanners;




·
            Bank
      note and check verification;




·
            Business
      card readers;




·
            Barcode
      scanning; and




·
            Optical
      mark readers used in lottery
terminals.





Basis
of Presentation





The
accompanying unaudited condensed consolidated financial statements of DCT have
been prepared in accordance with accounting principles generally accepted in the
United States for interim financial information, and the instructions to Form
10-Q and Article 8-03 of Regulation S-X. Accordingly, they do not include
all information and disclosures necessary for a presentation of the Company’s
financial position, results of operations, and cash flows in conformity with
accounting principles generally accepted in the United States
(“GAAP”).





In the
opinion of management, all adjustments (which include only normal recurring
adjustments) necessary to present fairly the financial position, results of
operations and cash flows for all periods presented have been made. Preparing
financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenue and expenses. Actual
results may differ from these estimates. The results of operations for the
period ended September 30, 2009 are not necessarily indicative of the operating
results that may be expected for the entire year ending December 31, 2009. The
interim financial statements should be read in conjunction with the financial
statements in the Company’s Annual Report on Form 10-K for the year ended
December 31, 2008, filed with the Securities and Exchange Commission (“SEC”) on
April 15, 2009.





The
consolidated financial statements include the accounts of DCT and its one
subsidiary Syscan.  All significant intercompany transactions and
balances have been eliminated.  DCT’s functional currency is the
United States (U.S.) dollar.  As such, DCT does not have any
translation adjustments.  Monetary accounts denominated in non-U.S.
currencies, such as cash or payables to vendors, have been re-measured to the
U.S. dollar.  Gains and losses resulting from foreign currency
transactions are included in the results of operations.  To date, DCT
has not entered into hedging activities to offset the impact of foreign currency
fluctuations.




- 7
-





Certain
accounts have been reclassified to conform to the current period
presentation.  Such reclassifications did not affect DCT’s total net
sales, operating income (loss), net income (loss) available to common
stockholders, financial position or liquidity.





Note
2 – Recent Accounting Pronouncements




Accounting
Standards Codification




In
June 2009 the Financial Accounting Standards Board (“FASB”), established
the Accounting Standards Codification (“Codification”), as the source of
authoritative generally accepted accounting principles (“GAAP”) recognized by
the FASB. The Codification does not change how the Company accounts for its
transactions or the nature of the related disclosures made. However, when
referring to guidance issued by the FASB, the Company will now refer to sections
in the Codification.  This change was made effective by the FASB for
periods ending on or after September 15, 2009.




New
Accounting Standards





In March
2008, the FASB issued amended standards for disclosures about derivative
instruments and hedging activities, which requires enhanced disclosure related
to derivatives and hedging activities and thereby seeks to improve the
transparency of financial reporting. Under the amended standards, entities are
required to provide enhanced disclosures relating to: (a) how and why an entity
uses derivative instruments; (b) how derivative instruments and related hedge
items are accounted for; and (c) how derivative instruments and related hedged
items affect an entity’s financial position, financial performance, and cash
flows.  The amended standards were adopted by DCT on January 1, 2009
and had no impact on the consolidated financial position, cash flows and results
of operations as of or for the reporting period ending September 30,
2009.





In May
2008, the FASB issued amended standards for the accounting for convertible debt
instruments that may be settled in cash upon conversion (including partial cash
settlement).  The amended standards require the issuer of certain
convertible debt instruments that may be settled in cash (or other assets) on
conversion to separately account for the liability (debt) and equity (conversion
option) components of the instrument in a manner that reflects the issuer's
non-convertible debt borrowing rate. These amended standards were adopted by DCT
on January 1, 2009 and had no impact on the consolidated financial position,
cash flows and results of operations as of or for the reporting period ending
September 30, 2009.




In June
2008, the FASB issued amended standards for determining whether an equity-linked
financial instrument (or embedded feature) is indexed to an entity’s own stock,
and mandates a two-step evaluation process.   DCT adopted the
amended standards on January 1, 2009 and they had no impact on the consolidated
financial position, cash flows and results of operations as of or for the
reporting period ending September 30, 2009.




During
May 2009, the FASB provided new guidance on management’s assessment of
subsequent events.  The new guidance is directed specifically to
management, as management is responsible for preparing an entity’s financial
statements. The guidance clarifies that management must evaluate, as of each
reporting period, events or transactions that occur after the balance sheet date
through the date that the financial statements are issued. The Company adopted
the new guidance during the second quarter of fiscal year 2009 and its adoption
did not have a material impact on the Company’s financial condition or results
of operations. The Company has evaluated subsequent events up through the date
of the filing of this report with the SEC.  During this period, DCT did not
have any material subsequent events.





In
August 2009, the FASB issued amended standards for the fair value
measurement of liabilities. These amended standards clarify that, in
circumstances in which a quoted price in an active market for the identical
liability is not available, DCT is required to use one of the following: the
quoted price of the identical liability when traded as an asset, quoted prices
for similar liabilities, or quoted prices for similar liabilities when traded as
assets. If these quoted prices are not available, DCT will be required to use
another valuation technique, such as an income approach or a market
approach.  DCT will adopt these amended standards during the fourth quarter
of fiscal year 2009.  The adoption is not expected to have a significant
impact on DCT’s consolidated financial position, cash flows or results of
operations.




- 8
-





In
October 2009, the FASB issued new standards for revenue recognition with
multiple deliverables. These new standards impact the determination of when the
individual deliverables included in a multiple-element arrangement may be
treated as separate units of accounting. Additionally, these new standards
modify the manner in which the transaction consideration is allocated across the
separately identified deliverables by no longer permitting the residual method
of allocating arrangement consideration.  These new standards are effective
for fiscal years beginning on or after June 15, 2010; however, early adoption is
permitted.  The adoption is not expected to have a significant impact on
DCT’s consolidated financial position, cash flows or results of
operations.





Note
3 – Related-Party Transactions





Related-Party
Purchases





The
Company purchases the majority of its finished scanner imaging products from
Shenzhen Syscan Technology (“SST”), a wholly-owned subsidiary of Syscan
Technology Holdings Limited ("STH"), the parent company of DCT’s former majority
stockholder.





Purchases
from SST totaled $1,677,000 and $4,120,000 for the three and nine months ended
September 30, 2009, respectively, and $1,903,000 and $5,111,000 for the three
and nine months ended September 30, 2008, respectively.  All purchases
from SST were carried out in the normal course of business.  As a
result of these purchases, DCT was liable to SST for $355,000 and $393,000 at
September 30, 2009 and December 31, 2008, respectively.





Related-Party
Net Sales





During
the three and nine months ended September 30, 2009, DCT recorded net sales
totaling $40,000 and $48,000, respectively, for finished scanners sold to
SST.  The related cost of goods sold was $14,000 and $21,000,
respectively, for the three and nine months ended September 30,
2009.  During the three months ended September 30, 2008, DCT recorded
net sales totaling $57,000 for finished scanners sold to SST.  The
related cost of goods sold was $41,000.





All sales
transactions to SST contained similar terms and conditions as for other
transactions of this nature entered into by DCT.





