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, 2010





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
            
            80-0133251(State
      or other jurisdiction of
            
            (I.R.S.Employerincorporation
      or organization)
            
            Identification
      Number)




4255
Burton Drive


San
Jose, California 95054


(Address
of principal executive offices, Zip code)





408-436-9888


(Registrant’s
telephone number, including area code)





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the 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 has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).  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 11, 2010 was
21,770,276











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 include 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 our 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, 2010




INDEX





PagePART I – FINANCIAL
      INFORMATION
            4Item
      1
            Financial
      Statements
            4Item
      2
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            19Item
      4
            Controls
      and Procedures
            25PART II – OTHER
      INFORMATION
            26Item
      1
            Legal
      Proceedings
            26Item
      1A
            Risk
      Factors
            26Item
      2
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            26Item
      3
            Defaults
      Upon Senior Securities
            27Item
      4
            Submission
      of Matters to a Vote of Security HoldersItem
      5
            Other
      Information
            27Item
      6
            Exhibits
            28Signatures
            29





3




PART
I.  FINANCIAL INFORMATION





Item
1 - Financial Statements





DOCUMENT
CAPTURE TECHNOLOGIES, INC.


CONDENSED
CONSOLIDATED BALANCE SHEETS


(in
thousands)





September
      30,
              2010
            
            
            December
      31,
              2009ASSETS
            
            (unaudited)
            
            
            
            *Current assets:Cash
      and cash equivalents
            
            $
            3,937
            
            
            $
            328Trade
      receivables
            
            
            2,262
            
            
            
            1,497Inventories,
      net
            
            
            1,376
            
            
            
            1,674Prepaid
      expenses and other current assets
            
            
            130
            
            
            
            132Total
      current assets
            
            
            7,705
            
            
            
            3,631Restricted
      cash
            
            
            5
            
            
            
            5Other
      non-current assets
            
            
            50
            
            
            
            -Fixed
      assets, net
            
            
            148
            
            
            
            176Total
    assets
            
            $
            7,908
            
            
            $
            3,812LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Line
      of credit
            
            $
            -
            
            
            $
            202Trade
      payables to related parties
            
            
            794
            
            
            
            341Trade
      payables and other accrued expenses
            
            
            346
            
            
            
            440Accrued
      compensation and benefits
            
            
            99
            
            
            
            124Deferred
      revenue and customer deposits
            
            
            26
            
            
            
            111Total
      current liabilities
            
            
            1,265
            
            
            
            1,218Stock
      option liability
            
            
            1,776
            
            
            
            -Long-term
      deferred rent
            
            
            18
            
            
            
            -Commitments
      and contingencies (Note 10)Stockholders’
      equity:Preferred
      stock $.001 par value, 2,000 authorized, 0 issued andoutstanding
      at September 30, 2010 and December 31, 2009Common
      stock $.001 par value, 50,000 authorized; 22,711 and 19,406
      sharesissued
      and outstanding at September 30, 2010 and December 31,
      2009,respectively
            
            
            23
            
            
            
            19Additional
      paid-in capital
            
            
            38,253
            
            
            
            35,697Accumulated
      deficit
            
            
            (33,427
            )
            
            
            (33,122
            )Total
      stockholders’ equity
            
            
            4,849
            
            
            
            2,594Total
      liabilities and stockholders’ equity
            
            $
            7,908
            
            
            $
            3,812







*
              Amountsderived
      from the audited financial statements for the year ended December 31,
      2009.




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
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009Net
      sales
            
            $
            3,539
            
            
            $
            2,975
            
            
            $
            10,269
            
            
            $
            7,992Cost
      of sales
            
            
            2,138
            
            
            
            1,847
            
            
            
            6,263
            
            
            
            4,908Gross
      profit
            
            
            1,401
            
            
            
            1,128
            
            
            
            4,006
            
            
            
            3,084Operating
      expenses:Selling,
      general and administrative
            
            
            1,332
            
            
            
            829
            
            
            
            3,284
            
            
            
            2,929Research
      and development
            
            
            263
            
            
            
            295
            
            
            
            807
            
            
            
            728Total
      operating expenses
            
            
            1,595
            
            
            
            1,124
            
            
            
            4,091
            
            
            
            3,657Operating
      (loss) income
            
            
            (194
            )
            
            
            4
            
            
            
            (85
            )
            
            
            (573
            )Total
      non-operating income (expense), net
            
            
            (234
            )
            
            
            (9
            )
            
            
            (218
            )
            
            
            (8
            )Net
      loss before income taxes
            
            
            (428
            )
            
            
            (5
            )
            
            
            (303
            )
            
            
            (581
            )Provision
      (benefit) for income taxes
            
            
            -
            
            
            
            (76
            )
            
            
            2
            
            
            
            (76
            )Net
      (loss) income
            
            
            (428
            )
            
            
            71
            
            
            
            (305
            )
            
            
            (505
            )Accretion
      of preferred stock redemption value
            
            
            -
            
            
            
            (5
            )
            
            
            -
            
            
            
            (30
            )Net
      (loss) income available to common stockholders
            
            $
            (428
            )
            
            $
            66
            
            
            $
            (305
            )
            
            $
            (535
            )Basic
      (loss) income per common share
            
            $
            (0.02
            )
            
            $
            0.00
            
            
            $
            (0.02
            )
            
            $
            (0.03
            )Diluted
      (loss) income per common share
            
            $
            (0.02
            )
            
            $
            0.00
            
            
            $
            (0.02
            )
            
            $
            (0.03
            )Weighted
      average common shares outstanding
            
            
            21,826
            
            
            
            18,750
            
            
            
            20,213
            
            
            
            18,562Weighted
      average common shares outstanding,assuming
      dilution
            
            
            21,826
            
            
            
            22,583
            
            
            
            20,213
            
            
            
            18,562





5





DOCUMENT
CAPTURE TECHNOLOGIES, INC.


