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 June 30, 2010





 ̈
            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)


1798
Technology Drive


Suite
178


San
Jose, California 95110


(Address
of principal executive offices, Zip code)





408-436-9888
ext. 207


(Registrant’s
telephone number, including area code)





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    ̈





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   xNo   ̈





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   ̈ 
  Accelerated filer    ̈ 
 Non-accelerated filer   ̈ 
  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      ̈ 
    No    x





The
number of shares of Common Stock outstanding as of August 11, 2010 was
23,267,274.





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 JUNE 30, 2010




INDEX





PagePART
      I – FINANCIAL
      INFORMATIONItem
      1
                        Financial
      Statements
                        4Item
      2
                        Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                        16Item
      4
                        Controls
      and Procedures
                        22PART
      II – OTHER
      INFORMATIONItem
      1
                        Legal
      Proceedings
                        23Item
      1A
                        Risk
      Factors
                        23Item
      2
                        Unregistered
      Sales of Equity Securities and Use of Proceeds
                        23Item
      3
                        Defaults
      Upon Senior Securities
                        23Item
      4
                        Submission
      of Matters to a Vote of Security Holders
                        23Item
      5
                        Other
      Information
                        23Item
      6
                        Exhibits
                        23Signatures
                        24


- 3
-


PART
I.  FINANCIAL INFORMATION





Item
1 - Financial Statements





DOCUMENT
CAPTURE TECHNOLOGIES, INC.


CONDENSED
CONSOLIDATED BALANCE SHEETS


(in
thousands)





June 30,
                            
                            
                            December 31,2010
                            
                            
                            2009(unaudited)
                            
                            
                            *ASSETSCurrent
      assets:Cash
      and cash equivalents
                            
                            $
                            306
                            
                            
                            $
                            328Trade
      receivables
                            
                            
                            2,016
                            
                            
                            
                            1,497Inventories,
      net
                            
                            
                            1,331
                            
                            
                            
                            1,674Prepaid
      expenses and other current assets
                            
                            
                            88
                            
                            
                            
                            132Total
      current assets
                            
                            
                            3,741
                            
                            
                            
                            3,631Restricted
      cash
                            
                            
                            5
                            
                            
                            
                            5Other
      assets
                            
                            
                            21
                            
                            
                            
                            -Fixed
      assets, net
                            
                            
                            160
                            
                            
                            
                            176Total
      assets
                            
                            $
                            3,927
                            
                            
                            $
                            3,812LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Line
      of credit
                            
                            $
                            -
                            
                            
                            $
                            202Trade
      payables to related parties
                            
                            
                            147
                            
                            
                            
                            341Trade
      payables and other accrued expenses
                            
                            
                            405
                            
                            
                            
                            440Accrued
      compensation and benefits
                            
                            
                            117
                            
                            
                            
                            124Deferred
      revenue and customer deposits
                            
                            
                            50
                            
                            
                            
                            111Total
      current liabilities
                            
                            
                            719
                            
                            
                            
                            1,218Commitments
      and contingencies (Note 10)Stockholders’
      equity:Preferred
      stock $.001 par value, 2,000 authorized, 0 issued and Outstanding June 30,
      2010 and December 31, 2009Common
      stock $.001par value, 50,000 authorized, 19,406 shares issued and
      outstanding at June 30, 2010 and December 31, 2009
                            
                            
                            19
                            
                            
                            
                            19Additional
      paid-in capital
                            
                            
                            36,188
                            
                            
                            
                            35,697Accumulated
      deficit
                            
                            
                            (32,999
                            )
                            
                            
                            (33,122
                            )Total
      stockholders’ equity
                            
                            
                            3,208
                            
                            
                            
                            2,594Total
      liabilities and stockholders’ equity
                            
                            $
                            3,927
                            
                            
                            $
                            3,812





*Amounts
derived 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 June 30,
                  
                  
                  Six Months Ended June 30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Net
      sales
                  
                  $
                  3,302
                  
                  
                  $
                  3,002
                  
                  
                  $
                  6,730
                  
                  
                  $
                  5,017Cost
      of sales
                  
                  
                  2,022
                  
                  
                  
                  1,824
                  
                  
                  
                  4,125
                  
                  
                  
                  3,061Gross
      profit
                  
                  
                  1,280
                  
                  
                  
                  1,178
                  
                  
                  
                  2,605
                  
                  
                  
                  1,956Operating
      expenses:Selling,
      general and administrative
                  
                  
                  986
                  
                  
                  
                  911
                  
                  
                  
                  1,952
                  
                  
                  