Revised
Consulting Agreement




In August
2009, DCT amended an existing consulting contract, originally entered in July
2008, with one of its shareholders who owns more than 5% of DCT’s outstanding
stock. The amendment called for DCT to make a one-time cash payment of $30,000,
and for the consultant to return to DCT 275,000 of non-qualified stock options,
at an exercise price of $0.30 per share, to purchase shares of DCT common stock.
Stock options were originally granted to the shareholder in July 2008. All other
terms of the original contract remain in effect.





Legal
Services Agreement





On
September 15, 2009, DCT entered into a legal services agreement with Jody R.
Samuels, a director of the Company.  Pursuant to the agreement Mr. Samuels
will provide certain legal services to us which will consist of assisting the
Company in (i) the preparation of its periodic and other filings with the
Securities and Exchange Commission (“SEC”), including proxy statements, special
and annual meetings of shareholders, (ii) the negotiation of financing and
corporate development transactions, (iii) preparation and review of
documentation related to financing arrangements and corporate development
transactions, (iv) preparing registration statements, and responding to any SEC
inquiries/comment letters, (v) documenting corporate governance policies and
procedures, and (vi) any other legal matters reasonably within the legal
expertise of Mr. Samuels.





Pursuant
to the Agreement, Mr. Samuels is paid $4,000 per month.  The Agreement may
be cancelled by either party with 30 days prior written notice.




Note
4 – Concentration of Credit Risk and Major Customers





Financial
instruments that subject DCT to credit risk are cash balances maintained in
excess of federal depository insurance limits and trade
receivables.




- 9
-





Cash
and Cash Equivalents





DCT
maintains cash balances at several banks. Cash accounts maintained in the United
States are insured by the Federal Deposit Insurance Corporation ("FDIC") up to
$250,000.  DCT invests its excess cash balances in an overnight
investment account, which is not FDIC insured.  As of September 30,
2009, DCT had consolidated balances of approximately $26,000 not guaranteed by
the FDIC. DCT has not experienced any losses in such accounts and believes the
exposure is minimal.





Major
Customers and Trade Receivables





A
relatively small number of customers account for a significant percentage of
DCT’s sales.  Customers that exceeded 10% of total revenues were as
follows:





Three
      Months Ended
              September
      30,
            
            
            Nine
      Months Ended
              September
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008Customer
      A
            
            
            13
            %
            
            
            28
            %
            
            
            11
            %
            
            
            30
            %Customer
      B
            
            
            21
            
            
            
            20
            
            
            
            22
            
            
            
            18Customer
      C
            
            
            15
            
            
            
            19
            
            
            
            13
            
            
            
            16Customer
      D
            
            
            20
            
            
            
            11
            
            
            
            19
            
            
            
            *











Trade
receivables from all significant customers at September 30, 2009 totaled
$1,667,000.  As of September 30, 2009, all the Company's trade
receivables were unsecured.





Note
5 – Concentration of Supplier Risk





DCT
purchases substantially all finished scanner imaging products from one vendor
that is also a wholly-owned subsidiary of the parent company of its former
majority stockholder. See Note 3.  If this vendor became unable or
unwilling to provide materials in a timely manner and DCT was unable to find
alternative vendors, DCT's business, operating results and financial condition
would be materially adversely affected.





Note
6 – Employee Equity Incentive Plans





General





DCT’s
share-based awards are long-term retention plans that are intended to attract,
retain and provide incentives for talented employees.  DCT believes
its share-based awards are critical to its operation and productivity. The
employee share-based award plans allow DCT to grant, on a discretionary basis,
incentive stock options and non-qualified stock options.




- 10
-





Stock
Options





DCT
issues options under three different stock option plans (all approved by
shareholders) as well as through employment agreements with key employees,
executives and consultants (approved by the board of directors on a case-by-case
basis).  The following table sets forth, by the respective option
plan, certain aspects of DCT’s stock options as of September 30,
2009:





Option
      Approval Method
              
              
              Options
      Outstanding and Options AvailableDescription
              
              Board
      of Directors
              
              
              Board
      of Directors and Shareholders
              
              
              Total
              
              
              Outstanding
              
              
              Available
      For Future Grant
              
              
              Total2002
      Amended and RestatedStock
      Option Plan
              
              
              
              
              
              3,200,000
              
              
              
              3,200,000
              
              
              
              3,200,000
              
              
              
              -
              
              
              
              3,200,000Key
      Personnel Option Grants
              
              
              6,650,000
              
              
              
              -
              
              
              
              6,650,000
              
              
              
              4,616,165
              
              
              
              -
              
              
              
              4,616,1652006
      Stock Option Plan
              
              
              
              
              
              
              2,500,000
              
              
              
              2,500,000
              
              
              
              1,421,000
              
              
              
              1,079,000
              
              
              
              2,500,0002009
      Stock Option Plan (1)
              
              
              
              
              
              
              1,500,000
              
              
              
              1,500,000
              
              
              
              -
              
              
              
              1,500,000
              
              
              
              1,500,000Total
              
              
              6,650,000
              
              
              
              7,200,000
              
              
              
              13,850,000
              
              
              
              9,237,165
              
              
              
              2,579,000
              
              
              
              11,816,165





(1)





Stock-Based
Compensation





The
following table sets forth the total stock-based compensation expense included
in DCT’s Statements of Operations (in thousands):





Three
      Months Ended
              September
      30,
            
            
            Nine
      Months Ended
              September
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008Selling,
      general and administrative
            
            $
            98
            
            
            $
            147
            
            
            $
            350
            
            
            $
            312Research
      and development
            
            
            14
            
            
            
            30
            
            
            
            60
            
            
            
            79Total
            
            $
            112
            
            
            $
            177
            
            
            $
            410
            
            
            $
            391





At
September 30, 2009, DCT had approximately $1,001,000 of total unrecognized
compensation cost related to unvested stock options. This cost is expected to be
recognized over a weighted-average period of approximately 2.3
years.





Stock
Option Activity and Outstanding





DCT had
the following stock option activity during the nine months ended September 30,
2009:





Options
            
            
            Weighted-Average
      Exercise PriceOutstanding
      at December 31, 2008
            
            
            9,295,498
            
            
            $
            0.32Granted
            
            
            350,000
            
            
            
            0.45Exercised
            
            
            -
            
            
            
            -Cancelled
            
            
            (408,333
            )
            
            
            (0.38
            )Outstanding
      at September 30, 2009
            
            
            9,237,165
            
            
            $
            0.32





The
following table summarizes all options outstanding and exercisable by price
range as of September 30, 2009:





Options
      Outstanding
            
            
            Options
      ExercisableRange
      of Exercise Prices
            
            
            Number
      Outstanding
            
            
            Weighted-Average
      Remaining Contractual Life (Years)
            
            
            Weighted-Average
      Exercise Price
            
            
            Number
      Exercisable
            
            
            Weighted-Average
      Exercise Price$0.01
            
            
            
            2,241,165
            
            
            
            2.57
            
            
            $
            0.01
            
            
            
            2,241,165
            
            
            $
            0.01$0.30
      - $0.35
            
            
            
            4,810,000
            
            
            
            8.81
            
            
            $
            0.30
            
            
            
            1,384,583
            
            
            $
            0.30$0.45
      - $0.51
            
            
            
            250,000
            
            
            
            9.31
            
            
            $
            0.49
            
            
            
            -
            
            
            
            -$0.60
      - $0.70
            
            
            
            1,936,000
            
            
            
            7.30
            
            
            $
            0.69
            
            
            
            1,936,000
            
            
            $
            0.699,237,165
            
            
            
            
            
            
            
            
            
            
            
            5,561,748




- 11
-




The
“intrinsic value” of options is the excess of the value of DCT stock over the
exercise price of such options.  The total intrinsic value of options
outstanding was approximately $1,774,000 and $4,369,000 at September 30, 2009
and December 31, 2008, respectively. The total intrinsic value for exercisable
options was $1,230,000 and $1,723,000 at September 30, 2009 and December 31,
2008, respectively.