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)


(in
thousands)





Nine
      Months Ended
              September
      30,2010
            
            
            2009Operating
      activities:Net
      loss
            
            $
            (305
            )
            
            $
            (505
            )Adjustments
      to reconcile net loss to net cash provided (used) byoperating
      activities:Depreciation
      expense included in operating expenses
            
            
            40
            
            
            
            46Depreciation
      expense included in cost of sales
            
            
            40
            
            
            
            -Stock-based
      compensation cost – options
            
            
            663
            
            
            
            410Fair
      value of common stock and warrants issued for services
      rendered
            
            
            72
            
            
            
            111Change
      in fair value of stock option liability
            
            
            232
            
            
            
            -Other
      non-cash income/expenses, net
            
            
            45
            
            
            
            (24
            )Changes
      in operating assets and liabilities:Trade
      receivables
            
            
            (765
            )
            
            
            (787
            )Inventories
            
            
            298
            
            
            
            288Prepaid
      expenses and other
            
            
            (62
            )
            
            
            (182
            )Trade
      payables to related parties
            
            
            453
            
            
            
            (38
            )Trade
      payables and other current liabilities
            
            
            (119
            )
            
            
            (46
            )Deferred
      revenue and customer deposits
            
            
            (85
            )
            
            
            (85
            )Long-term
      deferred rent
            
            
            18
            
            
            
            -Cash
      provided (used) by operating activities
            
            
            525
            
            
            
            (812
            )Investing
      activities:Capital
      expenditures
            
            
            (52
            )
            
            
            (58
            )Cash
      used by investing activities
            
            
            (52
            )
            
            
            (58
            )Financing
      activities:Net
      (payments) advanceson bank line of
      credit
            
            
            (225
            )
            
            
            817Proceeds
      from issuance of common stock, net of issuance costs
            
            
            3,973
            
            
            
            -Payments
      for repurchase of common stock
            
            
            (604
            )
            
            
            -Deferred
      financing costs
            
            
            (8
            )
            
            
            (20
            )Cash
      paid upon the maturity of preferred stock
            
            
            -
            
            
            
            (75
            )Cash
      provided by financing activities
            
            
            3,136
            
            
            
            722Net
      increase (decrease) in cash and cash equivalents
            
            
            3,609
            
            
            
            (148
            )Cash
      and cash equivalents at beginning of period
            
            
            328
            
            
            
            405Cash
      and cash equivalents at end of period
            
            $
            3,937
            
            
            $
            257Supplemental
      disclosures of cash flow information:Non-cash
      investing and financing activities:Conversion
      of convertible preferred stock to common stock
            
            $
            -
            
            
            $
            75Conversion
      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”) and can be found in a variety of applications
including, but not limited to, the following:





·
            Document
      and information management;


·
            Identification
      card and driver license 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, 2010 are not necessarily indicative of the operating
results that may be expected for the entire year ending December 31, 2010. 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, 2009, filed with the Securities and Exchange Commission (“SEC”) on
March 31, 2010.





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




Note
2 – Recent Accounting Pronouncements




In
October 2009, the Financial Accounting Standards Board (“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 for
accounting purposes. Additionally, these new standards modify the manner in
which the arrangement consideration is allocated across the separately
identified deliverables by no longer permitting the residual method of
allocating arrangement consideration. These new standards are required to be
adopted in the first quarter of 2011; however, early adoption is
permitted.   DCT does not expect these new standards to
significantly impact our consolidated financial statements.




In
October 2009, the FASB issued new standards for the accounting for certain
revenue arrangements that include software. These new standards amend the scope
of pre-existing software revenue guidance by removing from the guidance tangible
products and certain software. These new standards are required to be adopted in
the first quarter of 2011; however, early adoption is permitted. DCT does not
expect these new standards to significantly impact our consolidated financial
statements.




In
January 2010, the FASB issued amended standards that require additional
fair value disclosures. These disclosure requirements are effective in two
phases. In the first quarter of 2010, we adopted the requirements for
disclosures about inputs and valuation techniques used to measure fair value as
well as disclosures about significant transfers. Beginning in the first quarter
of 2011, these amended standards will require presentation of disaggregated
activity within the reconciliation for fair value measurements using significant
unobservable inputs (Level 3). These amended standards do not affect our
consolidated statements of operations or balance sheets.





Note
3 – Related-Party Transactions





Purchases





Historically,
the Company has purchased the majority of its finished scanner imaging products
from Shenzhen Syscan Technology (“SST”), a wholly-owned subsidiary of Syscan
Technology Holdings Limited (“STH”).  As of September 30, 2010, SST
held approximately 14% of DCT’s outstanding common stock.





Purchases
from SST totaled $1,989,000 and $5,475,000 for the three and nine months ended
September 30, 2010, respectively, and $1,677,000 and $4,120,000 for the three
and nine months ended September 30, 2009, 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 $794,000 and $341,000 at
September 30, 2010 and December 31, 2009, respectively.





Net
Sales





During
the three and nine months ended September 30, 2010, DCT recorded net sales
totaling $111,000 and $181,000, respectively, for finished scanners sold to
SST.  The related cost of sales was $93,000 and $153,000,
respectively.  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 sales was $14,000
and $21,000, respectively.  All sales to SST contained similar terms
and conditions as for other transactions of this nature entered into by
DCT.





Legal
Services Agreement





On
September 15, 2009, DCT entered into a legal services agreement (“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 for a total of $12,000
and $36,000 for the three and nine months ended September 30, 2010,
respectively.  The Agreement may be cancelled by either party with 30 days
prior written notice.




8




Agreement
to License Office Space





On April
26, 2010, DCT entered into a two-year license agreement (“License”) with Beau
Dietl & Associates(“BDA”) to license office
space from BDA in New York City.  The purpose of the License is for
DCT to have a physical presence in New York City.  In connection with
the License, the Company paid BDA an upfront license fee of $50,000 as payment
in full.  The $50,000 payment was capitalized and is being amortized,
using the straight-line method, to selling, general and administrative expense
over the term of the License.  In connection with the License, DCT
recorded rent expense of $6,000 and $10,000 for the three and nine months ended
September 30, 2010, respectively.





The
License can be cancelled by either party with 90 days written
notice.





Consulting
Agreement





On August
13, 2010, the Company’s Board of Directors approved a consulting agreement with
National Health Media (“NHM”) for purposes of assisting DCT establish contacts
and generate sales of DCT’s products to companies specifically in the healthcare
industry.   As compensation for the agreement, DCT agreed to pay
NHM five percent of sales of DCT products, in excess of $10,000,000, directly
attributable to introductions made by NHM.  No commissions were
incurred, in connection with the NHM agreement, through September 30, 2010. Additionally,
DCT paid NHM $400,000 upon execution of the agreement.  DCT recorded
selling, general and administrative expense of $400,000 for the three months
ended September 30, 2010, as services were fully rendered by NHM prior to
September 30, 2010.





The term
of the NHM agreement is 48 months and is automatically renewed for one-year
periods unless terminated by NHM with 30-days written notice, or by DCT at any
time.





As of
September 30, 2010, the owner of NHM held approximately one percent of DCT’s
outstanding common stock.





Reimbursed
Expenses incurred by Related-Party Consultants





During
the three months ended September 30, 2010, DCT reimbursed expenses incurred by
related-party consultants totaling approximately $4,400.





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.