                  2,100Research
      and development
                  
                  
                  279
                  
                  
                  
                  202
                  
                  
                  
                  544
                  
                  
                  
                  433Total
      operating expenses
                  
                  
                  1,265
                  
                  
                  
                  1,113
                  
                  
                  
                  2,496
                  
                  
                  
                  2,533Operating
      income (loss)
                  
                  
                  15
                  
                  
                  
                  65
                  
                  
                  
                  109
                  
                  
                  
                  (577
                  )Total
      other income (expense)
                  
                  
                  52
                  
                  
                  
                  1
                  
                  
                  
                  16
                  
                  
                  
                  1Net
      income (loss) before income taxes
                  
                  
                  67
                  
                  
                  
                  66
                  
                  
                  
                  125
                  
                  
                  
                  (576
                  )Provision
      for income taxes
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2
                  
                  
                  
                  -Net
      income (loss)
                  
                  
                  67
                  
                  
                  
                  66
                  
                  
                  
                  123
                  
                  
                  
                  (576
                  )Accretion
      of preferred stock redemption value
                  
                  
                  -
                  
                  
                  
                  (13
                  )
                  
                  
                  -
                  
                  
                  
                  (25
                  )Net
      income (loss) available to common stockholders
                  
                  $
                  67
                  
                  
                  $
                  53
                  
                  
                  $
                  123
                  
                  
                  $
                  (601
                  )Basic
      income (loss) per common share
                  
                  $
                  0.00
                  
                  
                  $
                  0.00
                  
                  
                  $
                  0.01
                  
                  
                  $
                  (0.03
                  )Diluted
      income (loss) per common share
                  
                  $
                  0.00
                  
                  
                  $
                  0.00
                  
                  
                  $
                  0.01
                  
                  
                  $
                  (0.03
                  )Weighted
      average common shares outstanding
                  
                  
                  19,406
                  
                  
                  
                  18,469
                  
                  
                  
                  19,406
                  
                  
                  
                  18,466Weighted
      average common shares outstanding, assuming dilution
                  
                  
                  24,285
                  
                  
                  
                  22,354
                  
                  
                  
                  24,285
                  
                  
                  
                  18,466


- 5
-


DOCUMENT
CAPTURE TECHNOLOGIES, INC.


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)


(in
thousands)





Six Months Ended
                  June 30,2010
                
                
                2009Operating
      activities:Net
      income (loss)
                
                $
                123
                
                
                $
                (576
                )Adjustments
      to reconcile net income (loss) to net cash provided (used) by operating
      activities:Depreciation
      expense included in operating expenses
                
                
                30
                
                
                
                27Depreciation
      expense included in cost of sales
                
                
                31
                
                
                
                -Stock-based
      compensation cost – options
                
                
                419
                
                
                
                298Fair
      value of common stock and warrants issued for services
      rendered
                
                
                72
                
                
                
                111Other
      non-cash income/expenses, net
                
                
                32
                
                
                
                (9
                )Changes in operating assets and liabilities:Trade
      receivables
                
                
                (519
                )
                
                
                (17
                )Inventories
                
                
                343
                
                
                
                360Prepaid
      expenses and other
                
                
                20
                
                
                
                (31
                )Trade
      payables to related parties
                
                
                (194
                )
                
                
                (277
                )Trade
      payables and other current liabilities
                
                
                (42
                )
                
                
                134Income
      taxes payable
                
                
                -
                
                
                
                (75
                )Deferred
      revenue and customer deposits
                
                
                (61
                )
                
                
                (49
                )Cash
      provided (used) by operating activities
                
                
                254
                
                
                
                (104
                )Investing
      activities:Capital
      expenditures
                
                
                (45
                )
                
                
                (55
                )Cash
      used by investing activities
                
                
                (45
                )
                
                
                (55
                )Financing
      activities:Net
      (payments) advanceson bank line of
      credit
                
                
                (225
                )
                
                
                1,216Deferred
      financing costs
                
                
                (6
                )
                
                
                -Cash
      (used) provided by financing activities
                
                
                (231
                )
                
                
                1,216Net
      (decrease) increase in cash and cash equivalents
                
                
                (22
                )
                
                
                1,057Cash
      and cash equivalents at beginning of period
                
                
                328
                
                
                
                405Cash
      and cash equivalents at end of period
                
                $
                306
                
                
                $
                1,462


- 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 June 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
-


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





Note
2 – Recent Accounting Pronouncements





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





In
October 2009, the FASB issued new standards for the accounting for certain
revenue arrangements that include software elements. These new standards amend
the scope of pre-existing software revenue guidance by removing from the
guidance non-software components of tangible products and certain software
components of tangible products. 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 its consolidated financial
statements.





