**UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION**





Washington,
      D.C. 20549





**FORM
      10-QSB**





**QUARTERLY
      REPORT UNDER SECTION 13 OR 15(D)**


**OF
      THE SECURITIES EXCHANGE ACT OF 1934**


**FOR
      THE QUARTERLY PERIOD ENDED JUNE 30, 2006**





Commission
      File Number 0-21816





**INFINITE
      GROUP, INC.**


(Exact
      name of small business issuer as specified in its charter)




Delaware
            52-1490422(State
                or other jurisdiction
              of
                incorporation or organization)
            (I.R.S.
                Employer
              Identification
                No.)




60
      Office Park Way


Pittsford,
      New York 14534


(Address
      of principal executive office)





(585)
      385-0610


(Issuer’s
      telephone number, including area code)





Check
      whether the issuer: (1) filed all reports required to be filed by Section 13
      or
      15(d) of the Exchange Act during the past 12 months (or for such shorter period
      that the issuer was required to file such reports), and (2) has been subject
      to
      such filing requirements for the past 90 days.      Yes
xNo o





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





Number
      of
      shares outstanding of each of the issuer's classes of common equity, as of
      the
      latest practicable date: As of August 7, 2006, there were 22,034,965 shares
      of
      common stock outstanding.





Transitional
      Small Business Disclosure Format.      Yes o No x









INFINITE
      GROUP, INC.


**FORM
      10-QSB REPORT**





Infinite
      Group, Inc.





TABLE
      OF
      CONTENTS





**PAGE**PART
                I –FINANCIAL INFORMATIONItem
                1.
            Consolidated
                Financial StatementsBalance
                Sheet - June 30, 2006 (unaudited) and December 31, 2005
                (audited)
            
            3Statements
                of Operations-(unaudited) for the three and six month periods ended
                June
                30, 2006 and 2005
            
            4Statements
                of Cash Flows-(unaudited) for the six month periods ended June 30,
                2006
                and 2005
            
            5Notes
                to Consolidated Financial Statements
            
            6Item
                2.
            Management’s
                Discussion and Analysis or Plan of Operations
            
            11Item
                3.
            Controls
                and Procedures
            
            21PART
                II – OTHER INFORMATIONItem
                1.
            Legal
                Proceedings
            
            22Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            
            22Item
                3.
            Defaults
                Upon Senior Securities
            
            22Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            
            22Item
                5.
            Other
                Information
            
            22Item
                6.
            Exhibits
            
            22SIGNATURES
            
            
            23




**FORWARD-LOOKING
      STATEMENTS**




Certain
      statements made in this Quarterly Report on Form 10-QSB are “forward-looking
      statements” regarding the plans and objectives of management for future
      operations and market trends and expectations. Such statements involve known
      and
      unknown risks, uncertainties and other factors that may cause our actual
      results, performance or achievements to be materially different from any future
      results, performance or achievements expressed or implied by such
      forward-looking statements. The forward-looking statements included herein
      are
      based on current expectations that involve numerous risks and uncertainties.
      Our
      plans and objectives are based, in part, on assumptions involving the continued
      expansion of our business. Assumptions relating to the foregoing involve
      judgments with respect to, among other things, future economic, competitive
      and
      market conditions and future business decisions, all of which are difficult
      or
      impossible to predict accurately and many of which are beyond our control.
      Although we believe that our assumptions underlying the forward-looking
      statements are reasonable, any of the assumptions could prove inaccurate and,
      therefore, there can be no assurance that the forward-looking statements
      included in this report will prove to be accurate. In light of the significant
      uncertainties inherent in the forward-looking statements included herein, the
      inclusion of such information should not be regarded as a representation by
      us
      or any other person that our objectives and plans will be achieved. We undertake
      no obligation to revise or update publicly any forward-looking statements for
      any reason. The terms “we”, “our”, “us”, or any derivative thereof, as used
      herein refer to Infinite Group, Inc., a Delaware corporation, and its
      predecessors.


2


**PART
      I**


**FINANCIAL
      INFORMATION**


**Item
      1. Financial Statements**





**INFINITE
                GROUP, INC.****Consolidated
                Balance Sheets****June
                30,**
            
            **December
                31,****2006**
              **(Unaudited)**
            
            **2005**
              **(Audited)****ASSETS****Current
                assets:**Cash
            
            **$**
            **76,258**
            
            $
            109,090Accounts
                receivable, net of allowance of $53,000 ($53,000 - 2005)
            
            
            **315,356**
            
            
            875,538Notes
                receivable, current portion
            
            
            **4,732**
            
            
            4,746Inventories
            
            
            **26,677**
            
            
            24,664Prepaid
                expenses and other current assets
            
            
            **59,220**
            
            
            49,516Total
                current assets
            
            
            **482,243**
            
            
            1,063,554**Property
                and equipment, net**
            
            
            **178,173**
            
            
            190,520**Software
                development costs, net**
            
            
            **190,383**
            
            
            207,348**Other
                assets:**Notes
                receivable
            
            
            **75,894**
            
            
            78,439Deposits
            
            
            **19,523**
            
            
            16,703Total
                other assets
            
            
            **95,417**
            
            
            95,142Total
                assets
            
            **$**
            **946,216**
            
            $
            1,556,564**LIABILITIES
                AND STOCKHOLDERS’ DEFICIENCY****Current
                liabilities:**Note
                payable
            
            
            **30,000**
            
            
            30,000Accounts
                payable
            
            
            **166,349**
            
            
            412,100Accrued
                pension and retirement
            
            
            **209,244**
            
            
            152,050Accrued
                payroll
            
            
            **175,245**
            
            
            186,863Accrued
                interest payable
            
            
            **136,911**
            
            
            118,913Accrued
                expenses-other
            
            
            **72,919**
            
            
            60,977****Current
                maturities of long-term obligations-bank
            
            
            **36,695**
            
            
            12,778**Total
                current liabilities**
            
            
            **827,363**
            
            
            973,681**Long-term
                obligations:**Bank
                notes payable
            
            
            **20,238**
            
            
            50,600Notes
                payable-related parties
            
            
            **1,160,124**
            
            
            1,260,124Accrued
                pension expense
            
            
            **2,465,012**
            
            
            2,405,612Total
                liabilities
            
            
            **4,472,737**
            
            
            4,690,017Commitments
                and contingencies**Stockholders’
                deficiency:**Common
                stock, $.001 par value, 60,000,000 (20,000,000 - 2005) shares authorized;
                22,034,965 (19,856,881 - 2005) shares issued and
                outstanding
            
            
            **22,035**
            
            
            19,857Additional
                paid-in capital
            
            
            **28,785,525**
            
            
            28,523,334Common
                stock, no shares authorized, not issued (175,084 - 2005)
            
            
            **—**
            
            
            56,028Accumulated
                deficit
            
            
            **(29,287,226**
            **)**
            
            (28,685,817
            )Accumulated
                other comprehensive loss
            
            
            **(3,046,855**
            **)**
            
            (3,046,855
            )Total
                stockholders’ deficiency
            
            
            **(3,526,521**
            **)**
            
            (3,133,453
            )Total
                liabilities and stockholders’ deficiency
            
            **$**
            **946,216**
            
            $
            1,556,564See
                notes to consolidated financial statements.





3







**INFINITE
                GROUP, INC.****Consolidated
                Statements of Operations (Unaudited)****Six
                Months Ended**
            
            **Three
                Months Ended****June
                30,**
            
            **June
                30,****2006**
            
            **2005**
            
            **2006**
            
            **2005****Sales**
            
            **$**
            **2,964,002**
            
            $
            4,134,550
            
            **$**
            **1,340,566**
            
            $
            2,009,823Cost
                of services
            
            
            **2,354,776**
            
            
            2,886,028
            
            
            **1,048,917**
            
            
            1,371,147**Gross
                profit**
            
            
            **609,226**
            
            
            1,248,522
            
            
            **291,649**
            
            
            638,676Costs
                and expenses:General
                and administrative
            
            
            **614,205**
            
            
            710,335
            
            
            **240,967**
            
            
            353,944Selling
            
            
            **816,191**
            
            
            140,072
            
            
            **403,657**
            
            
            139,178Research
                and development
            
            
            **140,710**
            
            
            161,924
            
            
            **72,588**
            
            
            90,243Depreciation
                and amortization
            
            
            **43,627**
            
            
            23,749
            
            
            **30,588**
            
            
            12,568Write-off
                of capitalized financing costs
            
            
            **—**
            
            
            44,857
            
            
            **—**
            
            
            44,857Total
                costs and expenses
            
            
            **1,614,733**
            
            
            1,080,937
            
            
            **747,800**
            
            
            640,790**Operating
                income (loss)**
            
            
            **(1,005,507**
            **)**
            
            167,585
            
            
            **(456,151**
            **)**
            
            (2,114
            )Other
                income (expense):Interest
                income
            