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,
2010, DCT had consolidated balances of approximately $3,689,000, which were 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 and
accounts receivable were as follows:





Three
      Months Ended
              September
      30,
            
            
            Nine
      Months Ended
              September
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009Customer
      A
            
            
            22
            %
            
            
            20
            %
            
            
            18
            %
            
            
            19
            %Customer
      B
            
            
            20
            
            
            
            13
            
            
            
            19
            
            
            
            11Customer
      C
            
            
            12
            
            
            
            21
            
            
            
            16
            
            
            
            22Customer
      D
            
            
            10
            
            
            
            *
            
            
            
            *
            
            
            
            *Customer
      E
            
            
            *
            
            
            
            15
            
            
            
            10
            
            
            
            13








*
            Customer
      accounted for less than 10% for the period
  indicated.




9




Trade
receivables from all significant customers at September 30, 2010 totaled
$1,696,000.  As of September 30, 2010, 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 – 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.





Stock
Options





DCT
issues options under four different stock option plans as well as through
employment agreements with key employees, executives and consultants (approved
by the board of directors on a case-by-case basis).  Options generally
vest over two to three years from the date of grant and expire seven to ten
years from the date of grant.





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
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009Selling,
      general and administrative
            
            $
            212
            
            
            $
            98
            
            
            $
            568
            
            
            $
            350Research
      and development
            
            
            32
            
            
            
            14
            
            
            
            95
            
            
            
            60Total
            
            $
            244
            
            
            $
            112
            
            
            $
            663
            
            
            $
            410





At
September 30, 2010, DCT had approximately $1,676,000 of total unrecognized
compensation cost related to unvested stock options. This cost is expected to be
recognized over a weighted-average period of approximately 1.9
years.





Stock
Option Activity and Outstanding





DCT had
the following stock option activity during the nine months ended September 30,
2010:





Options
            
            
            Weighted-Average
      Exercise PriceOutstanding
      at December 31, 2009
            
            
            11,355,498
            
            
            $
            0.32Granted
            
            
            2,850,000
            
            
            
            0.30Exercised
            
            
            -
            
            
            
            -Cancelled
            
            
            (311,000
            )
            
            
            (0.45
            )Outstanding
      at September 30, 2010
            
            
            13,894,498
            
            
            $
            0.31




10




The
following table summarizes all options outstanding and exercisable by price
range as of September 30, 2010:





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
            
            
            
            1.57
            
            
            $
            0.01
            
            
            
            2,241,165
            
            
            $
            0.01$0.29
      - $0.35
            
            
            
            9,753,333
            
            
            
            7.26
            
            
            $
            0.31
            
            
            
            2,835,833
            
            
            $
            0.30$0.60
      - $0.70
            
            
            
            1,900,000
            
            
            
            6.30
            
            
            $
            0.69
            
            
            
            1,900,000
            
            
            $
            0.6913,894,498
            
            
            
            
            
            
            
            
            
            
            
            6,976,998





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 (of which all are expected to vest) was approximately $5,286,000 and
$788,000 at September 30, 2010 and December 31, 2009, respectively. The total
intrinsic value for exercisable options was $2,641,000 and $722,000 at September
30, 2010 and December 31, 2009, respectively. No options were exercised
during the nine months ended September 30, 2010.





Note
7 – Basic and Diluted Net Income (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 and nine months ended September 30, 2010 and the nine months
ended September 30, 2009, 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, but 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




The above
calculation excluded 4,088,000 of stock options and warrants from the
calculation of diluted earnings per common share as the exercise prices of these
stock options and warrants were greater than or equal to the market value of the
common shares.  Such options and warrants could be included in the
calculation in the future if the market value of DCT’s common shares increases
and is greater than the exercise price of these options and
warrants.




11




Note
8 – Equity





Common
Stock





Common
Stock Issuances - 2010





On August
5, 2010 (“Purchase Date”), DCT and NCR Corporation (“NCR”) entered into (i)
Share Purchase Agreement (“Purchase Agreement”), (ii) Investor Rights Agreement
(“IR Agreement”), and (iii) Voting Agreement (“Voting Agreement”) pursuant to
which NCR purchased from DCT 3,861,004 shares (“NCR Shares”) of the Company’s
common stock for an aggregate purchase price of $4,000,000
(“Investment”).  Additionally, DCT granted NCR a two-year option (“NCR
Option”) to purchase up to an additional $4,000,000 of Common Stock at an
exercise price of $1.036 per share, subject to adjustment, as more fully
described below.  Neither the Shares nor the NCR Option have been
registered with the Securities and Exchange Commission.  However, NCR
received demand registration rights, subject to certain limitations, and
unlimited piggy-back registration rights with respect to the NCR Shares and any
shares of Common Stock issued upon exercise of the NCR Option.  DCT
will use its best efforts to obtain an effective registration
statement.  As such, the Company does not believe that a contingent
obligation to make payments or transfer consideration under a registration
payment arrangement is probable.  The registration rights terminate
when all of the NCR Shares and any shares of Common Stock issued upon exercise
of the NCR Option may be sold pursuant to Rule 144 without restriction or
limitation, or, if earlier, on the fifth anniversary of the Purchase
Date.





The
Investment has anti-dilution protection for eighteen months following the date
of the IR Agreement.  Under the anti-dilution provisions, unless
waived by NCR, issuances or deemed issuances of Common Stock with an effective
price that is less than $1.036 (as adjusted), would result in the issuance of
additional shares of Common Stock, determined on a full ratchet basis, to
NCR.  See Note 11.





The NCR
Option is exercisable at any time or from time to time for two years from the
Purchase Date. The exercise price of the NCR Option is subject to adjustment for
stock splits or combinations; dividends or distributions payable in shares of
Common Stock; reclassifications, exchanges or substitutions; and
reorganizations, mergers, consolidations or sales of assets.  The
exercise price of the NCR Option is also subject to adjustment, on a full
ratchet basis, for issuances or deemed issuances of Common Stock with an
effective price that is less than the NCR Option exercise price then in
effect.  See Note 11.





The
Voting Agreement is between DCT, NCR and certain investors of DCT. Under the
Voting Agreement, NCR was granted the right to appoint a board observer to
attend meetings of DCT’s Board of Directors in a nonvoting observer
capacity.  NCR was also granted the right, at its discretion, to
designate a member of DCT’s Board of Directors.  In the event of any
such designation, the DCT stockholders who are party to the Voting Agreement
agreed to vote their shares of DCT stock to elect NCR’s
designee.  Such stockholders also agreed that, at NCR’s request, they
would not sell their shares of DCT’s stock for up to 180 days following the
effective date of a final prospectus covering the resale of DCT’s stock by
NCR.