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”).  SST currently holds approximately 16%
of DCT’s outstanding common stock.





Purchases
from SST totaled $1,632,000 and $3,486,000 for the three and six months ended
June 30, 2010, respectively, and $1,270,000 and $2,443,000 for the three and six
months ended June 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 $147,000 and $341,000 at June 30, 2010 and
December 31, 2009, respectively.





Net
Sales





During
the three and six months ended June 30, 2010, DCT recorded net sales totaling
$24,000 and $70,000, respectively, for finished scanners sold to SST.  The
related cost of sales was $21,000 and $60,000, respectively.


DCT had
no sales or cost of sales to SST during the three or six months ended June 30,
2009.  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 $24,000 for the three and six months ended June 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 $4,000 for both the three and six months ended June 30,
2010.





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





Stock
Option Grants and Amended Consulting Agreement





On April
29, 2010, the Company’s board of directors approved an amendment to the business
advisory and consulting agreement between the Company and each of Richard “Bo”
Dietl and Daniel DelGiorno (the “Consultants”) dated July 28, 2008, whereby in
addition to the services already being provided pursuant to the agreement, the
Consultants will provide investor relations services in exchange for options to
purchase up to 1,500,000 shares of the Company’s common stock at a price of
$0.30 per share.  The options vest over a two year period with 50% of such
options vesting at the end of the first and second years of the agreement;
however, in the event of a change of control in the Company’s securities or
assets pursuant to introductions specifically made by Consultants to the
Company, all of the options shall immediately vest 100% in conjunction with such
event.  A change of control shall be defined as a change of ownership of
50% or more of the Company’s securities, or voting control thereof, or a
transfer of more than 50% of the Company’s tangible and/or intangible
assets.  See Note 6 for discussion of the associated stock-based
compensation cost.





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 June 30, 2010, DCT had
consolidated balances of approximately $53,000, 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
                    June 30,
                  
                  
                  Six Months Ended
                    June 30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Customer
      A
                  
                  
                  17
                  %
                  
                  
                  12
                  %
                  
                  
                  11
                  %
                  
                  
                  11
                  %Customer
      B
                  
                  
                  16
                  
                  
                  
                  17
                  
                  
                  
                  18
                  
                  
                  
                  23Customer
      C
                  
                  
                  15
                  
                  
                  
                  19
                  
                  
                  
                  15
                  
                  
                  
                  19Customer
      D
                  
                  
                  11
                  
                  
                  
                  16
                  
                  
                  
                  19
                  
                  
                  
                  10Customer
      E
                  
                  
                  10
                  
                  
                  
                  *
                  
                  
                  
                  *
                  
                  
                  
                  *Customer
      F
                  
                  
                  *
                  
                  
                  
                  13
                  
                  
                  
                  *
                  
                  
                  
                  10





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





Trade
receivables from all significant customers at June 30, 2010 totaled
$1,631,000.  As of June 30, 2010, all the Company's trade receivables were
unsecured.


- 9
-


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
                    June 30,
                  
                  
                  Six Months Ended
                    June 30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Selling,
      general and administrative
                  
                  $
                  218
                  
                  
                  $
                  105
                  
                  
                  $
                  356
                  
                  
                  $
                  252Research
      and development
                  
                  
                  31
                  
                  
                  
                  13
                  
                  
                  
                  63
                  
                  
                  
                  46Total
                  
                  $
                  249
                  
                  
                  $
                  118
                  
                  
                  $
                  419
                  
                  
                  $
                  298





At June
30, 2010, DCT had approximately $1,869,000 of total unrecognized compensation
cost related to unvested stock options. This cost is expected to be recognized
over a weighted-average period of approximately 2.1 years.





Stock
Option Activity and Outstanding





DCT had
the following stock option activity during the six months ended June 30,
2010:





Options
                  
                  
                  Weighted-
                    Average
                    Exercise
                    PriceOutstanding at December 31, 2009
                  
                  
                  11,355,498
                  
                  
                  $
                  0.32Granted
                  
                  
                  2,700,000
                  
                  
                  
                  0.30Exercised
                  
                  
                  -
                  
                  
                  
                  -Cancelled
                  
                  
                  (311,000
                  )
                  
                  
                  (0.45
                  )Outstanding
      at June 30, 2010
                  
                  
                  13,744,498
                  
                  
                  $
                  0.31





The
following table summarizes all options outstanding and exercisable by price
range as of June 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
                    