            
            **501**
            
            
            66,255
            
            
            **233**
            
            
            32,193Interest
                expense:Related
                parties
            
            
            **(58,035**
            **)**
            
            (44,333
            )
            
            **(28,739**
            **)**
            
            (22,476
            )Other
            
            
            **(29,156**
            **)**
            
            (146,650
            )
            
            **(15,522**
            **)**
            
            (79,656
            )****Total
                interest expense
            
            
            **(87,191**
            **)**
            
            (190,983
            )
            
            **(44,261**
            **)**
            
            (102,132
            )Other
                income-settlement of litigation
            
            
            **498,088**
            
            
            —
            
            
            —
            
            
            —Total
                other income (expense)
            
            
            **411,398**
            
            
            (124,728
            )
            
            **(44,028**
            **)**
            
            (69,939
            )Income
                (loss) from continuing operations before income tax expense
            
            
            **(594,109**
            **)**
            
            42,857
            
            
            **(500,179**
            **)**
            
            (72,053
            )Income
                tax expense
            
            
            **(7,300**
            **)**
            
            (1,300
            )
            
            **—**
            
            
            —**Income
                (loss) from continuing operations**
            
            
            **(601,409**
            **)**
            
            41,557
            
            
            **(500,179**
            **)**
            
            (72,053
            )**Discontinued
                operations:**Income
                from discontinued operations
            
            
            **—**
            
            
            12,233
            
            
            **—**
            
            
            4,979Net
                income (loss)
            
            **$**
            **(601,409**
            **)**
            $
            53,790
            
            **$**
            **(500,179**
            **)**
            $
            (67,074
            )Net
                income (loss) per share-basic:Income
                (loss) from continuing operations
            
            **$**
            **(.03**
            **)**
            $
            .00
            
            **$**
            **(.02**
            **)**
            $
            (.00
            )Income
                (loss) from discontinued operations
            
            
            **.00**
            
            
            .00
            
            
            **.00**
            
            
            .00Net
                income (loss)
            
            **$**
            **(.03**
            **)**
            $
            .00
            
            **$**
            **(.02**
            **)**
            $
            (.00
            )Net
                income (loss) per share-diluted:Income
                (loss) from continuing operations
            
            **$**
            **(.03**
            **)**
            $
            .00
            
            **$**
            **(.02**
            **)**
            $
            (.00
            )Income
                (loss) from discontinued operations
            
            
            **.00**
            
            
            .00
            
            
            **.00**
            
            
            .00Net
                income (loss)
            
            **$**
            **(.03**
            **)**
            $
            .00
            
            **$**
            **(.02**
            **)**
            $
            (.00
            )Weighted
                average number of shares outstanding:Basic
            
            
            **20,397,940**
            
            
            18,910,805
            
            
            **20,933,053**
            
            
            19,206,965Diluted
            
            
            **20,397,940**
            
            
            20,181,583
            
            
            **20,933,053**
            
            
            19,206,965See
                notes to consolidated financial statements.




4




**INFINITE
                GROUP, INC.****Consolidated
                Statements of Cash Flows (Unaudited)****For
                the Six Months Ended****June
                30,****2006**
            
            **2005****Operating
                activities:**Net
                income (loss)
            
            **$**
            **(601,409**
            **)**
            $
            53,790Adjustments
                    to reconcile net income (loss) to net cash provided by (used
                    in) operating
                    activities:Stock
                based compensation
            
            
            **107,921**
            
            
            **—**Depreciation
                and amortization
            
            
            **43,627**
            
            
            24,019Income
                from discontinued operations
            
            
            **—**
            
            
            (12,233
            )Write-off
                of capitalized financing costs
            
            
            **—**
            
            
            44,587(
                Increase) decrease in:Accounts
                receivable
            
            
            **560,182**
            
            
            (230,552
            )Inventories
            
            
            **(2,013**
            **)**
            
            (23,239
            )Other
                assets
            
            
            **(12,524**
            **)**
            
            (12,000
            )Increase
                (decrease) in:Accounts
                payable
            
            
            **(245,751**
            **)**
            
            35,195Accrued
                expenses
            
            
            **18,322**
            
            
            233,498Accrued
                pension and retirement
            
            
            **116,594**
            
            
            107,489**Net
                cash provided by (used in) operating activities of continuing
                operations**
            
            
            **(15,051**
            **)**
            
            220,554**Net
                cash provided by operating activities of discontinued
                operations**
            
            
            **—**
            
            
            854**Net
                cash provided by (used in) operating activities**
            
            
            **(15,051**
            **)**
            
            221,408**Investing
                activities:**Purchase
                of property and equipment
            
            
            **(14,315**
            **)**
            
            (53,615
            )Proceeds
                from notes receivable
            
            
            **2,559**
            
            
            2,137,307Decrease
                in restricted funds
            
            
            **—**
            
            
            30,327**Net
                cash provided by (used in) investing activities**
            
            
            **(11,756**
            **)**
            
            2,114,019**Financing
                activities:**Net
                repayments of bank notes payable
            
            
            **(6,445**
            **)**
            
            (50,207
            )Proceeds
                from issuance of common stock, net of costs
            
            
            **420**
            
            
            80,000Repayments
                of long-term obligations
            
            
            **—**
            
            
            (2,123,555
            )Net
                repayments of notes payable-other
            
            
            **—**
            
            
            (757
            )**Net
                cash provided by (used in) financing activities**
            
            
            **(6,025**
            **)**
            
            (2,094,519
            )Net
                increase (decrease) in cash
            
            
            **(32,832**
            **)**
            
            240,908Cash
                - beginning of period
            
            
            **109,090**
            
            
            97,297Cash
                - end of period
            
            **$**
            **76,258**
            
            $
            338,205Supplemental
                disclosure:Cash
                paid for:Interest
            
            **$**
            **71,894**
            
            $
            103,196Income
                taxes
            
            **$**
            **7,300**
            
            $
            1,300See
                notes to consolidated financial statements.




5




**INFINITE
      GROUP INC.**





**Notes
      to Consolidated Financial Statements (Unaudited)**





**Note
      1. Basis of Presentation**





The
      accompanying unaudited consolidated financial statements of Infinite Group
      Inc.
      (“Infinite Group Inc.” or the “Company”), included herein have been prepared by
      the Company in accordance with accounting principles generally accepted in
      the
      United States of America (U.S.) for interim financial information and with
      instructions to Form 10-QSB. Accordingly, they do not include all of the
      information and footnotes required by accounting principles generally accepted
      in the U.S. for complete financial statements. In the opinion of management,
      all
      adjustments considered necessary for a fair presentation have been included.
      All
      such adjustments are of a normal recurring nature. The accompanying unaudited
      consolidated financial statements should be read in conjunction with the
      Company’s audited consolidated financial statements and footnotes for the year
      ended December 31, 2005 and the notes thereto included in the Company’s Annual
      report on Form 10-KSB filed with the U.S. Securities and Exchange Commission
      (SEC). Results of consolidated operations for the six month period ended June
      30, 2006 are not necessarily indicative of the operating results to be attained
      in the year ending December 31, 2006. The consolidated financial statements
      herein include the accounts of the Company and its wholly owned subsidiaries.
      All material inter-company accounts and transactions have been eliminated in
      consolidation.





**Note
      2. Summary of Significant Accounting Policies**




**Critical
      Accounting Policies and Estimates**




There
      are
      several accounting policies that we believe are significant to the presentation
      of our consolidated financial statements. These policies require management
      to
      make complex or subjective judgments about matters that are inherently
      uncertain. Note 3 to our December 31, 2005 audited consolidated financial
      statements presents a summary of significant accounting policies.




The
      Company reclassified certain prior year amounts to conform with the current
      year’s presentation.




**Note
      3. Discontinued Operations and Reclassifications**





The
      statements of operations and cash flows for the three and six months ended
      June
      30, 2006 and 2005 account for the discontinued operations of the Photonics
      Group, consisting of Infinite Photonics, Inc. (IPI), which business was
      suspended in 2002 as a result of the loss of the DARPA contract as discussed
      below.





On
      October 30, 2002, IPI received a Notice of Termination of its DARPA contract
      for
      the government's convenience under the contract provisions entitled Termination,
      Federal Acquisition Regulation (FAR) 52.249.6. The DARPA contract had provided
      substantially all of the revenue of the Photonics Group. As of December 31,
      2004, the contract termination process was substantially complete. We have
      been
      reimbursed for substantially all costs associated with the termination.