Under the
provisions of the Accounting Standards Codification (“ASC”) 815,Derivatives and Hedging, the
anti-dilution feature of the NCR Shares is derivative instruments that requires
bifurcation from the host contract and recorded at fair value as a derivative
liability.  The fair value of the anti-dilution feature of the NCR
Shares was calculated using a custom Binomial option pricing
model.  The approach and inputs were:





·
              Developed
      a custom Binomial Model for the remaining term on the
    options.


·
              Price
      movement in Total Shareholder Value of DCT was modeled using Cox, Ross and
      Rubinstein (“CRR”) method.


·
              Volatility
      was derived from historical volatility for DCT and calculated over the
      respective remaining term of the
derivative.


·
              Estimated
      probability of a financing event taking place at each
  node.


·
              Reviewed
      relationship between future equity fund raising and level of cash and
      other liquid instruments.


·
              Used
      DCT’s financial projections to estimate probability of an equity financing
      event at each node.


·
              Calculated
      the price of penultimate nodes based on value of full ratchet, weighted by
      the probability of a financing event at the
  node.


·
              Risk-free
      interest rate was 0.42%.


·
              Propagated
      values up the binomial tree to model an American Option with early
      exercise feature.




12




Based on
the above, the anti-dilution feature of the NCR Shares was de minimis at the
Purchase Date and at September 30, 2010.




Under the
provisions of ASC 480, Distinguishing Liabilities from
Equity, a financial instrument is a liability if the number of shares
used to calculate the settlement amount is not fixed.  If a financial
instrument’s terms provide for any potential adjustment, regardless of the
probability of such adjustment(s) or whether such adjustments are in the
entity's control, the settlement amount is not fixed.  As the NCR
Option contains a price protection provision (or down-round provision) that
reduces the option’s strike price in the event the Company issues additional
shares at a more favorable price than the strike price, the NCR Option is
recognized at fair value as a liability.  The fair value of the NCR
Option was estimated using a custom Binomial option pricing model with the
following assumptions: 0.42% risk-free interest rate, expected volatility of
162%, expected dividend yield of 0%, and remaining life equal to the remaining
contractual life of the option.  Estimated fair value, on the Purchase
Date, was $1,544,000.  As such, of the $4,000,000 proceeds received
from NCR, $1,544,000 was booked as a stock option liability and the remaining
proceeds were booked as stockholders’ equity.   See Note
11.




During
August 2010, DCT issued 180,822 shares of common stock upon the cashless
exercise of warrants.  In connection with the cashless exercise,
434,178 warrants were cancelled.





Common
Stock Issuances - 2009





During
January 2009, DCT issued 25,000 shares of 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 convertible redeemable preferred stock (“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.





Common
Stock Repurchases





During
September 2010, DCT’s board of directors authorized DCT to repurchase (“DCT
Stock Repurchase Plan”) and retire $2,500,000 of its common stock in open market
transactions or privately negotiated transactions pursuant to Rule 10b-18 of the
Securities Exchange Act of 1934, as amended.  See Note
13.





Under
this authorization, DCT repurchased 736,785 shares of common stock at a total
cost of $604,000 through September 30, 2010.  DCT subsequently retired
the shares.  As such, the Company accounted for the repurchase shares
by recording a reduction to common stock and additional paid-in capital for
the total cost.





The
authorization does not have an expiration date, does not require DCT to purchase
a specific number of shares and may be modified, suspended or terminated at any
time.




13




Common
Stock Warrants





DCT had
the following common stock warrant activity during the nine months ended
September 30, 2010:





WarrantsOutstanding
      at December 31, 2009
            
            
            2,002,027Exercised
            
            
            (180,822
            )Cancelled
      in connection with cashless exercise
            
            
            (434,178
            )Expired
            
            
            (1,209,000
            )Issued
            
            
            220,000Outstanding
      at September 30, 2010
            
            
            398,027





In
certain instances, DCT issues warrants for consulting services.  DCT
amortizes the fair value, as calculated using the Black-Scholes valuation model,
of such warrants over the service period.  In connection with such
common stock warrants issued and outstanding, DCT charged selling, general and
administrative expense with the offset credit to additional paid in capital for
$72,000 and $100,000 during the nine months ended September 30, 2010 and 2009,
respectively.





Common
Shares Reserved for Future Issuance





At
September 30, 2010, the following common stock shares were reserved for future
issuance:





Warrants
      to purchase common stock
            
            
            398,027NCR
      Option
            
            
            3,861,004Equity
      incentive plan options authorized for future grants
            
            
            1,421,667Equity
      incentive plan options outstanding
            
            
            13,894,49819,575,196





Preferred
Stock





During
the three and nine months ended September 30, 2009, DCT reported $5,000 and
$30,000 of accretion of preferred stock redemption value associated with its
Series B Stock, which matured August 7, 2009.





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)
            187,500
      shares of common stock valued at the adjusted closing price, $0.40, of the
      stock on the Series B Stock Redemption
Date.





Note
9 – Bank 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 bore 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 were due
monthly and all unpaid interest and principal were due in full on September 2,
2010.  Upon certain events of default (as defined in the LOC agreement),
the default variable interest rate would increase to five percentage points
above the interest rate applicable immediately prior to the
default.  Additionally, the lender had the right to declare all of the
amounts due under the LOC immediately due and payable upon an event of
default.




14




During
September 2009, in connection with the LOC origination, 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, modification, 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 was determined using
the Black-Scholes valuation model with the following assumptions: remaining
contractual term of 7 years, 2.9% risk-free interest rate, expected volatility
of 406% and expected dividend yield of 0%.  The fair value of the
warrants was initially recorded as debt discount, with an offset to additional
paid in capital, and is being amortized over the life of the loan to interest
expense.





During
March 2010, DCT amended its existing LOC to increase the borrowing base as
follows:  (i) increase the percentage of borrowings from 75% to 80% of
eligible accounts receivable, and (ii) add 40% of eligible inventory (all as
defined in the LOC agreement) to the borrowing base.  In connection
with increasing the amendment, DCT paid the lender a loan modification fee of
$6,000, which was recorded as deferred financing costs and amortized over the
life of the loan to interest expense.





During
September 2010, DCT extended the maturity date of its $2,000,000 LOC from
September 2, 2010 to November 1, 2010.  As part of the extension, the
borrowing base was modified to only include borrowings against 80% of eligible
accounts receivable (as defined in the LOC agreement).  The inventory
borrowing base was not extended as the Company does not require the borrowing
capacity.  In connection with extension, DCT paid the lender a loan
modification fee of $2,000, which was recorded as deferred financing costs and
amortized over the life of the loan to interest expense.  Subsequent
to September 30, 2010, an amended line of credit (“Amended LOC”) was entered
into, which extended the maturity date to November 15, 2011.  See Note
13.  The interest rate was prime (3.25% at September 30, 2010) plus
2.75%.