                    
                    
                    1.82
                    
                    
                    $
                    0.01
                    
                    
                    
                    2,241,165
                    
                    
                    $
                    0.01$0.29
      - $0.35
                    
                    
                    9,603,333
                    
                    
                    
                    7.47
                    
                    
                    $
                    0.31
                    
                    
                    
                    1,534,583
                    
                    
                    $
                    0.30$0.60
      - $0.70
                    
                    
                    1,900,000
                    
                    
                    
                    6.55
                    
                    
                    $
                    0.69
                    
                    
                    
                    1,900,000
                    
                    
                    $
                    0.6913,744,498
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    5,675,748


- 10
-


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 $2,022,000 and
$788,000 at June 30, 2010 and December 31, 2009, respectively. The total
intrinsic value for exercisable options was $1,101,000 and $722,000 at June 30,
2010 and December 31, 2009, respectively. No options were exercised during the
six months ended June 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 six months ended June 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 and six months
ended June 30, 2010 and the three months ended June 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 and six
months ended June 30, 2010 and the three months ended June 30, 2009 is as
follows (in thousands, except
per share amounts):





Three Months Ended
                    June 30,
                  
                  
                  Six Months
                    Ended
                    June 30,2010
                  
                  
                  2009
                  
                  
                  2010Net
      income available to common shareholders (A)
                  
                  $
                  67
                  
                  
                  $
                  53
                  
                  
                  $
                  123Impact
      of convertible preferred stock
                  
                  
                  -
                  
                  
                  
                  13
                  
                  
                  
                  -Net
      income available to common shareholders used in diluted share calculation
      (B)
                  
                  $
                  67
                  
                  
                  $
                  66
                  
                  
                  $
                  123Weighted
      average common shares outstanding (C)
                  
                  
                  19,406
                  
                  
                  
                  18,469
                  
                  
                  
                  19,406Dilutive
      effect of convertible preferred stock
                  
                  
                  -
                  
                  
                  
                  441
                  
                  
                  
                  -Dilutive
      effect of warrants
                  
                  
                  64
                  
                  
                  
                  
                  
                  
                  
                  64Dilutive
      effect of employee equity incentive plans
                  
                  
                  4,815
                  
                  
                  
                  3,444
                  
                  
                  
                  4,815Weighted
      average common shares outstanding, assuming dilution
    (D)
                  
                  
                  24,285
                  
                  
                  
                  22,354
                  
                  
                  
                  24,285Basic
      earnings per common share (A)/(C)
                  
                  $
                  0.00
                  
                  
                  $
                  0.00
                  
                  
                  $
                  0.01Diluted
      earnings per common share (B)/(D)
                  
                  $
                  0.00
                  
                  
                  $
                  0.00
                  
                  
                  $
                  0.01




For the
three and six months ended June 30, 2010, DCT excluded 2,693,000 (5,445,000 for
the three months ended June 30, 2009) 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





DCT had
no common stock activity during the six months ended June 30, 2010.





DCT’s
Board of Directors approved the issuance of 25,000 restricted common shares to a
consultant for investor relations services rendered during the six months ended
June 30, 2009.  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 six months ended June 30,
2009.





Preferred
Stock





During
the three and six months ended June 30, 2009, DCT reported $13,000 and $25,000
of accretion of preferred stock redemption value associated with its series B
convertible redeemable preferred stock (“Series B Stock”), which matured August
7, 2009.  DCT had no other preferred stock activity during any period
presented.





Common
Stock Warrants





DCT had
the following common stock warrant activity during the six months ended June 30,
2010:





WarrantsOutstanding
      at December 31, 2009
                  
                  
                  2,002,027Expired
                  
                  
                  (1,209,000
                  )Issued
                  
                  
                  220,000Outstanding
      at June 30, 2010
                  
                  
                  1,013,027





In
certain instances, DCT issues warrants for consulting services.  DCT
amortizes the fair value of such warrants over the service period.  In
connection with such common stock warrants issued and outstanding, DCT charged
selling, general and administrative expense with the offset credit to additional
paid in capital for $32,000 and $72,000 during the three and six months ended
June 30, 2010, respectively, and $100,000 during the six months ended June 30,
2009.





DCT
estimated the fair value of the warrants issued under the Black-Scholes
valuation model using the following weighted average assumptions during the six
months ended June 30, 2010: contractual term of two years, 0.6% risk-free
interest rate, expected volatility of 285% and expected dividend yield of
0%.  Assumptions during the six months ended June 30, 2009 were: 
contractual term of three years, 1.8% risk-free interest rate, expected
volatility of 266% and expected dividend yield of 0%.