Note
7 – Basic and Diluted Net Loss Per Common Share





Basic net
income (loss) per share is computed by dividing net income (loss) by the
weighted average number of shares of common stock outstanding during the
period.  Diluted net income (loss) per share is computed by dividing
net income (loss) by the weighted average number of shares of common stock and
common stock equivalents outstanding during the period.





Common
stock equivalents were not considered in calculating diluted net loss per common
share for the three months ended September 30, 2008 or for the nine months ended
September 30, 2009 and 2008 as their effect would be
anti-dilutive.  Common stock equivalents were taken into consideration
in calculating diluted net income per common share for the three months ended
September 30, 2009.  However, the impact did not change net income per
share.  As a result, for all periods presented, DCT’s basic and
diluted net income (loss) per share is the same.





The
computation of DCT’s basic and diluted earnings per share for the three months
ended September 30, 2009 is as follows (in thousands, except per share
amounts):





Net
      income available to common shareholders (A)
            
            $
            66Impact
      of convertible preferred stock
            
            
            5Net
      income available to common shareholders used in diluted share calculation
      (B)
            
            $
            71Weighted
      average common shares outstanding (C)
            
            
            18,750Dilutive
      effect of employee equity incentive plans
            
            
            3,833Weighted
      average common shares outstanding, assuming dilution (D)
            
            
            22,583Basic
      earnings per common share (A)/(C)
            
            $
            0.00Diluted
      earnings per common share (B)/(D)
            
            $
            0.00





Note
8 – Equity





Common
Stock





During
January 2009, DCT’s Board of Directors approved the issuance of 25,000
restricted common shares to a consultant for investor relations
services.  The common shares have piggyback registration rights to the
next registration statement filed by DCT.  DCT amortized the estimated
fair value of the common shares ratably over the service
period.  Accordingly, $11,000 was charged to selling, general and
administrative expense and credited to additional paid-in capital during the
nine months ended September 30, 2009.





During
August 2009, DCT issued 187,500 shares of common stock in connection with the
maturity of DCT’s Series B Stock.  See further discussion
below.





During
September 2009, DCT issued 750,000 shares of common stock in exchange for
warrants to purchase 650,000 shares of the Company’s common stock and the
related put option of $350,000.  In connection with the exchange, DCT
de-recognized the $350,000 warrant put option liability and recorded the offset
to additional paid in capital.  There was no gain or loss associated
with the exchange.




- 12
-





Preferred
Stock





Preferred
Stock Accounting Treatment





Preferred Stock
Classification.   DCT’s series A 5% cumulative convertible
redeemable preferred stock (“Series A Stock”), which matured March 15, 2008, and
series B convertible redeemable preferred stock (“Series B Stock”), which
matured August 7, 2009, were reported as temporary equity.





The
difference between the initial recorded value of the Series A Stock and Series B
Stock and the minimum redemption value was accreted, on a straight-line basis,
from the respective issuance date through the maturity date with the offset
booked to DCT’s accumulated deficit.  The accretion of DCT’s Series A
Stock and Series B Stock redemption value is disclosed as a reconciling item and
adjusts DCT’s reported net income (loss), together with the Series A Stock
dividends and deemed dividends, to net income (loss) available to common
stockholders.





Likely Embedded
Derivative.  As required by the Derivative Instruments and
Hedging Topic of the FASB Accounting Standards Codification, the conversion
features of DCT’s Series A Stock and Series B Stock were derivative instruments
(referred to collectively as “Derivative Instruments”) that required bifurcation
from the host contract.  Accordingly, the fair value of DCT’s
outstanding Derivative Instruments was recorded in DCT’s Balance Sheet as a
liability.  The fair value of the Derivative Instruments was adjusted
at each reporting date.  Increases in the estimated fair value of
DCT’s Derivative Instruments were recorded as non-operating expense on DCT’s
Statements of Operations.  Decreases in the estimated fair value of
DCT’s Derivative Instruments were recorded as non-operating income on DCT’s
Statements of Operations.





DCT
estimated the fair value of these derivatives using the Black-Scholes valuation
model. The Black-Scholes valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. The Black-Scholes valuation model requires the input of highly
subjective assumptions, including the expected stock price volatility. DCT's
Derivative Instruments have characteristics significantly different from traded
options, and the input assumptions used in the model can materially affect the
fair value estimate.   As of September 30, 2009, all of the host
contracts had matured and DCT had no outstanding Derivative
Instruments.  As of December 31, 2008, the fair value of DCT’s
Derivative Instruments was determined under the following
assumptions:





Series
      B Stock remaining contractual term (years)
            
            
            0.6Expected
      volatility
            
            
            111
            %Expected
      dividend yield
            
            
            -Risk
      free interest rate
            
            
            0.3
            %





See
further discussion and disclosure of fair value at Note 9.





Series
B Stock Maturity





On August
7, 2009 (the "Series B Stock Redemption Date"), all of DCT’s outstanding Series
B Stock was redeemed for a per share redemption price equal to the principal
value on the Series B Stock Redemption Date (the "Series B Stock Redemption
Price").  The Series B Stock Redemption Price was payable either in
cash or in shares of common stock at DCT’s sole discretion.  DCT
elected to pay the Series B Stock Redemption Price as follows:





Cash
            
            $
            75,000Common
      stock (1)
            
            
            75,000Series
      B Stock Redemption Price
            
            $
            150,000







(1)




- 13
-





Series
A Stock Maturity





On March
15, 2008 (the "Series A Stock Redemption Date"), all of DCT’s outstanding Series
A Stock was redeemed for a per share redemption price equal to the stated value
on the Series A Stock Redemption Date (the "Series A Stock Redemption
Price").  The Series A Stock Redemption Price included principal and
accrued dividends.  The Series A Stock Redemption Price was payable
either in cash or in shares of common stock at DCT’s sole
discretion.  DCT elected to pay all of the Series A Stock Redemption
Price in shares of common stock.  According to the terms of the Series
A Stock agreement, the shares of common stock that were delivered to holders of
the Series A Stock were valued at 85% of the fifteen-day volume weighted average
price of the common stock on the Series A Redemption Date.





Series
A Stock Deemed Dividends





In
accordance with the Convertible Securities with Beneficial Conversion
FeaturesTopic of
the FASB Accounting Standards Codification, DCT’s Series A Stock had an embedded
contingent beneficial conversion feature because the conversion price was less
than the fair value of DCT’s common stock on the maturity and conversion of the
Series A Stock into common stock.  The embedded beneficial conversion
feature was considered contingent because it was based on how much of the Series
A Stock Redemption Price was paid in DCT’s common stock versus
cash.