Upon
certain events of default (as defined in the Original 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 Original LOC immediately due and payable upon an event of
default.





As of
September 30, 2010, DCT was in compliance with all Original LOC debt covenants
and had unused borrowing capacity of
$1,786,000.




Note
10 – Commitments and Contingencies




Operating
Leases





During
September 2010, DCT negotiated a new lease that (i) combined our corporate
office and warehouse spaces, and (ii) increased square footage, to approximately
32,000 square feet, for expanded domestic production capabilities and
significant operational efficiencies.  The new lease is non-cancelable
and extends through October 2015.  Future annual minimum commitments
as of September 30, 2010 are as follows (in thousands):





2011
            
            $
            1092012
            
            
            1972013
            
            
            2402014
            
            
            261Thereafter
            
            
            302$
            1,109




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.  In certain instances, 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, 2010, termination payments totaling
$1,055,000 remain in effect.




15




OEM
and Development Agreement




During
the second quarter of 2009, the Company entered into an OEM agreement (“OEM
Agreement”) with a customer to sell scanners.  The OEM Agreement was
subsequently amended to include product development (“Development
Agreement”).  To date, DCT has only sold product under the OEM
Agreement.  During July 2010, the Development Agreement was cancelled
by DCT’s customer.  DCT will continue to sell product under the OEM
Agreement.   Each party shall retain its rights in any intellectual
property rights owned or licensed to it prior to commencement of
development.  All intellectual property (“IP”) developed by DCT under
the Development Agreement will be owned exclusively by DCT, except for specific
parts and mechanism designs provided by the customer.





During
the three months ended September 30, 2010, DCT recognized $36,000 of revenue
originally deferred until product under the Development Agreement was
sold.  Management does not believe the cancellation of the Development
Agreement will have a material impact on DCT’s results of
operations.




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
11 – Fair Value





Under the
provisions of ASC 820, Fair
Value Measurements and Disclosures, the NCR Option (see Note 8) is
adjusted to its fair value at the end of each reporting period. The Binomial
option pricing model was used to estimate the fair value of the NCR Option with
the following assumptions: 0.42% risk-free interest rate, expected volatility of
162%, expected dividend yield of 0%, and remaining life equal to the remaining
contractual life of the option.The change in fair
value each period is reported as non-operating gain or loss. Generally, this
accounting treatment will result in a reported loss during any accounting period
in which there is a reported increase in the value of the Company’s common stock
as quoted on the OTC Bulletin Board. Conversely, this accounting treatment
generally will result in a reported gain during any accounting period in which
there is reported decrease in the value of the Company’s common stock as quoted
on the OTC Bulletin Board.





The NCR
Option fair value is measured using Level 3 inputs, unobservable inputs to the
valuation methodology that are significant to the measurement of the fair value,
as defined by ASC 820.





A
reconciliation of the NCR Option fair value is as follows (in thousands):





Fair
      Value Fair Value
              Measurements
      Using Significant Unobservable
              Inputs
      (Level 3)Issuance
            
            $
            1,544Unrealized
      loss included in earnings(1)
            
            
            232Balance
      at September 30, 2010
            
            $
            1,776







(1)
            Included
      as a component of non-operating income (expense),
  net.




16




Note
12 – Segment and Geographic Information




Segment
Information





DCT
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, 2010 and 2009, DCT recorded net
sales throughout the U.S., Europe and other, 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
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009U.S.
            
            $
            3,250
            
            
            $
            2,754
            
            
            $
            9,443
            
            
            $
            7,301Europe
      and other
            
            
            177
            
            
            
            183
            
            
            
            644
            
            
            
            643Asia
            
            
            112
            
            
            
            38
            
            
            
            182
            
            
            
            48$
            3,539
            
            
            $
            2,975
            
            
            $
            10,269
            
            
            $
            7,992





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





September
      30, 2010
            
            
            December
      31, 2009U.S.
            
            $
            7,513
            
            
            $
            3,574Europe
            
            
            311
            
            
            
            128Asia
            
            
            84
            
            
            
            110$
            7,908
            
            
            $
            3,812





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 – Subsequent Events





Amended
LOC





As
previously discussed in Note 9, DCT amended its LOC (“Amended LOC”) during
November 2010.  The Amended LOC lowers the annual interest rate from
prime plus 2.75% to prime plus 1.0% and extends the maturity date to November
15, 2011.  All other significant terms and conditions remain
unchanged.





In
connection with the Amended LOC, DCT paid the lender a loan origination fee of
$5,000.





As of the
date of this filing, DCT was in compliance with all Amended LOC debt
covenants.





Consulting
Agreement





On
October 5, 2010, DCT entered into a consulting with UI
Partners.  Pursuant to the terms of the agreement (“UI Agreement”), UI
Partners will conduct a marketing management program for DCT.  In
connection with the UI Agreement, DCT paid UI Partners a non-refundable $50,000
as compensation for services provided.  The marketing management
program is for six months and may be cancelled with ample notice at any
time.





Financial
Advisory Agreement





On
October 29, 2010, DCT entered into a nonexclusive financial advisory agreement
(“GSS Agreement”) with Garden State Securities (“GSS”), a Financial Industry
Regulatory Authority (“FINRA”) member firm.  Pursuant to the terms of
the GSS Agreement, GSS shall provide financial advisory services to DCT for 12
months, unless earlier terminated in accordance with the terms of the GSS
Agreement.  The services include, but are not be limited to, assisting
DCT in developing, studying and evaluating a financing plan, strategic and
financial alternatives, and merger and acquisition proposals; and also assisting
in introductions, negotiations and discussions pertaining thereto.




17




The
Company has agreed to pay GSS for its services in connection with the GSS
Agreement 425,000 shares of its restricted common stock and $30,000 upon
execution of the GSS Agreement.  Thereafter, commencing on the fourth
month and continuing through the twelfth month of the GSS Agreement, the Company
shall issue to GSS 47,223 restricted shares of its common stock per month and
shall pay GSS $7,500 per month.





In the
event that the GSS Agreement remains in effect for an initial 90-day period,
then GSS shall be granted a right of first refusal for future financings for a
period of twelve months thereafter.





The GSS
Agreement may be terminated by either party prior to the initial 90 day period
of the GSS Agreement by providing 20 days written notice to the other
party.  In the event that GSS terminates the GSS Agreement prior to
the initial 90-day period GSS has agreed to return a pro rata number of the
initial 425,000 shares received pursuant to this GSS Agreement.





The
shares issued to GSS were issued pursuant to the exemption from registration
contained in Section 4(2) of the Securities Act of 1933, as
amended.