Note
9 – Bank Line of Credit





As of
June 30, 2010, DCT had a $2,000,000 line of credit (“LOC”) at a commercial
bank.  Borrowings under the LOC are limited to (i) 80% of eligible accounts
receivable less the aggregate face amount of all outstanding letters of credit,
cash management services, and foreign exchange contracts, and (ii) 40% of
eligible inventory (all as defined in the LOC agreement).  The interest
rate is prime (3.25% at June 30, 2010) plus 2.75% for advances drawn against
receivables, with a minimum interest rate of 6%; and prime plus 3.75% for
advances drawn against inventory, with a minimum interest rate of 7%. 
Interest payments are due monthly and all unpaid interest and principal is due
in full on September 2, 2010.





Upon
certain events of default (as defined in the LOC agreement), the default
variable interest rate increases five percentage points above the interest rate
applicable immediately prior to the default.  Additionally, the lender has
the right to declare all of the amounts due under the LOC immediately due and
payable upon an event of default.





As of
June 30, 2010, DCT was in compliance with all LOC debt covenants and had unused
borrowing capacity of $1,928,000.


- 12
-


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.   During March 2010, in connection with increasing
the LOC borrowing base, DCT paid the lender a loan modification fee of
$6,000.   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 has been amortized
over the life of the loan to interest expense.





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





The
Company recorded interest expense of $17,000 and $32,000 during the three
and six months ended June 30, 2010 in connection with the LOC warrants and
amortization of the LOC origination, modification and legal
fees.




Note
10 – Commitments and Contingencies




Operating
Leases




As of
June 30, 2010, our current office and warehouse facility leases were both
month-to-month with no future rental commitment.  We anticipated finalizing
a new lease, in a new co-located facility, by September 30, 2010.  The new
lease will (i) combine our corporate office and warehouse spaces, and (ii)
increase square footage to expand domestic production capabilities.




Employment
Agreements




DCT
maintains employment agreements with its executive officers which extend through
2010. The agreements provide for a base salary and annual bonus to be determined
by the Board of Directors.  The agreements also provide for termination
payments, stock options, non-competition provisions, and other terms and
conditions of employment. In addition, DCT maintains employment agreements with
other key employees with similar terms and conditions.  As of June 30,
2010, termination payments totaling $1,055,000 remain in effect.





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.  The customer has the right to cancel the contract at any
time without cause upon giving DCT two weeks’ notice (see Note 13). Upon
cancellation, 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.


At June
30, 2010, DCT had $36,000 of deferred revenue associated with the Development
Agreement.




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 – Settlement of Legal Proceedings





During
November 2007, a legal complaint was filed against DCT seeking declaratory
judgment that one of DCT’s patents is invalid and not infringed by the claimant
(“Claimant”).  The complaint (“Case A”) was filed in the U.S. District
Court, Northern District of California.


- 13
-


During
March 2007, DCT filed a legal complaint against Claimant seeking damages and
declaratory relief for breach of a license agreement between DCT and
Claimant.  The complaint (“Case B”) was filed in the U.S. District Court,
Northern District of California.





During
May 2010, DCT and Claimant entered into an agreement to (i) dismiss Case A
without prejudice, (ii) dismiss Case B with prejudice to both parties, and (iii)
settle other legal issues and disputes arising from Case A and Case B
(“Settlement”).  In connection with the Settlement, DCT received monies
from Claimant, which was recorded as non-operating income.





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 six months ended June 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):





ThreeMonthsEnded
                    June30,
                  
                  
                  SixMonthsEnded
                    June30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009U.S.
                  
                  $
                  3,088
                  
                  
                  $
                  2,836
                  
                  
                  $
                  6,193
                  
                  
                  $
                  4,547Europe and
      other
                  
                  
                  190
                  
                  
                  
                  156
                  
                  
                  
                  467
                  
                  
                  
                  460Asia
                  
                  
                  24
                  
                  
                  
                  10
                  
                  
                  
                  70
                  
                  
                  
                  10$
                  3,302
                  
                  
                  $
                  3,002
                  
                  
                  $
                  6,730
                  
                  
                  $
                  5,017





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





June30,2010
                  
                  
                  December31,
                    2009U.S.
                  
                  $
                  3,695
                  
                  
                  $
                  3,574Europe
                  
                  
                  161
                  
                  
                  
                  128Asia
                  
                  
                  71
                  
                  
                  
                  110$
                  3,927
                  
                  
                  $
                  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





Cancellation
of Development Agreement





On July
23, 2010, the aforementioned Development Agreement (see Note 10) was cancelled
by DCT’s customer.  DCT will continue to sell product under the OEM
Agreement.  During the third quarter of 2010, DCT anticipates
recognizing $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.