Under the
FASB Accounting Standards Codification, a contingent beneficial conversion
feature should be recognized in earnings when all contingencies are
resolved.  DCT recorded a deemed dividend on its Series A Stock during
the nine months ended September 30, 2008 totaling $231,000.  This
non-cash dividend was recorded to reflect the implied economic value to the
preferred stockholder of converting Series A shares into common stock at a 15%
discount of the common stock price at the time of conversion.  The
fair value was calculated using the difference between the agreed-upon
conversion price of the Series A Preferred Stock into shares of common stock and
the fair market value of DCT's common stock on the conversion date. This amount
was charged to accumulated deficit with the offsetting credit to additional
paid-in-capital.





DCT
treated the deemed dividend on Series A Stock as a reconciling item to adjust
its reported net loss, and together with Series A Stock dividends recorded
during the applicable period, to adjust the net loss available to common
stockholders line item on the Statements of Operations.





Common
Stock Warrants





DCT had
the following common stock warrant activity during the nine months ended
September 30, 2009:





WarrantsOutstanding
      at December 31, 2008
            
            
            3,284,000Cancelled
            
            
            (700,000
            )Converted
      to common stock
            
            
            (650,000
            )Outstanding
      at September 30, 2009
            
            
            1,934,000





The
following table summarizes certain aspects of DCT’s outstanding warrants as of
September 30, 2009:





Warrants
      Issued in Connection with:
            
            Number
      of Shares Issued and Vested
            
            
            Exercise
      Price
            
            Issuance
      Date
            
            Expiration
      DateSeries
      A Stock
            
            
            186,500
            
            
            $
            1.00
            
            3/15/05
            
            3/15/10Series
      A Stock
            
            
            932,500
            
            
            
            2.00
            
            3/15/05
            
            3/15/10Consulting
      agreement
            
            
            90,000
            
            
            
            0.65
            
            1/1/07
            
            1/1/10Consulting
      agreement
            
            
            110,000
            
            
            
            0.65
            
            1/1/08
            
            1/1/11Consulting
      agreement
            
            
            615,000
            
            
            
            0.60
            
            11/6/08
            
            11/6/111,934,000





In
certain instances, DCT issues warrants for investor relations
services.  DCT amortizes the fair value of such warrants over the
service period.  In connection with such common stock warrants issued
and outstanding, DCT charged selling, general and administrative expenses with
the offset credit to additional paid in capital for $100,000 during the nine
months ended September 30, 2009, and $18,000 and $69,000 during the three and
nine months ended September 30, 2008, respectively. DCT estimated the fair value
of the warrants issued under the Black-Scholes valuation model using the
following weighted average assumptions: contractual term of three years, 1.8%
risk-free interest rate, expected volatility of 266% and expected dividend yield
of 0%.




- 14
-





Note
9 – Fair Value





Fair
value is defined as the exchange price that would be received for an asset or
paid to transfer a liability in the principal or most advantageous market in an
orderly transaction between market participants at the measurement
date.





According
to the Fair Value Topic of the FASB Accounting Standards Codification, there are
three levels of inputs that may be used to measure fair value:




Level 1. Quoted
prices in active markets for identical assets or liabilities.  DCT had
no Level 1 assets or liabilities at September 30, 2009.





Level 2. Observable
inputs other than Level 1 prices, such as quoted prices for similar assets
or liabilities, quoted prices in markets with insufficient volume or infrequent
transactions (less active markets), or model-derived valuations in which all
significant inputs are observable or can be derived principally from or
corroborated with observable market data for substantially the full term of the
assets or liabilities.  DCT had no Level 2 assets or liabilities at
September 30, 2009.





Level 3.  Unobservable
inputs to the valuation methodology that are significant to the measurement of
the fair value of assets or liabilities.  DCT had no Level 3
assets.  Level 3 liabilities include (i) warrant and (ii) derivative
contracts liabilities.  DCT estimates the fair value of Level 3
liabilities using the Black-Scholes valuation model.  During the three
months ended September 30, 2009, DCT’s Level 3 liabilities either matured or
converted to equity.  As such, DCT had no Level 3 liabilities as of
September 30, 2009.




The
carrying value of cash and cash equivalents, trade receivables and payables,
prepaid expenses and other current assets, amounts due to related parties, and
other payables and liabilities approximates fair value due to the short period
of time to maturity.





The
following table summarizes the changes in Level 3 liabilities measured at fair
value on a recurring basis for the nine months ended September 30, 2009 (in thousands):





Fair
      Value of Warrant Liability
            
            
            Liability
      under Derivative Contracts
            
            
            TotalBalance
      at December 31, 2008
            
            $
            350
            
            
            $
            9
            
            
            $
            359Unrealized
      gain included in net income (loss) (1)
            
            
            
            
            
            
            (9
            )
            
            
            (9
            )Conversion
      of warrants to common stock
            
            
            (350
            )
            
            
            
            
            
            
            (350
            )Maturity
      of host contract (2)
            
            
            
            
            
            
            -
            
            
            
            -Balance
      at September 30, 2009
            
            $
            -
            
            
            $
            -
            
            
            $
            -





(1) Included


(2)
Series B Stock.





Note
10 – Bank Line of Credit





Line
of Credit





During
September 2009, DCT replaced its $3,000,000 existing line of credit (“LOC”) with
a similar $2,000,000 LOC with a different commercial bank.  Borrowings
under the LOC are limited to 75% of eligible accounts receivable less the
aggregate face amount of all outstanding letters of credit, cash management
services, and foreign exchange contracts (all as defined in the LOC
agreement).  The LOC bears an annual interest rate of prime (3.25% at
September 30, 2009) plus 2.00% for advances drawn against accounts receivables,
with a minimum interest rate of 4%.  Interest payments are due monthly
and all unpaid interest and principal is due in full on September 2, 2010. 
Upon certain events of default (as defined in the LOC agreement), the default
variable interest rate increases five percentage points above the interest rate
applicable immediately prior to the default.  Additionally, the lender
has the right to declare all of the amounts due under the LOC immediately due
and payable upon an event of default.  As of September 30, 2009, DCT
had unused borrowing capacity of $774,000 on its LOC.




- 15
-




As of
September 30, 2009, DCT was in compliance with all LOC debt
covenants.




In
connection with the LOC, DCT paid the lender a loan origination fee and legal
fees which totaled approximately $20,000, and issued a warrant to purchase
68,027 shares of the Company’s Common Stock at $0.588 per
share.   The loan origination fees and legal fees are recorded as
deferred financing costs included in other current assets and are being
amortized over the life of the loan to interest expense.  The $35,000
fair value of the warrants, as determined under the Black-Scholes valuation
model, was originally recorded as debt discount and is being amortized over the
life of the loan to interest expense.