Common
Stock Repurchases





As part
of the aforementioned DCT Stock Repurchase Plan (see Note 8), DCT repurchased
941,095 shares of common stock at a total cost of $664,000 from October 1, 2010
through November 11, 2010.





Appointment
of Principal Officers





On
November 3, 2010, DCT entered into an employment agreement (“Agreement”) with
Craig H. Weber pursuant to which Mr. Weber became DCT’s President and Chief
Operating Officer effective immediately. The initial term of the Agreement
is two years, with additional one-year extensions. Mr. Weber will receive
(i) a base salary of $250,000, and (ii) 1,400,000 options, exercisable at
$0.67 per share. One-half of the options vest on November 3, 2011 and one-half
of the options vest on November 3, 2012.  Mr. Weber will be
entitled to an annual bonus at the discretion of DCT’s board of directors, as
well as a bonus based on certain performance metrics to be mutually agreed
upon by and between DCT and Mr. Weber.  DCT also agreed to reimburse
Mr. Weber for certain relocation expenses specifically defined in the
Agreement.




18




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,
2009 as filed with the Securities and Exchange Commission on March 31,
2010.  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
      and Strategy. 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, 2010 compared
      to the three and nine months ended September 30, 2009.  A brief
      description of certain aspects, transactions and events is
      provided.




·
            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, 2010 as compared to the nine months ended September 30,
      2009.




·
            Contractual
      Obligations, Off-Balance-Sheet Arrangements, and
      Trends.As of September 30, 2010, an overview of (i)
      contractual obligations and contingent liabilities and commitments,
      including an expected payment schedule, (ii) an explanation of
      off-balance-sheet arrangements, and (iii) known
  trends.




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 related to document digitization and utilization. We sell our
products to customers throughout the world, including the United States, Canada,
Europe, Africa, South America, Australia and Asia.




Strategy





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 five groups of image-capture products, and will be
expanding our product offerings to meet the increased market demand for: (1)
faster, easier-to-use products; and (2) enhanced security, including identity
and financial transaction protection.





During
August 2010, DCT and NCR Corporation (“NCR” or “Investor”) entered into three
separate agreements and amended one existing agreement as follows: (i) Share
Purchase Agreement; (ii) Investor Rights Agreement, (iii) Voting Agreement, and
(iv) Amendment to Strategic Master Procurement
Agreement.  Collectively, these four items are referred to hereafter
as the “NCR Transaction.”




19




Pursuant
to the NCR Transaction, NCR purchased 3,861,004 shares of DCT common stock,
directly from DCT, for an aggregate purchase price of $4,000,000.  The
equivalent per share price was $1.036, subject to anti-dilution
adjustment.   In connection therewith, DCT also granted NCR a
two-year option to purchase up to an additional $4,000,000 of Common Stock at an
exercise price of $1.036 per share, subject to anti-dilution
adjustment.





DCT
management believes the NCR Transaction was both a strategic and financial
milestone for DCT.  Funds received from the NCR Transaction will be
used to invest in DCT’s future by partnering with NCR to develop transaction
turnkey solutions in both the Remote Deposit Capture (“RDC”) and Healthcare
markets.




During
September 2010, we negotiated a new lease that (i) combined our corporate office
and warehouse spaces, and (ii) increased square footage to expand domestic
production capabilities.  By combining our corporate office and
warehouse spaces, we will gain significant operational
efficiencies.  We are expanding our domestic production capabilities
to capitalize on certain market-specific opportunities, particularly with
federal, state and local government agencies that require products to be
manufactured in the U.S. under the Trade Agreements Act (“TAA”).




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, sales and expenses, and related disclosure of contingent assets and
liabilities. On an on-going 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, 2009 have not materially changed since that
report was filed.




20




Results
of Operations





The
following table summarizes certain aspects of our results of operations for the
three and nine months ended September 30, 2010 compared to the three and nine
months ended September 30, 2009 (in thousands):





Three
      Months Ended September 30,
            
            
            Nine
      Months Ended June 30,2010
            
            
            2009
            
            
            $
            
            
            %
            
            
            2010
            
            
            2009
            
            
            $
            
            
            %Net
      sales
            
            $
            3,539
            
            
            $
            2,975
            
            
            $
            564
            
            
            
            19
            %
            
            $
            10,269
            
            
            $
            7,992
            
            
            $
            2,277
            
            
            
            28
            %Cost
      of sales
            
            
            2,138
            
            
            
            1,847
            
            
            
            291
            
            
            
            16
            
            
            
            6,263
            
            
            
            4,908
            
            
            
            1,355
            
            
            
            28As
      a percentage of sales
            
            
            60
            %
            
            
            62
            %
            
            
            
            
            
            
            
            
            
            
            61
            %
            
            
            61
            %Selling,
      general and administrative expense
            
            
            1,332
            
            
            
            829
            
            
            
            503
            
            
            
            61
            
            
            
            3,284
            
            
            
            2,929
            
            
            
            355
            
            
            
            (12
            )Research
      and development expense
            
            
            263
            
            
            
            295
            
            
            
            (32
            )
            
            
            (11
            )
            
            
            807
            
            
            
            728
            
            
            
            79
            
            
            
            11Non-operating
      income (expense), net
            
            
            (234
            )
            
            
            (9
            )
            
            NM
            
            
            NM
            
            
            
            (218
            )
            
            
            (8
            )
            
            NM
            
            
            NM


NM = Not
Meaningful


Net
Sales





During
the first quarter of 2009, we experienced the bottom of the severe slowdown of
the U.S. economy and related slowdown of information technology (“IT”) capital
spending that began in 2008. Sales rebounded during the remainder of 2009 and
have continued strong during 2010.   As such, sales for both the
three and the nine months ended September 30, 2010 were higher compared to the
three and nine months ended September 30, 2009.   Specifically,
the increase in sales is a result of increased number of scanners sold resulting
from organic growth experienced by our existing, recurring customers; unit sales
of scanners increased 27% and 35% for the three and nine months ended September
30, 2010 compared to the three and nine months ended September 30,
2009.  Our average selling price remains fairly constant, but did
fluctuate somewhat during both the three and nine months ended September 30,
2010 as a result of the mix of products sold and certain volume-related price
discounts.





Our
international sales continue to be a strategic component of our
business.  International sales as a percentage of sales remain fairly
consistent:   8% for both the three months ended September 30,
2010 and 2009; and 8% and 9% for the nine months ended September 30, 2010 and
2009, respectively.  The majority of our international sales are in
Europe.  Because our products can be easily configured to support
different languages, and we provide ongoing support for Romanized, Cyrillic and
Sinographic character software, we are able to actively pursue sales
opportunities in many different international markets.