- 14
-


NCR
Purchase of Common Stock





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 (the “Shares”) of the Company’s
common stock, par value $.001 per share, (“Common Stock”) for an aggregate
purchase price of $4,000,000 (the “Investment”).  Additionally, DCT granted
NCR a two-year option (“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 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 Shares and any
shares of Common Stock issued upon exercise of the Option.  The
registration rights terminate when all of the Shares and any shares of Common
Stock issued upon exercise of the 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.





The
Option is exercisable at any time or from time to time for two years from the
Purchase Date. The exercise price of the 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 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 Option exercise price then in effect.





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.  DCT stockholders, who are party to
the Voting Agreement, agreed, in the event of any such designation, to vote
their shares of Company 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.





Concurrent
with the execution of the Purchase Agreement, DCT and NCR also amended their
existing Strategic Supplier Master Procurement Agreement (the “Reseller
Agreement”).  The Reseller Agreement, dated July 17, 2009, covers the
manufacture and sale by DCT to NCR, and the purchase and resale by NCR, of
specified scanning products.  The original Reseller Agreement had a
three-year term, which automatically renewed unless either party gave at least
180 days’ prior written notice.  The amendment extends the current term to
August 6, 2014, and provides, subject to certain exceptions, that DCT will not
sell, directly or indirectly, any products to any entity who engages in the
business of (i) operating or supplying remote deposit capture products, services
or functionality or (ii) operating or supplying product that facilitate the
scanning, transmitting, storage of electronic documents on a bank’s secure
server.


- 15
-


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.
      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 six months ended June 30, 2010 compared to
      the three and six months ended June 30, 2009.  A brief description of
      certain aspects, transactions and events is provided, including
      related-party transactions that impact the comparability of the results
      being analyzed.




·
            Liquidity
      and capital resources. This section provides an analysis of our
      financial condition and cash flows as of and for the six months ended June
      30, 2010 as compared to the six months ended June 30,
  2009.




·
            Contractual
      Obligations, Off-Balance-Sheet Arrangements, and Trends.As
      of June 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.




We are
currently negotiating a new lease that will (i) combine our corporate office and
warehouse spaces, and (ii) increase 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”).


- 16
-


Critical
Accounting Policies




Our
MD&A is based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires us
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an 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.


- 17
-


Results
of Operations





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





ThreeMonthsEndedJune30,
                  
                  
                  SixMonthsEndedJune30,2010
                  
                  
                  2009
                  
                  
                  $
                  
                  
                  %
                  
                  
                  2010
                  
                  
                  2009
                  
                  
                  $
                  
                  
                  %Net
      sales
                  
                  $
                  3,302
                  
                  
                  $
                  3,002
                  
                  
                  $
                  300
                  
                  
                  
                  10
                  %
                  
                  $
                  6,730
                  
                  
                  $
                  5,017
                  
                  
                  $
                  1,713
                  
                  
                  
                  34
                  %Cost
      of sales
                  
                  
                  2,022
                  
                  
                  
                  1,824
                  
                  
                  
                  198
                  
                  
                  
                  11
                  
                  
                  
                  4,125
                  
                  
                  
                  3,061
                  
                  
                  
                  1,064
                  
                  
                  
                  35As
      a percentage of sales
                  
                  
                  61
                  %
                  
                  
                  61
                  %
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  61
                  %
                  
                  
                  61
                  %Selling,
      general and administrative expense
                  
                  
                  986
                  
                  
                  
                  911
                  
                  
                  
                  75
                  
                  
                  
                  8
                  
                  
                  
                  1,952
                  
                  
                  
                  2,100
                  
                  
                  
                  (148
                  )
                  
                  
                  (7
                  )Research
      and development expense
                  
                  
                  279
                  
                  
                  
                  202
                  
                  
                  
                  77
                  
                  
                  
                  38
                  
                  
                  
                  544
                  
                  
                  
                  433
                  
                  
                  
                  111
                  
                  
                  
                  26Non-operating
      income (expense)
                  
                  
                  52
                  
                  
                  
                  1
                  
                  
                  NM
                  
                  
                  NM
                  
                  
                  
                  16
                  
                  
                  
                  1
                  
                  
                  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. Revenues rebounded during the remainder of 2009 and
have continued strong during the first two quarters of 2010.   As
such, revenues for both the three and the six months ended June 30, 2010 were
higher compared to the three and six months ended June 30, 2009. 
 Specifically, the increase in revenues is a result of increased number of
scanners sold; sales of scanners increased 3% and 40% for the three and six
months ended June 30, 2010 compared to the three and six months ended June 30,
2009.  Our average selling price fluctuated during both the three and six
months ended June 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 revenues as a percentage of revenues remain fairly
consistent:   6% for both the three months ended June 30, 2010 and
2009; and 8% and 9% for the six months ended June 30, 2010 and 2009,
respectively.  The majority of our international revenues 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 revenue
opportunities in many different international markets.