In
      accordance with FASB 144, the disposal of the Photonics segment has been
      accounted for as a disposal of business segment and accordingly, the operating
      results are segregated and reported as discontinued operations in the
      accompanying consolidated statements of operations and cash flows and consist
      of
      income from discontinued operations of $12,233 for the six months ended June
      30,
      2005.




6




**Note
      4. Stock Option Plans**





As
      of
      June 30, 2006 the Company’s Stock Option Plans (the “Plan”) provided for the
      grant of incentive (ISO’s) or non-qualified stock options (non-ISO’s) for the
      purchase of common stock for up to 5,623,500 shares to employees, directors
      and
      consultants. The Plan is administered by the compensation committee established
      by the Company’s board of directors, which determines the terms of the options
      including the exercise price, expiration date, number of shares, and vesting
      provisions.




In
      December 2004, the Financial Accounting Standards Board issued SFAS 123R,
      Share-Based Payment (“SFAS 123R”). SFAS 123R supersedes SFAS 123, Accounting for
      Stock Based Compensation, and Accounting Principles Board Opinion 25, Accounting
      for Stock Issued to Employees (“APB 25) and its related implementation guidance.
      On January 1, 2006, we adopted the provisions of SFAS 123R using the modified
      prospective transition method. Under this method, the Company is required to
      record compensation expense for all stock based awards granted after the date
      of
      adoption and for the unvested portion of previously granted awards that remain
      outstanding as of the beginning of the adoption. Prior period financial
      statements have not been restated. Under SFAS 123R, compensation expense related
      to stock based payments is recorded over the requisite service period based
      on
      the grant date fair value of the awards.




Prior
      to
      the adoption of SFAS 123R, the Company accounted for employee stock options
      using the intrinsic value method in accordance with APB 25. Accordingly, no
      compensation expense was recognized for stock options issued to employees as
      long as the exercise price is greater than or equal to the market value of
      the
      common stock at the date of grant. In accordance with SFAS 123, the Company
      disclosed the summary of pro forma effects to reported net income or net loss
      as
      if the Company had elected to recognize compensation costs based on the fair
      value of the awards at the grant date.




The
      compensation cost that has been charged against income for options granted
      under
      the plans was $72,942 and $96,527, respectively, for the three and six months
      ended June 30, 2006. The impact of this expense was to increase basic and
      diluted net loss per share from $(.02) to $(.03) for the six months ended June
      30, 2006. There was no effect on loss per share for the three months ended
      June
      30, 2006. The adoption of SFAS 123R did not have an impact on cash flows from
      operating or financing activities. For stock options issued as Non-ISO’s , a tax
      deduction is not allowed for income tax purposes until the options are
      exercised. The amount of this deduction will be the difference between the
      fair
      value of the Company’s common stock and the exercise price at the date of
      exercise. Accordingly, there is a deferred tax asset recorded related for the
      tax effect of the financial statement expense recorded. The tax effect of the
      income tax deduction in excess of the financial statement expense will be
      recorded as an increase to additional paid-in capital. Due to the uncertainty
      of
      the Company’s ability to generate sufficient taxable income in the future to
      utilize the tax benefits of the options granted, the Company has recorded a
      valuation allowance to reduce its gross deferred tax asset to zero. As a result,
      for the six months ended June 30, 2006, there is no income tax expense impact
      from recording the fair value of options granted. No tax deduction is allowed
      for stock options issued as ISO’s.




The
      Company used volatility of 71% when computing the value of stock options and
      warrants issued during the three months ended June 30, 2006 and 100% for options
      issued during the three months ended March 31, 2006. This is based on a
      combination of both historical and implied volatility since the historical
      volatility has trended downward especially during the period from July 2005,
      when the Company brought current its public information in filings with the
      SEC.
      In addition, the Company’s volume of shares traded has increased in the past
      several months which the Company believes has provided more liquidity and less
      volatility than was previously experienced. The expected dividend yield is
      zero
      percent and the expected life of the options is ten years. The risk-free rate
      for periods within the contractual life of the option is based on the U.S.
      Treasury yield curve in effect at the time of grant and ranged from 4.42% to
      5.11% for the six months ended June 30, 2006.  The
      Company recorded expense for options and warrants issued to employees and
      independent service providers for the three and six months ended June 30, 2006
      as follows:




Three
                Months ended
            
            Six
                Months endedJune
                30, 2006
            
            June
                30, 2006Employee
                stock options
            
            $
            72,942
            
            $
            96,527Consultant
                stock options
            
            
            1,504
            
            
            3,009Warrants
            
            
            4,193
            
            
            8,385Total
                expense
            
            $
            78,639
            
            $
            107,921




7





A
      summary
      of all stock option activity for six months ended June 30, 2006
      follows:





**Number
                of Options**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**
            
            **Weighted-Average
                Remaining Contractual Term**
            
            **Aggregate
                Intrinsic Value**Outstanding
                at December 31, 2005
            
            
            4,020,900
            
            $
            .16Options
                granted
            
            
            830,000
            
            $
            .41Options
                expired
            
            
            (921,900
            )
            $
            .15Options
                exercised
            
            
            (3,000
            )
            $
            .14Outstanding
                at June 30, 2006
            
            
            3,926,000
            
            $
            .22
            
            
            8.3
                years
            
            $
            621,200Exercisable
                at June 30, 2006
            
            
            3,331,333
            
            $
            .19
            
            
            8.1
                years
            
            $
            600,267





The
      weighted average fair value of options granted during the six months ended
      June
      30, 2006 was approximately $.34 ($.10 during the six months ended June 30,
      2005). The total intrinsic value of options exercised during the six months
      ended June 30, 2006 was $480 and no options were exercised during the six months
      ended June 30, 2005.





A
      summary
      of the status of nonvested stock option activity for the six months ended June
      30, 2006 follows:


**Nonvested
                Shares**
            
            **Shares**
            
            **Weighted
                Average**
              **Fair
                Value**
              **at
                Grant Date**Nonvested
                at December 31, 2005
            
            
            50,666
            
            $
            .22Granted
            
            
            830,000
            
            
            .34Vested
            
            
            (276,667
            )
            
            .34Forfeited
            
            
            (9,332
            )
            
            .29Nonvested
                at June 30, 2006
            
            
            594,667
            
            $
            .34




At
      June
      30, 2006, there was approximately $181,000 of total unrecognized compensation
      cost related to non-vested options granted under the plan. That cost is expected
      to be recognized over a weighted average period of 1.8 years. The total fair
      value of shares vested during the six months ended June 30, 2006 was
      approximately $94,000.




Prior
      to
      2006, the Company had adopted the disclosure-only provisions of Statement of
      Financial Accounting Standards (SFAS) No. 123 -“Accounting for Stock-Based
      Compensation, “ and, accordingly the financial statements for the three and six
      months ended June 30, 2005 have not been restated. Had compensation expense
      for
      employee stock options granted under the plan been determined based on the
      fair
      value at the grant date consistent with SFAS 123R, the Company’s pro forma net
      income and loss per share from continuing operations would have changed as
      follows for the three and six months ended June 30, 2005.


8





Three
                Months Ended
              June
                30, 2005
            
            Six
                Months Ended
              June
                30, 2005Net
                income (loss) - as reported (000’s)
            
            $
            (67
            )
            $
            54Total
                stock based employee compensation expense determined under the fair
                value
                method for all awards (000’s)
            
            
            (119
            )
            
            (251
            )Net
                (loss) - pro forma (000’s)
            
            $
            (186
            )
            $
            (197
            )Income
                (loss) per share as reported - basic and diluted
            
            $
            (.00
            )
            $
            .00Loss
                per share pro forma - basic and diluted
            
            $
            (.01
            )
            $
            (.01
            )





**Note
      5. Business Segments**





Prior
      to
      2002, the Company’s business was organized, managed and internally reported as
      three segments. The segments were determined based on differences in products,
      production processes and internal reporting. During the fourth quarter of 2002,
      our contract with DARPA was terminated and as **** a
      result
      of the termination, management decided to suspend the activities of the
      Photonics Group in 2002 and liquidate the remaining assets. During the fourth
      quarter of the year ended December 31, 2003, we approved the sale of the assets
      and certain liabilities of our Laser Fare, Inc. (LFI) subsidiary, referred
      to as
      the Laser Group. As a result, in accordance with FASB 144, the disposal of
      the
      Photonics and Laser segments have been accounted for a s disposals of business segments and accordingly, the operating results were
      segregated and reported as discontinued operations.





Beginning
      in 2003, the Company revised its business strategy and began operating its
      newly
      formed IT Services Group., which is organized, managed and internally reported
      as one segment, the IT Services Group.