DCT’s LOC
balance at September 30, 2009 was comprised of the following:




Total
      principal due
            
            $
            817,000Less
      unamortized debt discount
            
            
            (32,000
            )$
            785,000




Interest
Expense Related to Amortization of Warrant Fair Values and Loan Origination
Fee





The
Company recorded non-cash interest expense of $3,000 and $2,000 in connection
with the LOC warrants and amortization of the LOC origination fee, respectively,
during the three months ended September 30, 2009.




Note
11 – Commitments and Contingencies




Operating
Leases




The
Company is committed under various non-cancelable operating leases which extend
through February 2011. Future minimum rental commitments as of September 30,
2009 are as follows (in
thousands):




Year
      Ending
              September
      30,
            
            Future
      Minimum Lease Payments2009
            
            $
            1782010
            
            
            1Total
            
            $
            179




Employment
Agreements




DCT
maintains employment agreements with its executive officers which extend through
2010. The agreements provide for a base salary and annual bonus to be determined
by the Board of Directors.  The agreements also provide for
termination payments, stock options, non-competition provisions, and other terms
and conditions of employment. In addition, DCT maintains employment agreements
with other key employees with similar terms and conditions.  As of
September 30, 2009, termination payments totaling $1,028,000 remain in
effect.





Research
and Development Agreement




During
the second quarter of 2009, the Company entered into an agreement with a
customer to develop a scanner to meet the customer’s specific product
requirements. The customer has the right to terminate the contract at any time
without cause upon giving DCT two weeks’ notice. If terminated, the customer
shall pay DCT for all work-in-progress or work completed up to the date of
termination. Each party shall retain its rights in any intellectual property
rights owned or licensed to it prior to commencement of development. All
intellectual property developed by DCT will be owed exclusively by the customer
and DCT will not distribute the developed product to any other customer (unless
DCT receives prior written approval from the customer).  During the
first 12 months following the initial product shipment, the customer is
committed to buying a certain minimum number of scanners, developed under this
agreement.




- 16
-




In
connection with the agreement, the Company deferred $36,000 of revenue, which
will be recognized upon shipment of the developed product.




Litigation,
Claims and Assessments




The
Company experiences routine litigation in the normal course of its business and
does not believe that any pending litigation will have a material adverse effect
on DCT’s financial condition, results of operations or cash flows.




Note
12 – Segment and Geographic Information




Segment
Information





DCT
currently operates in one segment: the design, development and delivery of
various imaging technology solutions, most notably scanners.





Geographic
Information





During
the three and nine months ended September 30, 2009 and 2008, DCT recorded net
sales throughout the U.S., Europe and Asia as determined by the final
destination of the product.  The following table summarizes total net
sales attributable to significant countries (in thousands):





Three
      Months Ended
              September
      30,
            
            
            Nine
      Months Ended
              September
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008U.S.
            
            $
            2,754
            
            
            $
            2,775
            
            
            $
            7,301
            
            
            $
            7,845Europe
      and other
            
            
            183
            
            
            
            187
            
            
            
            643
            
            
            
            614Asia
            
            
            38
            
            
            
            57
            
            
            
            48
            
            
            
            101$
            2,975
            
            
            $
            3,019
            
            
            $
            7,992
            
            
            $
            8,560





Presented
below is information regarding identifiable assets, classified by operations
located in the U.S., Europe and Asia (in thousands):




September
      30,
              2009
            
            
            December
      31,
              2008U.S.
            
            $
            3,730
            
            
            $
            3,093Europe
      and other
            
            
            140
            
            
            
            169Asia
            
            
            34
            
            
            
            59$
            3,904
            
            
            $
            3,321




Assets
located in Europe relate to DCT’s field service, sales, distribution and
inventory management in the Netherlands.  Assets located in Asia
relate to tooling equipment required to manufacture DCT’s product.





Note
13 – Restricted Cash





As of
September 30, 2009, the Company had $5,000 of restricted cash, held at a
commercial bank, used as collateral for the Company’s customer credit card
acceptance program.  The cash collateral account is restricted until
DCT closes its credit card acceptance account.




- 17
-




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




The
following discussion should be read in conjunction with Document Capture
Technologies, Inc.’s (“DCT” or “Company”) unaudited condensed consolidated
financial statements and notes included herein.  The results described
below are not necessarily indicative of the results to be expected in any future
period.  Certain statements in this discussion and analysis, including
statements regarding our strategy, financial performance and revenue sources,
are forward-looking statements based on current expectations and entail various
risks and uncertainties that could cause actual results to differ materially
from those expressed in the forward-looking statements.  Readers are
referred to DCT’s Annual Report on Form 10-K for the year ended December 31,
2008 as filed with the Securities and Exchange Commission on April 15,
2009.  We undertake no duty to update any forward-looking statement to
conform the statement to actual results or changes in our
expectations.




Management's
discussion and analysis of financial condition and results of operations
("MD&A") is provided as a supplement to the accompanying unaudited condensed
consolidated financial statements and notes to help provide an understanding of
our financial condition, changes in financial condition and results of
operations. The MD&A section is organized as follows:




·
            Overview.
      This section provides a general description of the Company's business, as
      well as recent developments that we believe are important in understanding
      the results of operations and anticipating future trends in those
      operations.




·
            Critical
      accounting policies. This section provides an analysis of the
      significant estimates and judgments that affect the reported amounts of
      assets, liabilities, revenues and expenses, and related disclosure of
      contingent assets and liabilities.




·
            Results of
      operations. This section provides an analysis of our results of
      operations for the three and nine months ended September 30, 2009 compared
      to the three and nine months ended September 30, 2008.  A brief
      description of certain aspects, transactions and events is provided,
      including related-party transactions that impact the comparability of the
      results being analyzed.




·
            Liquidity
      and capital resources. This section provides an analysis of our
      financial condition and cash flows as of and for the nine months ended
      September 30, 2009 as compared to the nine months ended September 30,
      2008.




Overview




We are in
the business of designing, developing and delivering imaging technology
solutions. Our technology is protected under multiple patents.  We
focus our research and development toward new deliverable and marketable
technologies. We sell our products to customers throughout the world, including
the United States, Canada, Europe, South America, Australia and
Asia.




Our
strategy includes a plan to expand our document/image-capture product line and
technology while leveraging our assets in other areas of the imaging industry.
We are actively shipping six groups of image-capture products.  We
have expanded our document/image-capture product offerings, and will continue to
expand our product offerings in the future in response to the increased market
demand for faster, easier-to-use products and increased security to meet the
growing need for information protection, including identity and financial
transaction protection.




During
2008 DCT focused on re-aligning its operations toward its core
revenue-generating competencies in an effort to cut costs and maximize profits.
Looking to the future, DCT has identified several significant market
opportunities available to the Company in 2009-2010 and beyond and we believe
that with the corporate initiatives taken since 2008, we are well-positioned to
capitalize on such opportunities.




DCT has
introduced two new products in the three month period ending September 30, 2009
and looking forward to the future, we plan to introduce one additional new
product by the end of 2009.  These new products include new technology
for added functionality as well as improved existing
functionality.  Additionally, our new products already have an
existing market, and we have already begun delivery or received orders for all
three new products.