We have
successfully expanded our significant customer base.  And as a result,
total sales to significant customers (customers who represent more than 10% of
our net sales) decreased to 69% during the three months ended June 30, 2010 from
77% during the three months ended 2009; and decreased to 63% during the six
months ended June 30, 2010 from 73% during the six months ended June 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 revenue
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:


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-




·
            Mix
      of products sold;




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




·
            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 the three months
ended June 30, 2010 as compared to the three months ended June 30, 2009 was
primarily attributable to the following:




·
            Increased
      stock-based compensation costs (a non-cash charge).  Stock-based
      compensation cost was $218,000 and $105,000 for the three months ended
      June 30, 2010 and June 30, 2009, respectively.  See “Note 6 - 
       Employee Equity Incentive Plans” in Part I, Item 1 of this Form
      10-Q.




·
            Increased
      amortization of the fair value (a non-cash charge) of equity instruments
      issued for consulting services.  Amortization increased to $32,000
      during the three months ended June 30, 2010 from $0 during the three
      months ended June 30, 2009.  See “Note 8 - Equity” in Part I, Item 1
      of this Form 10-Q.




The above
increases were somewhat offset by our decreased investor relations expenses
associated with DCT’s initiatives to reduce cash operating
expenses.




The
decrease in selling, general and administrative expense during the six months
ended June 30, 2010 as compared to the six months ended June 30, 2009 was
primarily attributable to 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 increased research and development expense was primarily
attributable to increased personnel expenses, as our headcount during the three
and six months ended June 30, 2010 was double the headcount during the three and
six months ended June 30, 2009.


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-


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)





The most significant components of our
non-operating income (expense) during the three and six months ended June 30,
2010 were (i)Cash payment
received in June 2010 as settlement for twopending lawsuits and other legal
issues,
(ii) interest
expenseon our line of
credit, and
(iii) realized loss on foreign currency
resulting from the devaluation of the Euro against the US
dollar.





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





Liquidity
and Capital Resources





At June
30, 2010, principal sources of liquidity included cash and cash equivalents of
$306,000 and an available borrowing capacity of $1,928,000 on our bank line of
credit.  We had no significant cash outlays, except as part of our normal
operations, during the six months ended June 30, 2010 or June 30,
2009.





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





As of or for the Six
                    Months Ended June 30,2010
                  
                  
                  2009Cash
      and cash equivalents
                  
                  $
                  306
                  
                  
                  $
                  1,462Line
      of credit
                  
                  
                  -
                  
                  
                  
                  1,216Working
      capital
                  
                  
                  3,022
                  
                  
                  
                  1,616Cash
      provided (used) by operating activities
                  
                  
                  254
                  
                  
                  
                  (104
                  )Cash
      used by investing activities
                  
                  
                  (45
                  )
                  
                  
                  (55
                  )Cash
      (used) provided by financing activities
                  
                  
                  (231
                  )
                  
                  
                  1,216





Operating
activities:  During the six months ended June 30, 2010, our
operating activities provided $254,000 of cash.  This was a result of our
$123,000 net income, $584,000 of net non-cash expenses, and $453,000 net cash
used by changes in operating assets and liabilities.  During the six months
ended June 30, 2009, our operating activities used $104,000 of cash.  This
was a result of our $576,000 net loss, $427,000 of net non-cash expenses, and
$45,000 net cash provided 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, and
amortization of debt discount.  The most significant change in operating
assets and liabilities during the six months ended June 30, 2010 was the
$519,000 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 the early collection effort, the change
in accounts receivable would have only been a $32,000 use of cash. The remaining
changes in operating assets and liabilities during both the six months ended
June 30, 2010 and 2009 were indicative of the normal operational fluctuations
related to the timing of product shipments, trade receivable collections,
inventory management, and timing of vendor payments.





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





Financing
activities:  During the six months ended June 30, 2010, financing
activities consisted of (i) negotiating an increase to our existing line of
credit borrowing base, and (ii) $225,000 pay off of our line of credit. 
During the six months ended June 30, 2009, financing activities consisted of a
$1,216,000 draw against our bank line of credit to meet short-term obligations
incurred during the normal course of business.