All
      of
      our business segments of the Company operate entirely within the U.S. There
      were
      no revenues from customers in foreign countries during 2005 and 2006. The
      Company relies on inter-segment cooperation and management does not represent
      that these segments, if operated independently, would report the results shown.





A
      summary
      of selected consolidated information for the Company’s industry segments during
      the periods ended June 30, 2005 is set forth as follows.


Photonics
                    Group
                
                Laser
                    Group
                
                IT
                    Services Group
                
                ConsolidatedThree
                    Months ended June 30, 2005Sales
                    to unaffiliated customers
                
                $
                —
                
                $
                —
                
                $
                2,009,823
                
                $
                2,009,823Operating
                    loss
                
                $
                —
                
                $
                (46,486
                )
                $
                44,372
                
                $
                (2,114
                )Income
                    from discontinued operations
                
                $
                4,979
                
                $
                —
                
                $
                —
                
                $
                4,979Six
                    Months ended June 30, 2005Sales
                    to unaffiliated customers
                
                $
                —
                
                $
                —
                
                $
                4,134,550
                
                $
                4,134,550Operating
                    income (loss)
                
                $
                —
                
                $
                (48,087
                )
                $
                215,672
                
                $
                167,585Income
                    from discontinued operations
                
                $
                12,233
                
                $
                —
                
                $
                —
                
                $
                12,233


9





**Note
      6. Supplemental Cash Flow Information**





Non-cash
      investing and financing transactions, including non-monetary exchanges, consist
      of the following:





**Six
                Months Ended****June 30,****2006**
            
            **2005**Conversion
                of notes payable to commonstock
            
            **$**
            **100,000**
            
            $
            —Conversion
                of accounts payable to commonstock
            
            **$**
            —
            
            $
            2,250





**Note
      7. Earnings Per Share**





Basic
      income per share is based on the weighted average number of common shares
      outstanding during the periods presented. Diluted income per share is based
      on
      the weighted average number of common shares outstanding, as well as dilutive
      potential common shares which, in the Company’s case, comprise shares issuable
      under stock options and stock warrants. Stock options with exercise prices
      that
      exceed the average fair value of the Company’s common stock had an antidilutive
      effect and therefore, were excluded from the computation of earnings per share.
      The treasury stock method is used to calculate dilutive shares, which reduces
      the gross number of dilutive shares by the number of shares purchasable from
      the
      proceeds of the options assumed to be exercised. In a loss period, the
      calculation for basic and diluted earnings per share is considered to be the
      same, as the impact of potential common shares is anti-dilutive.





The
      following table sets forth the computation of basic and diluted earnings per
      share for the period with net income from continuing operations as
      follows:




Six
                Months EndedJune 30, 2005Numerator:Income
                available to common stockholders
            
            $
            53,790Weighted
                average shares outstanding
            
            
            18,910,805Denominator
                for diluted income per share:Weighted
                average shares outstanding
            
            
            18,910,805Common
                stock options and stock warrants
            
            
            1,270,778Weighted
                average shares and conversions
            
            
            20,181,583





For
      the
      three and six months ended June 30,
      2006 and three months ended June 30, 2005 all outstanding stock options,
      warrants and convertible debt have not been considered common stock equivalents
      because their assumed exercise would be anti-dilutive. The converible debt
      became eligible for conversuion during the second quarter of 2006.  If the
      Company had generated earnings during the three and six months ended June 30,
      2006 and three months ended June 30, 2005, 8,794,621, 5,334,160
      and 1,148,807 common stock equivalent shares, respectively, would have been
      added to the weighted average shares outstanding. These additional shares
      represent the assumed exercise of common stock options, warrants and convertible
      debt whose exercise price is less than the average of the Company’s stock during
      the period. The proceeds of the exercise are assumed to be used to purchase
      common shares for treasury and the incremental shares are added to the weighted
      average shares outstanding.


10





**Item
      2.**  **Management’s
      Discussion and Analysis or Plan of Operations**





**Overview**





Beginning
      in the second quarter of 2003 we commenced operations in the field of
      information technology (IT) consulting services and biometric technology, and
      we
      opened an office in the Washington, DC metropolitan area. In March 2006, we
      opened a regional office in Jackson, Mississippi with the objective of
      developing new business in the Gulf Coast area of the U.S. We
      now
      provide business and technology integration and systems support primarily to
      U.S. government clients. We focus on aligning business processes with technology
      for delivery of solutions to meet our clients’ exact needs and providing expert
      management services to the lifecycle of technology-based projects.





We
      sold
      or closed our prior businesses on or before December 31, 2004. We are now solely
      focused in the fields of IT consulting services and biometric
      technology.





The
      following discussion relates to the businesses that were sold or closed and
      the
      current effect on our operations and financial position.





**Osley
      & Whitney, Inc. Retirement Plan**





Since
      our
      sale of Osley & Whitney, Inc. (O&W) in 2002, we have remained the
      sponsor of the O&W Retirement Plan. At June 30, 2006, the O&W defined
      benefit pension plan had an accrued pension obligation liability of $2,465,012
      and an accumulated other comprehensive loss of $3,046,855 which we recorded
      as a
      reduction of stockholders’ equity. The market value of plan assets increased
      from $3,315,524 at December 31, 2005 to $3,333,005 at June 30, 2006. The
      increase was comprised of an investment return of $240,218 offset by payment
      of
      benefits of $202,510 and expenses paid of $20,227 during the six months ended
      June 30, 2006.





We
      were
      required to contribute amounts in 2004, 2005 and 2006 and are required to make
      contributions in future years to fund the deficiency. We did not make
      contributions during 2004 and 2006 and we currently do not have the funds
      available to make the required contributions which currently approximate $1.4
      million. During 2005, we made a cash contribution of $6,439 and contributed
      500,000 shares of our common stock, which were valued on the contribution date
      at $175,000 using the closing market price. We recorded defined benefit pension
      expenses (including professional services and interest costs) associated with
      the O&W defined benefit retirement plan of approximately $92,000 and
      $123,000 for the six months ended June 30, 2006 and 2005, respectively. In
      March
      2005, we filed a funding waiver application requesting waivers of the minimum
      funding standard for the 2005 plan year of $513,551 and for the 2004 plan year
      of $979,328 (which includes quarterly cash disbursements aggregating
      approximately $455,000 for the year ended December 31, 2004 and unfunded prior
      year amounts). During 2006, we provided additional information for consideration
      in connection with our waiver application. During 2006, we changed the
      investment manager with the objective of improving the plan’s investment
      performance. We are now awaiting request for additional information or a
      response to our application.




**IT
      Consulting and Biometric Strategy**





Our
      IT
      services include strategic staffing, program management, project management,
      network services, technical engineering, software development, and enterprise
      resource planning. Beginning in 2003, we have entered into several subcontract
      agreements with a number of prime contractors to several U.S. government
      agencies.


11





In
      December 2003, we were awarded a Federal Supply Schedule Contract by the U.S.
      General Services Administration (GSA) for IT consulting services. Having a
      GSA
      Contract allows us to compete for and secure prime contracts with all executive
      agencies of the U.S. Government as well as other national and international
      organizations. We have one prime contract under GSA. Our GSA Schedule 70 was
      expanded and extended in June 2006 to encompass 85 different labor categories
      for a three year term.





In
      2003,
      we entered into a two year License Agreement with Ultra-Scan Corporation, a
      privately held technology company headquartered in Buffalo, New York, which
      was
      automatically extended for another two year period. The License Agreement gives
      us the ability to use, market and sell certain proprietary fingerprint
      recognition technology. We have completed the development of an access control
      terminal and related software called Touch-ThruTM incorporating that technology.
      We intend to market and sell that product beginning in 2006 in a variety of
      industries and markets, including the federal, state and local government,
      health care, travel and general security and access control. We have delivered
      demonstration units for trial by certain prospective customers and are engaging
      in other marketing and sales activities.




**Future
      Trends**




We
      believe that our operations, as currently structured, together with our current
      financial resources, will result in improved financial performance in future
      years. We may raise additional debt or equity capital to fund our operations
      during the periods in which we incur losses and develop new business
      opportunities.




There
      is
      no assurance, that our current resources will be adequate to fund the
      liabilities for the O&W retirement plan or our current operations and
      business expansion or that we will be successful in raising additional working
      capital. Our failure to raise necessary working capital could force us to
      curtail operations, which would have a material adverse effect on our financial
      condition and results of operations.