Total
sales to significant customers (customers who represent more than 10% of our net
sales) decreased to 64% during the three months ended September 30, 2010 from
69% during the three months ended September 30, 2009; and decreased to 63%
during the nine months ended September 30, 2010 from 65% during the nine months
ended September 30, 2009.  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.





From time
to time, our key customers place large orders causing our quarterly net sales to
fluctuate significantly. We expect this trend and resulting fluctuations to
continue.  Although the number of scanners shipped during any quarter
has fluctuated, our selling prices remained fairly stable; we expect both trends
to continue for the foreseeable future.





Cost
of Sales, Including Gross Profit




Cost of
sales includes all direct costs related to the purchase of scanners and imaging
modules manufactured in China, and to services related to the delivery of those
items.  To a lesser extent, cost of sales also includes engineering
services, software royalties and depreciation of manufacturing
equipment.  For scanners where the final assembly and test is
completed in the U.S., additional labor costs are included.  Although
overall cost of sales as a percentage of sales remained steady for all periods
presented, it is dependent on, and may vary with, the following
factors:




·
            Mix
      of products sold;




·
            Changes
      to the negotiated prices of our finished product and key
      components;




21




·
            Currency
      fluctuations between the Chinese Yuan and the U.S.
  Dollar;




·
            Customer
      requirements for third-party software integrated into our products;
      and




·
            Changes
      to the proportion of scanners assembled in the U.S. versus the proportion
      of scanners assembled in China.





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.




The
increase in selling, general and administrative expense during both the three
and nine months ended September 30, 2010 as compared to the three and nine
months ended September 30, 2009 was primarily attributable to the
following:





·
            The
      commencement of a strategic consulting agreement with National Health
      Media (“NHM”) for purposes of assisting DCT establish contacts and
      generate sales of DCT’s products to companies specifically in the
      healthcare industry.  In connection therewith, DCT expensed a
      non-recurring fee of $400,000 for services provided by NHM during the
      three months ended September 30,
2010.




·
            Increased
      stock-based compensation costs (a non-cash charge).  Stock-based
      compensation cost was $212,000 and $98,000 for the three months ended
      September 30, 2010 and September 30, 2009, respectively; and $568,000 and
      $350,000 for the nine months ended September 30, 2010 and September 30,
      2009, respectively.  See “Note 6 - Equity Incentive Plans” in
      Part I, Item 1 of this Form 10-Q.




The above
increases were partially offset by the following:




·
            Decreased
      investor relations efforts associated with DCT’s initiatives to reduce
      cash operating expenses;




·
            Decreased
      accounting fees associated with retaining the same independent accounting
      firm from year to year; and




·
            Decreased
      legal fees.





We
anticipate that selling, general and administrative expenses will continue to
fluctuate as our business continues to grow.  However, we continue to
work to offset these expenses by reducing overhead expenses and
streamlining operations.





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
decrease in research and development expenses during the three months ended
September 30, 2010 as compared to the three months ended September 30, 2009 was
primarily attributable to bringing research and development efforts in
house.  During the three months ended September 30, 2009, we were using
expensive outside consultants to enhance our product development.  However,
we were able to terminate the consultants as we hired full-time
engineers.   Additionally, during the three months ended
September 30, 2009, we incurred significant mechanical engineering design
expenses as new products were readied for production.  DCT incurred no
such mechanical design-related expenses during the three months ended September
30, 2010.




22




The
aforementioned decrease to research and development expenses was partially
offset by the increased stock-based compensation costs (a non-cash
charge).  Stock-based compensation cost was $32,000 and $14,000 for
the three months ended September 30, 2010 and September 30, 2009,
respectively.  See “Note 6 - Equity Incentive Plans” in Part I, Item 1
of this Form 10-Q.





The
increase in research and development expenses during the nine months ended
September 30, 2010 as compared to the nine months ended September 30, 2009 was
primarily attributable to by the increased stock-based compensation costs (a
non-cash charge).  Stock-based compensation cost was $95,000 and
$60,000 for the nine months ended September 30, 2010 and September 30, 2009,
respectively.  See “Note 6 - Equity Incentive Plans” in Part I, Item 1
of this Form 10-Q.





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 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.





Non-Operating
Income (Expense), Net




The most significant
componentof our
non-operating income (expense) during the three and ninemonths endedSeptember 30, 2010 was $232,000
non-cash expense related to the increased fair value of our stock option
liability.  See “Note 11–Fair Value”in Part I, Item 1 of this Form 10-Q.
Generally, DCTwill report
a non-cash expense during any accounting period in which there is a reported
increase in the value of the Company’s common stock as quoted on the OTC
Bulletin Board.   Other, less impactful, components includeinterest
expenseon our line of
credit andrealized loss
on foreign currency resulting from thecurrency fluctuation between theEuroandthe US dollar.  Additionally, the nine months ended
September 30, 2010 includes cash received as settlement for two lawsuits and
other legal issues.





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





Liquidity
and Capital Resources





At
September 30, 2010, principal sources of liquidity included cash and cash
equivalents of $3,937,000 and an available borrowing capacity of $1,786,000 on
our bank line of credit.





The
following table summarizes certain aspects of DCT’s liquidity (in thousands):





As
      of or for the Nine Months Ended September 30,2010
            
            
            2009Cash
      and cash equivalents
            
            $
            3,937
            
            
            $
            257Line
      of credit payable
            
            
            -
            
            
            
            (785
            )Working
      capital
            
            
            6,440
            
            
            
            2,120Cash
      provided (used) by operating activities
            
            
            525
            
            
            
            (812
            )Cash
      used by investing activities
            
            
            (52
            )
            
            
            (58
            )Cash
      provided by financing activities
            
            
            3,136
            
            
            
            722




Operating
activities:  During the nine months ended September 30, 2010,
our operating activities provided $525,000 of cash.  This was a result
of our $305,000 net loss, $1,092,000 of net non-cash expenses, and $262,000 net
cash used by changes in operating assets and liabilities.  During the
nine months ended September 30, 2009, our operating activities used $812,000 of
cash.  This was a result of our $505,000 net loss, $543,000 of net
non-cash expenses, and $850,000 net cash used by changes in operating assets and
liabilities.





Non-cash
items included in net loss are depreciation expense, stock-based compensation
cost of options, fair value of warrants issued for services rendered, change in
fair value of stock option liability, and amortization of debt
discount.  The largest change in operating assets and liabilities
during the nine months ended September 30, 2010 was the $765,000 increased
accounts receivable resulting from a significant cash collections effort during
December 2009.  This effort resulted in the early collection of
approximately $487,000 of receivables prior December 31, 2009.  Had we
not undertaken this early collection effort, the increase in accounts receivable
would have been a $278,000 use of cash, which is more in line with our sales.
The remaining changes in operating assets and liabilities during both the nine
months ended September 30, 2010 and 2009 were indicative of normal operational
fluctuations related to timing of product shipments, trade receivable
collections, inventory management, and timing of vendor payments.