- 18
-




Critical
Accounting Policies




Our
MD&A is based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires us
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an ongoing basis, we evaluate our estimates, including those
related to revenue recognition, trade receivables and allowance for doubtful
accounts, inventories, and income taxes. We base our estimates on historical
experience and on various other assumptions that we believe are reasonable under
the circumstances, the results of which form the basis for making judgments
about the carrying values of assets and liabilities that are not readily
apparent from other sources. Actual results may differ from these estimates
under different assumptions or conditions.




An
accounting policy is deemed to be critical if it requires an accounting estimate
to be made based on assumptions about matters that are highly uncertain at the
time the estimate is made, and if different estimates that reasonably could have
been used or changes in the accounting estimate that are reasonably likely to
occur, could materially change the financial statements.




Our
disclosures of critical accounting policies in our Annual Report on Form 10-K
for the year ended December 31, 2008 have not materially changed since that
report was filed.




- 19
-




Results
of Operations





The
following table summarizes certain aspects of our results of operations for the
three and nine months ended September 30, 2009 compared to the three and nine
months ended September 30, 2008 (in thousands):





Three
      Months Ended September 30,
            
            
            Nine
      Months Ended September 30,2009
            
            
            2008
            
            
            
            $
            
            
            
            %
            
            
            2009
            
            
            2008
            
            
            
            $
            
            
            
            %Net
      sales
            
            $
            2,975
            
            
            $
            3,019
            
            
            $
            (44
            )
            
            
            (1
            )%
            
            $
            7,992
            
            
            $
            8,560
            
            
            $
            (568
            )
            
            
            (7
            )%Cost
      of sales
            
            
            1,847
            
            
            
            1,986
            
            
            
            (139
            )
            
            
            (7
            )
            
            
            4,908
            
            
            
            5,811
            
            
            
            (903
            )
            
            
            (16
            )As
      a percentage of sales
            
            
            62
            %
            
            
            66
            %
            
            
            
            
            
            
            
            
            
            
            61
            %
            
            
            68
            %Selling,
      general and administrative expense
            
            
            829
            
            
            
            836
            
            
            
            (7
            )
            
            
            (1
            )
            
            
            2,929
            
            
            
            2,308
            
            
            
            621
            
            
            
            27Research
      and development expense
            
            
            295
            
            
            
            166
            
            
            
            129
            
            
            
            78
            
            
            
            728
            
            
            
            539
            
            
            
            189
            
            
            
            35Total
      other income (expense)
            
            
            (9
            )
            
            
            (581
            )
            
            NM
            
            
            NM
            
            
            
            (8
            )
            
            
            (173
            )
            
            NM
            
            
            NMProvision
      (benefit) for income taxes
            
            
            (76
            )
            
            
            -
            
            
            NM
            
            
            NM
            
            
            
            (76
            )
            
            
            2
            
            
            NM
            
            
            NMDividend
      and deemed dividend on5%
      convertible preferred stock andaccretion
      of preferred stockredemption
      value
            
            
            (5
            )
            
            
            (14
            )
            
            NM
            
            
            NM
            
            
            
            (30
            )
            
            
            (358
            )
            
            NM
            
            
            NMNM
      = Not Meaningful





Net
Sales





The
decrease in net sales during the nine months ended September 30, 2009 as
compared to the nine months ended September 30, 2008 is attributable to the
overall slowdown of the general economic and market conditions in the U.S.
economy and the related slowdown of information technology (“IT”) capital
spending.  The U.S. economic downturn had more of an impact on our net
sales during the first quarter of 2009.  During the second and third
quarters of 2009 we were able to capitalize on some specific market
opportunities, which offset the economic downturn.  This resulted in
net sales during the three months ended September 30, 2009 being comparable to
the three months ended September 30, 2008.   Additionally, during
the three months ended September 30, 2009, we initiated a variety of sales
incentives whereby we gave customers additional product for certain
volume-related purchases of our more feature-rich products.  This
program had a favorable impact to our sales.





Although
our international sales are strategically important to the growth of our
business, international sales represent less than 10% of our total sales for all
periods presented.  During the three months ended September 30, 2009,
we expanded our sales and support staff in Europe for the purpose of further
developing our global presence and product recognition
internationally.  We also have been asked by several of our major
channel partners to broaden our product support and fulfillment capabilities in
Europe, Middle East, Africa and Western Asia.





From time
to time, our key customers place large orders causing our quarterly sales to
fluctuate significantly.   Additionally, the timing of when we
receive product to sell has a significant impact to our sales.  We
expect both of these trends and resulting fluctuations to continue.





Although
we continually concentrate on expanding our significant customer base, our
revenue remains dependent on a small number of significant
customers.  Total sales to significant customers (customers who
represent more than 10% of our net sales) were 69% and 78% during the three
months ended September 30, 2009 and 2008, respectively, and 65% and 64% during
the nine months ended September 30, 2009 and 2008, respectively.  See
“Note 4:  Concentration of Credit Risk and Major Customers” in Part I,
Item 1 of this Form 10-Q.   The identities of our largest
customers and their respective contributions to our net sales have varied in the
past and will likely continue to vary from period to period.




- 20
-





Cost
of Sales, Including Gross Profit




Cost of
sales includes all direct costs related to the purchase of scanners, imaging
modules and services related to the delivery of those items manufactured in
China, and to a lesser extent engineering services and software
royalties.  Cost of sales as a percentage of sales decreased during
both the three and nine months ended September 30, 2009 compared to the same
periods in 2008, and was due to the following:




·
            a higher
      proportion of overall net sales were generated from our more feature-rich
      products, which typically bear higher gross margins than our scanners with
      fewer product features;




·
            the
      price reduction of certain third-party software as we move toward less
      costly value-added software;




·
            the
      negotiated price reduction of some of our finished product;
      and




·
            our
      continued efforts toward reducing the cost of our
  products.




The above
noted factors were somewhat offset by the aforementioned sales incentive program
implemented during the three months ended September 30, 2009 and the fluctuation
of the U.S. dollar against the Chinese Yuan.





We expect
our cost of sales as a percentage of net sales to fluctuate somewhat during the
remainder of 2009 as we





·
            introduce
      new products,





·
            expand
      our sales incentive program,





·
            experience
      changes in our product mix, and





·
            work
      toward implementing further product cost reduction
    strategies.





Selling,
General and Administrative Expense




Selling,
general and administrative expenses consist primarily of personnel-related
expenses, including stock-based compensation costs, facilities-related expenses
and outside professional services such as legal and accounting.  To a
lesser extent, market development and promotional funds for our retail
distribution channels, tradeshows, website support, warehousing, logistics and
certain sales representative fees are also included.




The
majority of the increases in selling and marketing expenses being incurred
during the nine months ended September 30, 2009 as compared to the nine months
ended September 30, 2008 were primarily attributable to the
following:




·
            increased
      investor relations efforts associated with DCT’s initiatives toward
      increasing DCT’s awareness in the investment
  community,




·
            increased
      headcount as DCT expands its sales and diagnostic-level customer support
      initiatives, and




·
            increased
      accounting fees associated with changing independent accountants and
      maintaining DCT’s public reporting
requirements.




The
majority of the investor relations initiatives and the increased accounting fees
were incurred during the first six months of 2009.  As a result, the
three months ended September 30, 2009 is relatively unchanged from the three
months ended September 30, 2008.