**Results
      of Operations**





**Comparison
      of Three Months ended June 30, 2006 and 2005**





The
      following table compares our statement of operations data for the three months
      ended June 30, 2006 and 2005. We commenced the operations of our IT Services
      Group in the second quarter of 2003. The trends suggested by this table are
      not
      indicative of future operating results due to the relatively short track record
      that we have in focusing on the IT Services Group **.** We
      reclassified certain prior year amounts to conform to the current year’s
      presentation.


12




Three
                  Months Ended June 30,As
                  a % of Net
              
              
              
              As
                  a % of Net
              
              Increase2006
              
              Sales
              
              2005
              
              Sales
              
              (Decrease)Sales
              
              $
              1,340,566
              
              
              100.0
              %
              $
              2,009,823
              
              
              100.0
              %
              
              (33.3
              )%Cost
                  of services
              
              
              1,048,917
              
              
              78.2
              
              
              1,371,147
              
              
              68.2
              
              
              (23.5
              )Gross
                  profit
              
              
              291,649
              
              
              21.8
              
              
              638,676
              
              
              31.8
              
              
              (54.3
              )General
                  and administrative
              
              
              240,967
              
              
              18.0
              
              
              353,944
              
              
              17.6
              
              
              (31.9
              )Selling
              
              
              403,657
              
              
              30.1
              
              
              139,178
              
              
              6.9
              
              
              190.0Research
                  and development
              
              
              72,588
              
              
              5.4
              
              
              90,243
              
              
              4.5
              
              
              (19.6
              )Depreciation
                  and amortization
              
              
              30,588
              
              
              2.3
              
              
              12,568
              
              
              0.6
              
              
              143.4Write-off
                  of capitalized financing costs
              
              
              —
              
              
              —
              
              
              44,857
              
              
              2.2Total
                  operating expenses
              
              
              747,800
              
              
              55.8
              
              
              640,790
              
              
              31.9
              
              
              16.7Operating
                  loss
              
              
              (456,151
              )
              
              (34.0
              )
              
              (2,114
              )
              
              (0.1
              )
              
              21,477.3Net
                  interest expense
              
              
              (44,028
              )
              
              (3.3
              )
              
              (69,939
              )
              
              (3.5
              )
              
              (37.0
              )Net
                  loss from continuing operations
              
              
              (500,179
              )
              
              (37.3
              )
              
              (72,053
              )
              
              (3.6
              )
              
              594.2Income
                  from discontinued operations
              
              
              —
              
              
              —
              
              
              4,979
              
              
              0.2Net
                  loss
              
              $
              (500,179
              )
              
              (37.3
              )%
              $
              (67,074
              )
              
              (3.3
              )%
              
              645.7
              %Net
                  loss per share-basic
              
              $
              (.02
              )
              
              
              
              $
              (.00
              )




**Sales**





Sales
      for
      the three months ended June 30, 2006 were $1,340,566 which was a decrease of
      $669,257 or 33.3% as compared to sales for the three months ended June 30,
      2005
      of $2,009,823.





In
      March
      2006, one of our subcontracts for services to the U.S. government ended when
      required additional funds were not approved. We earned approximately $2.2
      million or 26% of our revenue from this subcontract during the year ended
      December 31, 2005. One other subcontract had staffing reductions. Due to the
      nature of certain of our contracts, contract terminations occur when projects
      are completed or when appropriations of funds are used and new appropriations
      are not approved. We have submitted proposals and have identified opportunities
      for other new contracts to replace sales that do not continue in the ordinary
      course of business, as well as to increase our sales.





When
      we
      experience contract terminations or reductions in customer staffing
      requirements, we attempt to identify other revenue generating project
      opportunities with our existing prime contractors or others to redeploy those
      employees who are no longer providing billable services. In March 2006, in
      response to the termination of the contract discussed above, we placed several
      formerly billable employees on unpaid leave, realigned positions of our business
      development staff, and redirected our selling and marketing activities towards
      those opportunities that heighten the probability of increased sales in 2006,
      while preserving our long term business development initiatives.





We
      are
      actively pursuing opportunities to develop additional sales in new and existing
      target markets. In March 2006 we opened a regional office in Jackson,
      Mississippi, and hired a new business development employee to pursue state
      and
      local government business opportunities within the Gulf Coast region. We also
      retained a lobbying firm to assist us in that effort. Moreover, we are also
      channeling energies towards forming alliances with large systems integrators,
      who are mandated by federal policy to direct defined percentages of their work
      to small business subcontractors. In addition, we are currently working on
      proposals for contract awards that we believe will enhance our posture as a
      government contractor.




We
      are
      focusing on a tactical program that seeks to grow business with existing clients
      and a strategic program that aligns us with major procurement activity for
      long
      term growth. We terminated our former business development director during
      the
      fiscal quarter ended March 31, 2006 and hired a new business development
      director, who commenced employment on June 1, 2006, in our Vienna, Virginia
      office with the objective of increasing our sales. We are recruiting new
      employees to fill positions in our expanded service provider role with a major
      subcontractor to the U.S. government. We expect to begin earning additional
      sales based on new project engagements beginning in the quarter ending September
      30, 2006 and thereafter.


13





Early
      successes in our 2006 initiatives are evident in the preferred relationships
      we
      have earned with several large systems integrators and one major product house.
      In addition, we are a member of one of only seven teams that won the U.S. Army’s
      recent Strategic Services Sourcing (S3) Government-Wide Acquisition Contract.
      Under our agreement with the prime contractor, we are identified as a primary
      Earned Value Management resource, as well as a provider of network and software
      services. However, although our future prospects are robust, the lengthy
      government financing and procurement processes may result in temporary operating
      losses until sales increases to support our infrastructure and provides
      consistent profitability.





**Cost
      of Services and Gross Profit**





Cost
      of
      services represents the cost of employee services related to the IT Services
      Group. Cost of services for the three months ended June 30, 2006 was $1,048,917
      or 78.2% of sales as compared to $1,371,147 or 68.2% of sales for the three
      months ended June 30, 2005. Gross profit was $291,649 or 21.8% of sales for
      the
      three months ended June 30, 2006 compared to $638,676 or 31.8% of sales for
      the
      three months ended June 30, 2005. The decrease in gross profit is due to a
      change in the mix of our business resulting from the termination of one
      contract, a reduction in staffing for another contract, and the costs of
      employees who did not generate billable sales after contract reductions. In
      addition, we recorded $2,503 as cost of services as a result of adopting SFAS
      123R in 2006. Although our objective is to maintain an overall gross margin
      of
      approximately 30%, in the future we may submit bids on new work with lower
      gross
      profit margins to generate opportunities for long-term, larger volume contracts
      and more stable sales.





**General
      and Administrative Expenses**





General
      and administrative expenses include corporate overhead such as compensation
      and
      benefits for administrative and finance personnel, rent, insurance, professional
      fees, travel, and office expenses. General and administrative expenses for
      the
      three months ended June 30, 2006 were $240,967 which was a decrease of $112,977
      or 31.9% as compared to $353,944 for the three months ended June 30, 2005.
      As a
      percentage of sales, general and administrative expenses were 18% for the three
      months ended June 30, 2006 as compared to 17.6% for the three months ended
      June
      30, 2005. We anticipate that general and administrative expenses will increase
      as we continue to grow our business and incur travel and other expenses
      associated with managing a larger business. In 2006, we experienced a decrease
      in accounting and legal expenses as a result of completing audits of our
      financial statements and related regulatory filings in 2005. In addition, we
      recorded $5,739 as expense for the three months ended June 30, 2006 as a result
      of adopting SFAS 123R.





General
      and administrative expenses include expenses (including professional services
      and interest costs) associated with the O&W defined benefit retirement plan
      of approximately $48,000 for each of the three months ended June 30, 2006 and
      2005.




**Selling
      Expenses**





For
      the
      three months ended June 30, 2006 we incurred selling expenses of $403,657
      associated with growing business in our IT Services Group as compared to
      $139,178 for the three months ended June 30, 2005. Beginning in the second
      quarter of 2005, we added new employees and changed the work assignment of
      one
      employee and added sales consultants to focus on generating new sales leads
      and
      new contract opportunities **.** Selling
      expenses consist of our business development staff including salaries, benefits,
      sales consultants, and travel expenses. As a result of the termination of one
      subcontract during the first quarter of 2006, we reduced certain salaried
      selling positions. In the second quarter of 2006, we hired new business
      development personnel, including a new business development director. We expect
      to add additional sales personnel in the future as sales increase or as specific
      new sales opportunities are realized. We recorded $64,700 as expense for the
      three months ended June 30, 2006 as a result of adopting SFAS 123R. We incurred
      additional expenses in 2006 associated with our new business development efforts
      in the Gulf Coast region.