Investing
activities:  Investing activities for both the nine months
ended September 30, 2010 and 2009 included capital purchases to support normal
business operations.





Financing
activities:  During the nine months ended September 30, 2010,
financing activities consisted of (i) $4,000,000 proceeds from the sale of our
common stock, less $27,000 of related stock issuance costs, (ii) $225,000 payoff
of our line of credit, (iii) $604,000 cash paid for the repurchase of our common
stock, and (iv) $8,000 deferred financing costs.  During the nine
months ended September 30, 2009, financing activities consisted of (i) $817,000
draw against our bank line of credit to meet short-term obligations incurred
during the normal course of business, and (ii) $75,000 cash payment upon the
maturity of our preferred stock





Cash
and Working Capital Requirements




With the
$4,000,000 NCR Investment during the three months ended September 30, 2010,
DCT’s financial position and strength significantly
improved.  Historically, DCT has actively controlled operating
expenses to align with current and projected net sales.  As such, DCT
anticipates using the NCR Investment to enhance DCT’s future product offering by
developing our core assets and intellectual property and expand into new market
segments. We believe the anticipated expansion into these new, but related,
market segments will complement DCT’s existing business.





We will
continue to focus on managing our existing expense infrastructure, which will
allow the most productive use of the NCR Investment.





Management
believes that current cash and other sources of liquidity are sufficient to fund
normal operations through the next 12 months.





Contractual
Obligations





The
following table summarizes our contractual obligations at September 30, 2010,
and the effect such obligations are expected to have on our liquidity and cash
flows in future periods (in
thousands):





Less
      Than
            
            
            One
      – Three
            
            
            Four
      – Five
            
            
            More
      than FiveTotal
            
            
            One
      Year
            
            
            Years
            
            
            Years
            
            
            YearsOperating
      lease obligations
            
            $
            1,109
            
            
            $
            109
            
            
            $
            437
            
            
            $
            540
            
            
            $
            23Total
      contractual cash obligations
            
            $
            1,109
            
            
            $
            109
            
            
            $
            437
            
            
            $
            540
            
            
            $
            23





23





Off-Balance
Sheet Arrangements





At
September 30, 2010, 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 10 -
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, 2010, which are likely to have a material effect on our future
liquidity.




24




Item
4 – Controls and Procedures





Evaluation
of Disclosure Controls and Procedures




Based on
management’s evaluation (with the participation of our Chief Executive Officer
(CEO) and Chief Financial Officer (CFO)), as of the end of the period
covered by this report, our CEO and CFO have concluded that our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934, as amended, (the Exchange Act)) are
effective to provide reasonable assurance that information required to be
disclosed by us in reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and forms and is accumulated and
communicated to management, including our principal executive officer and
principal financial officer, as appropriate to allow timely decisions regarding
required disclosure.





Changes
in Internal Controls over Financial Reporting




There
were no changes to our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the
period covered by this report that have materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.





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. 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 the effectiveness of controls 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 is 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, 2009 as filed with the Securities and
Exchange Commission on March 31, 2010.





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





Unregistered
Sales of Equity Securities





On August
5, 2010 (“Purchase Date”), DCT and NCR Corporation (“NCR”) entered into a Share
Purchase Agreement (“Purchase Agreement”), pursuant to which NCR purchased,
directly from DCT, 3,861,004 shares (“NCR Shares”) of the Company’s common stock
for an aggregate purchase price of $4,000,000.  Additionally, DCT
granted NCR a two-year option (“NCR Option”) to purchase up to an additional
$4,000,000 of Common Stock at an exercise price of $1.036 per
share.  Neither the NCR Shares nor the NCR Option have been registered
with the Securities and Exchange Commission.  However, NCR received
demand registration rights, subject to certain limitations, and unlimited
piggy-back registration rights with respect to the NCR Shares and any shares of
Common Stock issued upon exercise of the NCR Option.  The registration
rights terminate when all of the NCR Shares and any shares of Common Stock
issued upon exercise of the NCR Option may be sold pursuant to Rule 144 without
restriction or limitation, or, if earlier, on the fifth anniversary of the
Purchase Date.  The NCR Shares and NCR Options were issued to NCR
pursuant to Section 4(2) of the Securities Act of 1933, as amended.





The net
proceeds will be used to support the Company’s operations and the marketing and
promotion of its products, for product tooling and engineering, research and
development and strategic investments and transactions, and to otherwise fund
working capital for the Company’s operations.




Issuer
Purchases of Equity Securities





During
September 2010, DCT’s board of directors authorized DCT to repurchase (“DCT
Stock Repurchase Plan”) and retire $2,500,000 of its common stock in open market
transactions or in privately negotiated transactions pursuant to Rule 10b-18 of
the Securities Exchange Act of 1934, as amended.





The
authorization does not have an expiration date, does not require DCT to purchase
a specific number of shares and may be modified, suspended or terminated at any
time.





Total
      Number of Shares Purchased
            
            
            Average
      Price Paid per Share
            
            
            Total
      Number of Shares Purchased as
              Part
      of Publicly Announced Plans or Programs
            
            
            Maximum
      Dollar Value of Shares that May Yet Be Purchased Under the Plans or
      ProgramsJuly
      1 – July 31
            
            
            -
            
            
            
            
            
            
            -
            
            
            
            -August
      1 – August 31
            
            
            -
            
            
            
            
            
            
            -
            
            
            
            -September
      1 – September 30
            
            
            736,785
            
            
            $
            0.82
            
            
            
            736,785
            
            
            $
            1,896,000Total
            
            
            736,785
            
            
            $
            0.82
            
            
            
            736,785
            
            
            $
            1,896,000





26




Item
3 - Defaults Upon Senior Securities





None.





Item
5 - Other Information





None.




27




Item
6 - Exhibits





Exhibit
      Number
            
            Description
      of Exhibit
            
            Method
      of Filing10.1
            
            Lease
      Agreement by and between the Company and Washcop Limited Partners dated
      September 7, 2010
            
            Filed
      herewith10.2
            
            Form
      of Loan and Security Agreement, most recently amended November 2,
      1010,  by and between the Company and Bridge Bank, National
      Association
            
            Filed
      herewith31.1
            
            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




28




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
      15, 2010
              
              /s/
      David P. ClarkDavid
      P. Clark,
                Chief
      Executive Officer




Date:
      November 15, 2010
                
                /s/M. Carolyn
      EllisM.
      Carolyn Ellis
                    Chief
      Financial Officer
  29