We
anticipate that selling, general and administrative expenses will continue to
increase as our business continues to grow.  As well, we anticipate
that the costs associated with being a public company will continue to increase
as a result of our reporting requirements including, but not limited to,
expenses incurred to comply with the Sarbanes-Oxley Act of 2002.




- 21
-





Research
and Development Expense





Research
and development expense consists primarily of salaries and related costs,
including stock-based compensation costs of employees engaged in product
research, design and development activities, compliance testing, documentation,
prototypes and expenses associated with transitioning the product to
production.  The increase during both the three and nine months ended
September 30, 2009 as compared to the three and nine months ended September 30,
2008 was attributable to utilizing outside, specialized engineering contractors
to enhance our product development efforts.





We
anticipate that research and development expense will continue to increase over
the long term as a result of the growth of our existing products, new product
opportunities and any expansion into new markets and technologies. We remain
committed to significant research and development efforts to extend our
technology leadership in the imaging technology markets.





Total
Other Income (Expense)





Our total
other income (expense) during both the three and nine months ended September 30,
2009 was immaterial to our results of operations.





During
the nine months ended September 30, 2008, the most significant component of our
other income (expense) was the one-time gain on sale of assets of
$550,000.  Non-operating income (expense) was also impacted by our
increased debt, which resulted in interest expense of $159,000 and $427,000
during the three and nine months ended September 30, 2008,
respectively.  Of the interest expense recorded during the three and
nine months ended September 30, 2008, non-cash interest expense attributed to
amortization of debt discount resulting from debt issuance costs was $144,000
and $311,000, respectively.





Provision
(Benefit) for Income taxes





During
the three months ended September 30, 2009, we finalized and filed our income tax
returns for the tax year ended December 31, 2008.  As a result of the
finalized returns, we reversed the provision for income taxes estimate
originally booked.





Dividend
and Deemed Dividend on Series A Stock and Accretion of Preferred Stock
Redemption Value





During
the three and nine months ended September 30, 2009 and 2008, the total accretion
on our preferred stock was $5,000 and $30,000, respectively and $14,000 and
$113,000, respectively.  The decrease during both the three and the
nine month periods was attributable to the maturity of our Series A Stock on
March 15, 2008.





The nine
months ended September 30, 2008 include dividends of $14,000, which represent
the 5% per year dividends accrued on our Series A Stock through the March 15,
2008 maturity date.  We do not pay dividends on our Series B
Stock.





DCT
recorded a deemed dividend on its Series A Stock during the first quarter of
2008 totaling $231,000.  This non-cash dividend is to reflect the
implied economic value to the preferred stockholder of converting Series A
shares into common stock at a 15% discount of the common stock price at the time
of conversion.  The fair value was calculated using the difference
between the agreed-upon conversion price of the Series A Preferred Stock into
shares of common stock and the fair market value of DCT's common stock on the
conversion date. See “Note 8:  Equity” in Part I, Item 1 of this Form
10-Q.





As of
September 30, 2009, we had no preferred stock outstanding.





Liquidity
and Capital Resources





At
September 30, 2009, our principal sources of liquidity included cash and cash
equivalents of $257,000 and an available borrowing capacity of $774,000 on our
bank line of credit.




- 22
-





Our sales
generally have followed a seasonal trend.  Historically, our sales
have been higher in the second part of the year than in the
first.  This seasonal trend has occurred during the past several years
as well as the current year, and has typically constrained our working capital
during the first part of the year.  And although we expect the
historical trend of higher sales in the last part of the year as compared to the
first part of the year, there can be no assurance that it will continue in 2009,
especially in light of the current economic downturn in the US
economy.





Operating
activities:  During the nine months ended September 30, 2009,
our operating activities used $812,000 of cash.  This was primarily a
result of our $505,000 net loss, $561,000 of net non-cash expenses, and $868,000
net cash provided by changes in operating assets and
liabilities.  During the nine months ended September 30, 2008, our
operating activities provided $1,761,000 of cash.  This was primarily
a result of our $273,000 net loss, $572,000 of net non-cash expenses and
$1,462,000 net cash provided by changes in operating assets and
liabilities.  Non-cash items included in net loss for the nine months
ended September 30, 2009 were depreciation expense, stock-based compensation
cost of options, fair value of equity instruments (including restricted common
stock and warrants) issued for services rendered, amortization of deferred
financing costs and debt discount, and the change in fair value of our
derivative instruments.  Non-cash items included in net loss for the
nine months ended September 30, 2008 were our one-time gain of $550,000 for the
sale of assets related to terminated research and development activities,
depreciation expense, stock-based compensation cost of options, fair value of
equity instruments (including restricted common stock and warrants) issued for
services rendered, and the change in fair value of our derivative
instruments.  Changes in our operating assets and liabilities for both
the nine months ended September 30, 2009 and 2008 are indicative of the normal
operational fluctuations related to the timing of product shipments, trade
receivables collections, inventory management and timing of vendor
payments.





Investing
activities:  Our investing activities for the nine months ended
September 30, 2009 consisted of capital purchases to support normal business
operations.  During the nine months ended September 30, 2008, cash
provided by investing activities included $550,000 in cash proceeds from the
one-time sale of assets related to terminated research and development
activities.




Financing
activities:  During the nine months ended September 30, 2009,
our financing activities consisted of (i) replacing our existing line of credit
with a similar line of credit with a different commercial bank (as discussed
below), and (ii) $75,000 cash payment upon the maturity of our preferred
stock.  During the nine months ended September 30, 2008, our financing
activities consisted of (i) paying down our bank line of credit, and (ii) making
principal payments on our notes payable according to the terms of the
agreement.





Cash
and Working Capital Requirements





Our
working capital at September 30, 2009 was $2,120,000 as compared to working
capital of $1,820,000 at December 31, 2008.   The increase in
working capital was a result of the one-time conversion of warrants to purchase
650,000 shares of common stock into 750,000 shares of common
stock.  The warrants included a put option liability totaling
$350,000, which was de-recognized during the three months ended September 30,
2009.  The increase in working capital as a result of the $350,000
warrant liability de-recognition, was slightly offset by the $75,000 cash paid
upon the maturity of our preferred stock.  As of September 30, 2009 we
have no preferred stock and no warrants with put options
outstanding.





DCT
actively controls operating expenses to align with current and projected net
sales.  If we continue to successfully manage our projected net sales
and control our operating expenses, of which there can be no assurance,
management believes that current cash and other sources of liquidity are
sufficient to fund normal operations through the next 12 months.




- 23
-





Contractual
Obligations





The
following table summarizes our contractual obligations at September 30, 2009,
and the effect such obligations are expected to have on our liquidity and cash
flows in future periods (in
thousands):




Less
      Than
            
            
            One
      – Three
            
            
            Three
      – FiveTotal
            
            
            One
      Year
            
            
            Years
            
            
            YearsBank
      line of credit (1)
            
            $
            817
            
            
            $
            817
            
            
            $
            -
            
            
            $
            -Operating
      lease obligations
            
            
            179
            
            
            
            178
            
            
            
            1
            
            
            
            -Total
      contractual cash obligations
            
            $
            996
            
            
            $
            995
            
            
            $
            1
            
            
            $
            -










As of
September 30, 2009, DCT was in compliance with all LOC debt
covenants.