14




**Research
      and Development**





For
      the
      three months ended June 30, 2006 we continued to incur research and development
      expenses associated with growing business in our IT Services Group related
      to
      our biometrics applications and recorded $72,588 of expense compared to $90,243
      for the three months ended June 30, 2005, a decrease of $17,655. These expenses
      are principally related to the development of an access control terminal and
      related software called TouchThruTM. As the product development phase of
      TouchThruTM is completed, we expect related development expenses to decrease. We
      expect to incur selling and marketing expenses in the future as we develop
      sales
      of this product.





TouchThruTM
      is a self-contained terminal enabling physical access control using biometric
      identification. It incorporates fingerprint matching technology licensed from
      Ultra-Scan Corporation, a private technology company headquartered in Buffalo,
      New York. TouchThruTM will be the first biometric product we introduce, and we
      intend to be in a position to market and sell that product this year. We plan
      to
      market and sell TouchThruTM in a variety of industries and markets, including the
      federal, state and local government, health care, travel and general security,
      and access control. During the three months ended June 30, 2006, we delivered
      demonstration units for trial by certain prospective customers.





**Depreciation
      and Amortization**





Depreciation
      and amortization expense was $30,588 (including $14,250 of amortization of
      software development costs) for the three months ended June 30, 2006 compared
      to
      $12,568 for the three months ended June 30, 2005. This increase is due to
      depreciation of equipment and software that were added in 2005 and 2006 and
      amortization of software development costs as we begin to place TouchThruTM
demonstration units with prospective customers.





**Write-off
      of Capitalized Closing Costs**





In
      the
      second quarter of 2005, the buyer of the assets and businesses of LFI obtained
      new bank financing. The buyer paid all of its notes receivables to us, which
      proceeds were used to pay off all of LFI’s bank promissory notes and LFI’s
      capital lease obligation. As a result we wrote off the balance of LFI’s
      capitalized financing costs of $44,857.





**Operating
      Loss**





For
      the
      three months ended June 30, 2006 our operating loss was $(456,151) compared
      to
      an operating loss of $(2,114) for the three months ended June 30, 2005; an
      increase of $454,037. This is principally attributable to four
      factors. **** First,
      our sales declined from $2,009,823 in 2005 to $1,340,566 in 2006, a decrease
      of
      $669,257; second, our gross profit declined by $347,027; third, our selling
      expenses increased by $264,479; and fourth, these changes were offset in part
      by
      a decrease in general and administrative expenses of $112,977.





The
      non-recurring write-off of capitalized financing costs of $44,857 recorded
      in
      the three months ended June 30, 2005 had a significant impact in the reduction
      of net operating income to a net operating loss of $(2,114) for the three months
      ended June 30, 2005.





**Net
      Interest Expense**





Net
      interest expense consists of interest income offset by interest expense on
      indebtedness and fees for financing accounts receivable invoices. Net interest
      expense was $44,028 for the three months ended June 30, 2006 compared to net
      interest expense of $69,939 for the three months ended June 30, 2005. The
      reduction in net interest expense of $25,911 was principally due to a decrease
      in the volume of accounts receivable invoices that were financed in
      2006.




**Income
      from Discontinued Operations**





We
      recorded income from discontinued operations of $4,979 for the three months
      ended June 30, 2005. The income is the result of the Photonics Group which
      was
      reclassified as discontinued operations.


15





**Net
      Loss**





For
      the
      three months ended June 30, 2006, ** we
      recorded a net loss from continuing operations and a net loss each in the amount
      of $(500,179) or $(.02) per share. This compares to a net loss from continuing
      operations of $(72,053) or $(.00) per share and a net loss of $(67,074) or
      $(.00) per share for the three months ended June 30, 2005 *.*





The
      increase in net loss of $433,105 is principally attributable to a decrease
      in
      gross profit of $347,027 and an increase in selling expenses of $264,479, which
      were offset in part by decrease in general and administrative expenses of
      $112,977. We recorded expense of $72,942 for the three months ended June 30,
      2006 as a result of adopting SFAS 123R in 2006 and expense of $5,697 for the
      three months ended June 30, 2006 as a result of warrants and stock options
      issued to consultants.





**Comparison
      of Six Months ended June 30, 2006 and 2005**





The
      following table compares our statement of operations data for the six months
      ended June 30, 2006 and 2005. We commenced the operations of our IT Services
      Group in the second quarter of 2003. The trends suggested by this table are
      not
      indicative of future operating results due to the relatively short track record
      that we have in focusing on the IT Services Group **.** We
      reclassified certain prior year amounts to conform to the current year’s
      presentation.




Six
                  Months Ended June 30,As
                  a % of Net
              
              
              
              As
                  a % of Net
              
              Increase2006
              
              Sales
              
              2005
              
              Sales
              
              (Decrease)Sales
              
              $
              2,964,002
              
              
              100.0
              %
              $
              4,134,550
              
              
              100.0
              %
              
              (28.3
              )%Cost
                  of services
              
              
              2,354,776
              
              
              79.4
              
              
              2,886,028
              
              
              69.8
              
              
              (18.4
              )Gross
                  profit
              
              
              609,226
              
              
              20.6
              
              
              1,248,522
              
              
              30.2
              
              
              (51.2
              )General
                  and administrative
              
              
              614,205
              
              
              20.7
              
              
              710,335
              
              
              17.2
              
              
              (13.5
              )Selling
              
              
              816,191
              
              
              27.5
              
              
              140,072
              
              
              3.4
              
              
              482.7Research
                  and development
              
              
              140,710
              
              
              4.7
              
              
              161,924
              
              
              3.9
              
              
              (13.1
              )Depreciation
                  and amortization
              
              
              43,627
              
              
              1.5
              
              
              23,749
              
              
              0.6
              
              
              83.7Write-off
                  of capitalized financing costs
              
              
              —
              
              
              0.0
              
              
              44,857
              
              
              1.1Total
                  operating expenses
              
              
              1,614,733
              
              
              54.5
              
              
              1,080,937
              
              
              26.1
              
              
              49.4Operating
                  income (loss)
              
              
              (1,005,507
              )
              
              (33.9
              )
              
              167,585
              
              
              4.1
              
              
              (700.0
              )Net
                  interest expense
              
              
              (86,690
              )
              
              (2.9
              )
              
              (124,728
              )
              
              (3.0
              )
              
              (30.5
              )Other
                  income
              
              
              498,088
              
              
              16.8
              
              
              —
              
              
              0.0Income
                  tax expense
              
              
              (7,300
              )
              
              (0.2
              )
              
              (1,300
              )
              
              (0.0
              )
              
              461.5Net
                  income (loss) from continuing operations
              
              
              (601,409
              )
              
              (20.3
              )
              
              41,557
              
              
              1.0
              
              
              (1,547.2
              )Income
                  from discontinued operations
              
              
              —
              
              
              0.0
              
              
              12,233
              
              
              0.3
              
              
              (100.0
              )Net
                  income (loss)
              
              $
              (601,409
              )
              
              (20.3
              )%
              $
              53,790
              
              
              1.3
              %
              
              (1,218.1
              )%Net
                  income (loss) per share-basic and diluted
              
              $
              (0.03
              )
              
              
              
              $
              0.00


**Sales**





Sales
      for
      the six months ended June 30, 2006 were $2,964,002 which was a decrease of
      $1,170,548 or 28.3% as compared to sales for the six months ended June 30,
      2005
      of $4,134,550. In March 2006, one of our subcontracts for services to the U.S.
      government ended when required additional funds were not approved. We earned
      approximately $2.2 million or 26% of our revenue from this subcontract during
      the year ended December 31, 2005. One other subcontract had staffing reductions.
      Due to the nature of certain of our contracts, contract terminations occur
      when
      projects are completed or when appropriations of funds are used and new
      appropriations are not approved. We have submitted proposals and have identified
      opportunities for other new contracts to replace sales that do not continue
      in
      the ordinary course of business, as well as to increase our
      sales.


16





When
      we
      experience contract terminations or reductions in customer staffing
      requirements, we attempt to identify other revenue generating project
      opportunities with our existing prime contractors or others to redeploy those
      employees who are no longer providing billable services. In March 2006, in
      response to the termination of the contract discussed above, we placed several
      formerly billable employees on unpaid leave, realigned positions of our business
      development staff, and redirected our selling and marketing activities towards
      those opportunities that heighten the probability of increased sales in 2006,
      while preserving our long term business development initiatives.





We
      are
      actively pursuing opportunities to develop additional sales in new and existing
      target markets. In March 2006 we opened a regional office in Jackson,
      Mississippi, and hired a new business development employee to pursue state
      and
      local government business opportunities within the Gulf Coast region. We also
      retained a lobbying firm to assist us in that effort. Moreover, we are also
      channeling energies towards forming alliances with large systems integrators,
      who are mandated by federal policy to direct defined percentages of their work
      to small business subcontractors. In addition, we are currently working on
      proposals for contract awards that we believe will enhance our posture as a
      government contractor.