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-


Cash
and Working Capital Requirements





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





Our
current line of credit matures on September 2, 2010.  Our current lender
has already communicated the desire to extend DCT’s current credit facility
through September 2011.  Although management believes DCT will be able to
obtain an additional line of credit upon maturity of the existing line of
credit, there is no guarantee that DCT will be able to secure a line of credit
on terms that are acceptable to DCT.





Contractual
Obligations




As of
June 30, 2010, our office and warehouse leases were both month-to-month with no
future rental commitment.  We anticipate finalizing a new lease by
September 30, 2010.  The new lease will (i) combine our corporate office
and warehouse spaces, and (ii) increase square footage to expand domestic
production capabilities.  The expected contractual obligations are
summarized (in
thousands):




Less Than
                    
                    
                    One – Three
                    
                    
                    More than
                      ThreeTotal
                    
                    
                    One Year
                    
                    
                    Years
                    
                    
                    YearsBank
      line of credit (1)
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    -Expected
      operating lease obligations
                    
                    
                    1,657
                    
                    
                    
                    229
                    
                    
                    
                    1,030
                    
                    
                    
                    398Total
      contractual cash obligations
                    
                    $
                    1,657
                    
                    
                    $
                    229
                    
                    
                    $
                    1,030
                    
                    
                    $
                    398





(1) As of
June 30, 2010, we had $0 balance on our $2,000,000 bank line of credit
(“LOC”).  Borrowings under the LOC are limited to (i) 80% of eligible
accounts receivable less the aggregate face amount of all outstanding letters of
credit, cash management services, and foreign exchange contracts, and (ii) 40%
of eligible inventory (all as defined in the LOC agreement).  The interest
rate is prime (3.25% at June 30, 2010) plus 2.75% for advances drawn against
receivables, with a minimum interest rate of 6%; and prime plus 3.75% for
advances drawn against inventory, with a minimum interest rate of 7%. 
Interest payments are due monthly and all unpaid interest and principal is due
in full on September 2, 2010.





Upon
certain events of default (as defined in the LOC agreement), the default
variable interest rate increases five percentage points above the interest rate
applicable immediately prior to the default.  Additionally, the lender has
the right to declare all of the amounts due under the LOC immediately due and
payable upon an event of default.





As of
June 30, 2010, we were in compliance with all LOC debt covenants and had unused
borrowing capacity of $1,928,000.




Off-Balance
Sheet Arrangements





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


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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





As of
March 31, 2010, our CEO and CFO concluded that our disclosure controls and
procedures were not effective as of March 31, 2010 for the sole reason that
DCT’s Board of Directors did not include an independent financial expert. 
Effective June 8, 2010, DCT added an independent financial expert to its Board
of Directors, which resulted in effective, comprehensive, entity-level internal
controls.  With the addition of the newly appointed independent financial
expert, our CEO and CFO were able to conclude that internal controls were
effective as of June 30, 2010.





There
were no changes, other than as discussed above, in our internal controls over
financial reporting that occurred during the quarterly 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.


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PART
II.  OTHER INFORMATION





Item
1 - Legal Proceedings





During
November 2007, a legal complaint was filed against DCT seeking declaratory
judgment that one of DCT’s patents is invalid and not infringed by the claimant
(“Claimant”).  The complaint (“Case A”) was filed in the U.S. District
Court, Northern District of California.





During
March 2007, DCT filed a legal complaint against Claimant seeking damages and
declaratory relief for breach of a license agreement between DCT and
Claimant.  The complaint (“Case B”) was filed in the U.S. District Court,
Northern District of California.





During
May 2010, DCT and Claimant entered into an agreement to (i) dismiss Case A
without prejudice, (ii) dismiss Case B with prejudice to both parties, and (iii)
settle other legal issues and disputes arising from Case A and Case B
(“Settlement”).  In connection with the Settlement, DCT received monies
from Claimant, which was recorded as non-operating income.





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





None.





Item
3 - Defaults Upon Senior Securities





None.





Item
5 - Other Information





None.





Item
6 - Exhibits





Exhibit
                  Number
                
                DescriptionofExhibit
                
                MethodofFiling31.1
                
                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


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-


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:
      August 11, 2010/s/David P.
      ClarkDavid
      P. Clark, Chief Executive OfficerDate:
      August 11, 2010/s/ M. Carolyn EllisM.
      Carolyn EllisChief
      Financial Officer


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-