Off-Balance
Sheet Arrangements





At
September 30, 2009, we did not have any relationship with unconsolidated
entities or financial partnerships, which other companies have established for
the purpose of facilitating off-balance sheet arrangements or other
contractually narrow or limited purposes. Therefore, we are not materially
exposed to any financing, liquidity, market or credit risk that could arise if
we had engaged in such relationships.





Trends





To the
best of our knowledge, except for the commitments described in “Note 11:
Commitments and Contingencies” in Part I, Item 1 of this Form 10-Q, there are no
other known trends or demands, commitments, events or uncertaintiesthat existed at
September 30, 2009, which are likely to have a material effect on our future
liquidity.





Item
4 – Controls and Procedures





Evaluation
of Disclosure Controls and Procedures





As of
September 30, 2009, we conducted an evaluation under the supervision and with
the participation of our management, including our Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures. The term “disclosure controls and
procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act,
means controls and other procedures of a company that are designed to ensure
that information required to be disclosed by the company in the reports it files
or submits under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the SEC's rules and forms.
Disclosure controls and procedures also include, without limitation, controls
and procedures designed to ensure that information required to be disclosed by a
company in the reports that it files or submits under the Exchange Act is
accumulated and communicated to the company's management, including its
principal executive and principal financial officers, or persons performing
similar functions, as appropriate, to allow timely decisions regarding required
disclosure. Based on this evaluation, our Chief Executive Officer and Chief
Financial Officer have concluded that our disclosure controls and procedures
were not effective as of September 30, 2009 for the reasons discussed below
related to material weaknesses in our internal control over financial
reporting.





Changes
in Internal Controls over Financial Reporting





At DCT’s
Annual Shareholders’ meeting, see in Part II, Item 4 of this Form 10-Q, our
independent financial expert was not re-elected to our Board of
Directors.  As a result, we did not have effective comprehensive
entity-level internal controls specific to the structure of our board of
directors.





- 24
-




Management’s
Remediation Initiatives




We are
currently in the process of interviewing candidates that meet the definition of
independent and financial expert and can fill the vacant position on our Board
of Directors.  We anticipate filling the director position by December
31, 2009. Additionally, we plan to test our updated controls and remediate our
material weaknesses by December 31, 2009.





Conclusion





To
mitigate the above identified material weakness, DCT executive management, two
of whom are also members of DCT’s Board of Directors, performed detailed
analyses, including but not limited to a detailed balance sheet and statement of
operations analytical review that compared changes from the prior period’s
financial statements and analyzed all significant differences. Additionally, DCT
executive management compared the actual results of operations to its internal
budgeted forecast and investigated any items where the actual results differed
from expectations.  Such detailed analyses were completed so
management could gain assurance that the financial statements and schedules
included in this Form 10-Q fairly present in all material respects DCT’s
financial position, results of operations and cash flows for all periods
presented.





Inherent
Limitations on Effectiveness of Controls





Our
management, including the CEO and CFO, does not expect that our Disclosure
Controls or our internal control over financial reporting will prevent or detect
all error and all fraud. A control system, no matter how well designed and
operated, can provide only reasonable, not absolute, assurance that the control
system’s objectives will be met. The design of a control system must reflect the
fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Further, because of the inherent limitations
in all control systems, no evaluation of controls can provide absolute assurance
that misstatements due to error or fraud will not occur or that all control
issues and instances of fraud, if any, have been detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty and that breakdowns can occur because of simple error or mistake.
Controls can also be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the controls. The
design of any system of controls is based in part on certain assumptions about
the likelihood of future events, and there can be no assurance that any design
will succeed in achieving its stated goals under all potential future
conditions. Projections of any evaluation of controls effectiveness to future
periods are subject to risks. Over time, controls may become inadequate because
of changes in conditions or deterioration in the degree of compliance with
policies or procedures.




- 25
-




PART
II.  OTHER INFORMATION





Item
1 - Legal Proceedings





We are
subject to various legal proceedings from time to time in the ordinary course of
business, none of which are required to be disclosed under this Item
1.





Item
1A – Risk Factors





There
have been no changes to the risk factors included in our Annual Report on Form
10-K for the year ended December 31, 2008 as filed with the Securities and
Exchange Commission on April 15, 2009.





Item
2 - Unregistered Sales of Equity Securities and Use of Proceeds





On August
7, 2009, we issued an aggregate of 187,500 shares of common stock in connection
with our Series B Preferred Stock redemption.





On
September 9, 2009, we issued 750,000 shares of common stock in connection with
the cancellation of a warrant to purchase 650,000 shares of our common
stock.





We did
not receive any proceeds with the aforementioned common stock
issuances.  All securities were issued pursuant to Section 4(2) of the
Securities Act of 1933, as amended.





Item
3 - Defaults Upon Senior Securities





None.





Item
4 - Submission of Matters to a Vote of Security Holders





On
September 14, 2009, the Company held its annual meeting of stockholders, whereby
its stockholders were asked to vote on the following Proposals:





1.
            To
      elect each of Edward Straw, David Clark, William Hawkins, Darwin Hu, Frank
      Musso and Jody Samuels to serve as directors of the Company until the next
      annual meeting of stockholders or until their successors have been duly
      elected or appointed and qualified.





2.
            To
      vote to approve the Company’s 2009 Stock Option Plan authorizing the
      issuance of up to 1,500,000 shares.





3.
            To
      vote to ratify the appointment by the Company’s Board of Directors of Hein
      & Associates LLP, to serve as the Company’s independent auditors for
      the year ended December 31, 2009.





All of
the nominees named in Proposal 1, except for Frank Musso, were elected by the
stockholders to serve as directors of the Company until the next annual meeting
of stockholders or until their successors have been duly elected or appointed
and qualified.  Each of Proposals 2 and 3 set forth above were
approved by the stockholders and received the requisite number of votes to
approve the proposed actions.





Item
5 - Other Information





None.




- 26
-





Item
6 - Exhibits





Exhibit
              Number
            
            Description
      of Exhibit
            
            Method
              of
      Filing31.1
            
            Certification
      Pursuant to Section 302 of the Sarbanes-Oxley Act – David P.
      Clark
            
            Filed
      herewith31.2
            
            Certification
      Pursuant to Section 302 of the Sarbanes-Oxley Act – M. Carolyn
      Ellis
            
            Filed
      herewith32.1
            
            Certification
      Pursuant to Section 906 of the Sarbanes-Oxley Act – David P.
      Clark
            
            Filed
      herewith32.2
            
            Certification
      Pursuant to Section 906 of the Sarbanes-Oxley Act – M. Carolyn
      Ellis
            
            Filed
      herewith




- 27
-




SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, Document Capture
Technologies, Inc. has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.




Document
      Capture Technologies, Inc.Date: November
      16, 2009
              
              /s/David
      P. ClarkDavid
      P. Clark, Chief Executive Officer




Date:
      November 16, 2009
              
              /s/M. Carolyn
      EllisM.
      Carolyn Ellis
                Chief
      Financial Officer





- 28
-