We
      are
      focusing on a tactical program that seeks to grow business with existing clients
      and a strategic program that aligns us with major procurement activity for
      long
      term growth. We terminated our former business development director during
      the
      fiscal quarter ended March 31, 2006 and hired a new business development
      director, who commenced employment on June 1, 2006, in our Vienna, Virginia
      office with the objective of increasing our sales. We are recruiting new
      employees to fill positions in our expanded service provider role with a major
      subcontractor to the U.S. government. We expect to begin earning additional
      sales beginning in the quarter ending September 30, 2006 and
      thereafter.





Early
      successes in our 2006 initiatives are evident in the preferred relationships
      we
      have earned with several large systems integrators and one major product house.
      In addition, we are a member of one of only seven teams that won the U.S. Army’s
      recent Strategic Services Sourcing (S3) Government-Wide Acquisition Contract.
      Under our agreement with the prime contractor, we are identified as a primary
      Earned Value Management resource, as well as a provider of network and software
      services. However, although our future prospects are robust, the lengthy
      government financing and procurement processes may result in temporary operating
      losses until sales increases to support our infrastructure and provides
      consistent profitability.





**Cost
      of Services and Gross Profit**





Cost
      of
      services represents the cost of employee services related to the IT Services
      Group. Cost of services for the six months ended June 30, 2006 was $2,354,776
      or
      79.4% of sales as compared to $2,886,028 or 69.8% of sales for the six months
      ended June 30, 2005. Gross profit was $609,226 or 20.6% of sales for the six
      months ended June 30, 2006 compared to $1,248,552 or 30.2% of sales for the
      six
      months ended June 30, 2005.





The
      decrease in gross profit is due to a change in the mix of our business resulting
      from the termination of one contract, a reduction in staffing for another
      contract, and the costs of employees who did not generate billable revenue
      after
      contract reductions. In addition, we recorded $16,595 as cost of services as
      a
      result of adopting SFAS 123R in 2006. Although our objective is to maintain
      an
      overall gross margin of approximately 30%, in the future we may submit bids
      on
      new work with lower gross profit margins to generate opportunities for
      long-term, larger volume contracts and more stable sales.




**General
      and Administrative Expenses**




General
      and administrative expenses include corporate overhead such as compensation
      and
      benefits for administrative and finance personnel, rent, insurance, professional
      fees, travel, and office expenses. General and administrative expenses for
      the
      six months ended June 30, 2006 decreased by $96,130 or 13.5%. In 2006, we
      experienced a decrease in accounting and legal expenses as a result of
      completing audits of our financial statements and related regulatory filings
      in
      2005.





As
      a
      percentage of sales, general and administrative expense was 20.7% for the six
      months ended June 30, 2006 and 17.2% for the six months ended June 30, 2005.
      We
      anticipate that general and administrative expenses will increase as we continue
      to implement our business strategy and incur travel and other expenses
      associated with managing a larger business. In addition, we recorded $7,023
      as
      expense for the six months ended June 30, 2006 as a result of adopting SFAS
      123R.


17




General
      and administrative expenses include expenses (including professional services
      and interest costs) associated with the O&W defined benefit retirement plan
      of approximately $92,000 and $123,000 for the six months ended June 30, 2006
      and
      2005, respectively.





**Selling
      Expenses**





For
      the
      six months ended June 30, 2006 we incurred selling expenses of $816,191
      associated with growing business in our IT Services Group compared to $140,072
      for the six months ended June 30, 2005. We recorded $72,909 as expense for
      the
      six months ended June 30, 2006 as a result of adopting SFAS 123R.





Beginning
      in the second quarter of 2005, we added new employees and changed the work
      assignment of one employee and added sales consultants to focus on generating
      new sales leads and new contract opportunities **.** Selling
      expenses consist of our business development staff including salaries, benefits,
      sales consultants, and travel expenses. As a result of the termination of one
      subcontract during the first quarter of 2006, we reduced certain salaried
      selling positions. In the second quarter of 2006, we hired new business
      development personnel, including a new business development director. We expect
      that selling expenses will increase in the future as we hire additional
      personnel and expand our development of new contract opportunities. We incurred
      additional expenses in 2006 associated with our new business development efforts
      in the Gulf Coast region.





**Research
      and Development**





For
      the
      six months ended June 30, 2006 we continued to incur research and development
      expenses associated with growing business in our IT Services Group related
      to
      our biometrics applications and recorded $140,710 of expense compared to
      $161,924 for the six months ended June 30, 2005, a decrease of $21,214. These
      expenses are principally related to the development of an access control
      terminal and related software called TouchThruTM. As the product development
      phase of TouchThruTM is completed, we expect related development expenses to
      decrease. We expect to incur selling and marketing expenses in the future as
      we
      develop sales of this product.





TouchThruTM
      is a self-contained terminal enabling physical access control using biometric
      identification. It incorporates fingerprint matching technology licensed from
      Ultra-Scan Corporation, a private technology company headquartered in Buffalo,
      New York. TouchThruTM will be the first biometric product we introduce, and we
      intend to be in a position to market and sell that product this year. We plan
      to
      market and sell TouchThruTM in a variety of industries and markets, including the
      federal, state and local government, health care, travel and general security,
      and access control. During the three months ended June 30, 2006, we delivered
      demonstration units for trial by certain prospective customers.





**Depreciation
      and Amortization**





Depreciation
      and amortization expense was $43,627 (including $16,965 of amortization of
      software development costs) for the six months ended June 30, 2006 compared
      to
      $23,749 for the six months ended June 30, 2005. This increase is due to
      depreciation of equipment and software that were added in 2005 and 2006 and
      amortization of software development costs as we begin to place TouchThruTM
demonstration units with prospective customers.





**Write-off
      of Capitalized Closing Costs**





In
      the
      second quarter of 2005, the buyer of the assets and businesses of LF obtained
      new bank financing. The buyer paid all of its notes receivable to us, which
      proceeds were used to pay off all of LF’s bank promissory notes and LF’s capital
      lease obligation. As a result we wrote off the balance of LF’s capitalized
      financing costs of $44,857.


18





**Operating
      Income (Loss)**





For
      the
      six months ended June 30, 2006 our operating loss was $(1,005,507) compared
      to
      operating income of $167,585 in the comparable period of 2005. This is
      principally attributable to four factors. **** First,
      our sales declined from $4,134,550 in 2005 to $2,964,002 in 2006, a decrease
      of
      $1,170,548; second, our gross profit declined by $639,296; third, our selling
      expenses increased by $676,119; and fourth, these changes were offset in part
      by
      a decrease in general and administrative expenses of $96,130.





The
      non-recurring write off of capitalized financing costs of $44,857 recorded
      in
      the six months ended June 30, 2005 contributed to the reduction of operating
      income for the six months ended June 30, 2005.





**Net
      Interest Expense**





Net
      interest expense consists of interest income offset by interest expense on
      indebtedness and fees for financing accounts receivable invoices. Net interest
      expense was $86,690 for the six months ended June 30, 2006 compared to $124,728
      for the six months ended June 30, 2005. The reduction in net interest expense
      of
      $38,038 was principally due to a decrease in the volume of accounts receivable
      invoices that were financed in 2006.




Other
      Income




We
      received and recorded other income of $498,088, net of legal fees and expenses
      of $164,412, in the first quarter of 2006. We were the plaintiff in a lawsuit
      filed in the Superior Court, State of Rhode Island on August 13, 1999
      captioned Infinite Group, Inc. vs. Spectra Science Corporation and Nabil
      Lawandy. In the action, we asserted that by fraud and in breach of fiduciary
      duties owed, Spectra and its president, Nabil Lawandy, caused us to sell to
      Spectra shares of Spectra’s Series A Preferred stock at a substantial discount
      to fair market value. We alleged that in entering into the transaction it relied
      on various representations made by Spectra and Mr. Lawandy, which were untrue
      at
      the time they were made. The trial was completed in February 2005, and the
      jury
      returned a verdict in our favor in the amount of approximately $600,000. We
      appealed the amount of the verdict and entered into a settlement with the
      defendants in January 2006 and recorded other income of $498,088.





**Income
      Taxes**





Income
      tax expense was $7,300 and $1,300 for the six months ended June 30, 2006 and
      2005, respectively, consisting of estimated federal minimum tax of $2,000 in
      2006 and state taxes.





**Income
      from Discontinued Operations**





We
      recorded income from discontinued operations of $12,223 for the six months
      ended
      June 30, 2005. The income is the result of the Photonics Group which was
      reclassified as discontinued operations.





**Net
      Income (Loss)**





For
      the
      six months ended June 30, 2006, ** we
      recorded a loss from continuing operations and a net loss of $(601,409), or
      $(.03) per share. This compares to income from continuing operations of $41,557
      or $.00 per share and net income of $53,790 or $.00 per share for the six months
      ended June 30, 2005 *.*





The
      decrease in net income of $655,199 is principally attributable to a decrease
      in
      gross profit of $639,296 and an increase in selling expenses of $679,119, which
      were offset in part by decrease in general and administrative expenses of
      $96,130 and by other income of $498,088. We also recorded expense of $96,527
      as
      a result of adopting SFAS 123R in 2006 and expense of $11,394 in 2006 as a
      result of warrants and stock options issued to consultants.




**Stock-Based
      Compensation**




In
      December 2004, the Financial Accounting Standards Board issued SFAS 123R,
      Share-Based Payment (“SFAS 123R”). SFAS 123R supersedes SFAS 123, Accounting for
      Stock Based Compensation, and Accounting Principles Board Opinion 25, Accounting
      for Stock Issued to Employees (“APB 25) and its related implementation guidance.
      On January 1, 2006, we adopted the provisions of SFAS 123R using the modified
      prospective transition method. Under this method, we are required to record
      compensation expense for all stock based awards granted after the date of
      adoption and for the unvested portion of previously granted awards that remain
      outstanding as of the beginning of the adoption and prior period financial
      statements have not been restated. Under SFAS 123R, compensation expense related
      to stock based payments is recorded over the requisite service period based
      on
      the grant date fair value of the awards.




19




Prior
      to
      the adoption of SFAS 123R, we accounted for employee stock options using the
      intrinsic value method in accordance with APB 25. Accordingly, no compensation
      expense was recognized for stock options issued to employees as long as the
      exercise price is greater than or equal to the market value of the common stock
      at the date of grant. In accordance with SFAS 123, the Company disclosed the
      summary of pro forma effects to reported net income or net loss as if we had
      elected to recognize compensation costs based on the fair value of the awards
      at
      the grant date.




Our
      board
      of directors and stockholders have approved stock options plans, which have
      authority to grant options to purchase up to an aggregate of 5,623,500 shares
      at
      June 30, 2006. Such options may be designated at the time of grant as either
      incentive stock options (ISO’s) or nonqualified stock options (Non-ISO’s).




The
      compensation cost that has been charged against income for options granted
      to
      employees under the plan was $72,942 for the three-months ended June 30, 2006
      and $96,527 for the six months ended June 30, 2006. The impact of this expense
      was to increase basic and diluted net loss per shares from $(.02) to $(.03)
      for
      the six months ended June 30, 2006. There was no effect on loss per share for
      the three months ended June 30, 2006. The adoption of SFAS 123R did not have
      an
      impact on cash flows from operating or financing activities. For stock options
      issued as Non-ISO’s a deduction is not allowed for income tax purposes until the
      option are exercised. The amount of this deduction will be the difference
      between the fair value of the Company’s common stock and the exercise price at
      the date of exercise. Accordingly, there is a deferred tax asset recorded
      related for the tax effect of the financial statement expense recorded. The
      tax
      effect of the income tax deduction in excess of the financial statement expense
      will be recorded as an increase to additional paid-in capital. Due to the
      uncertainty of our ability to generate sufficient taxable income in the future
      to utilize the tax benefits of the options granted, we have recorded a valuation
      allowance to reduce gross deferred tax asset to zero. As a result for the six
      months ended June 30, 2006, there is no income tax expense impact from recording
      the fair value of options granted. No tax deduction is allowed for stock options
      issued as ISO’s.





We
      recorded expense of $72,942 for employee stock options and $5,697 for warrants
      and stock options issued to consultants for the three months ended June 30,
      2006. We recorded expense of $96,527 for employee stock options and $11,394
      for
      warrants and stock options issued to consultants for the six months ended June
      30, 2006.





**Liquidity
      and Capital Resources**





At
      June
      30, 2006, we had cash of $76,258 available for our working capital needs and
      planned capital asset expenditures.





At
      June
      30, 2006, we had a working capital deficit of approximately $345,000. At
      December 31, 2005 we had working capital of approximately $90,000 **.** Our
      objective is to improve our working capital position from profitable operations
      or by raising additional cash from long-term debt or private placements of
      equity securities. As we incur operating losses or net losses, we will
      experience working capital shortages that may impair our business operations
      and
      growth strategy.




We
      have
      financed the activity of our new IT Services Group through the issuance of
      notes
      payable to third parties and to related parties, private placements of common
      stock and financing of our accounts receivable.





In
      2004,
      we established a financing line of up to $800,000 with a financial institution
      that allows us to sell selected accounts receivable invoices to the financial
      institution with full recourse against us. We pay fees based on the length
      of
      time that the invoice remains unpaid. At June 30, 2006, we had approximately
      $425,000 of availability under this line of which we could finance up to
      approximately $128,000 based on selected accounts receivable at June 30,
      2006.





We
      have
      used our common stock to provide compensation to certain employees and
      consultants and to fund liabilities. During the six months ended June 30, 2006
      we issued a warrant to acquire 50,000 shares of our common stock to a business
      development consultant which becomes exercisable only upon our realizing sales
      of $500,000 from the consultant’s efforts. The agreement has been accounted for
      in accordance with EITF 96-18 “Accounting for Equity Instruments That Are Issued
      to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods
      or
      Services” whereby the fair value of the warrant will be recorded when the
      performance criterion is met.


20




We
      were
      required to contribute amounts in 2004, 2005 and 2006 to the O&W Retirement
      Plan and are required to make contributions in future years to fund the
      deficiency. We did not make contributions during 2004 and 2006 and we currently
      do not have the funds available to make required contributions which currently
      approximate $1.4 million. During 2005, we made contributions of $6,439 and
      500,000 shares of our common stock, which were valued on the contribution date
      at $175,000 using the closing market price. We recorded defined benefit pension
      expense of approximately $90,000 for each of the six months ended June 30,
      2006
      and 2005. In March 2005, we filed a funding waiver application requesting
      waivers of the minimum funding standard for the 2005 plan year of $513,551
      and
      for the 2004 plan year of $979,328 (which includes quarterly cash disbursements
      aggregating approximately $455,000 for the year ended December 31, 2004 and
      unfunded prior year amounts). During 2006, we provided additional information
      for consideration in connection with our waiver application. During 2006, we
      changed the investment manager with the objective of improving the plan’s
      investment performance.




We
      have
      financed the activity of our new IT Services Group through the issuance of
      notes
      payable to related parties, private placements of common stock and issuance
      of
      stock options and warrants. We also have a line of credit which we use to
      provide cash from the financing of our accounts receivable. In the future,
      we
      may issue additional debt or equity securities to satisfy our cash needs. Any
      debt incurred or issued may be secured or unsecured, at a fixed or variable
      interest rates and may contain other terms and conditions that our board of
      directors deems prudent. Any sales of equity securities may be at or below
      current market prices. We cannot assure you that we will be successful in
      generating sufficient capital to adequately fund our liquidity
      needs.





**Risk
      Factors**




You
      should consider the risk factors included in our Annual Report on Form 10-KSB
      for the year ended December 31, 2005 in evaluating our business and an
      investment in our common stock. Additional risks and uncertainties not presently
      known to us, which we currently deem immaterial or that are similar to those
      faced by other companies in our industry or business in general, such as
      competitive conditions, may also impair our business operations. If any of
      the
      results of the risks occur, our business, financial condition, or results of
      operations could be materially adversely affected.




**Item
      3. Controls and Procedures**





Evaluation
      of Disclosure Controls and Procedures. Our
      management, with the participation of our chief executive officer and chief
      financial officer, carried out an evaluation of the effectiveness of our
“disclosure controls and procedures” (as defined in the Securities Exchange Act
      of 1934 (the “Exchange Act”) Rules 13a-15(e) and 15-d-15(e)) as of the end of
      the period covered by this report (the “Evaluation Date”). Based upon that
      evaluation, the chief executive officer and chief financial officer concluded
      that, as of the Evaluation Date, our disclosure controls and procedures are
      effective to ensure that information required to be disclosed by us in the
      reports that we file or submit under the Exchange Act (i) is recorded,
      processed, summarized and reported, within the time periods specified in the
      SEC’s rules and forms and (ii) is accumulated and communicated to our
      management, including our chief executive officer and chief financial officer,
      as appropriate to allow timely decisions regarding required
      disclosure.





Changes
      in Internal Control over Financial Reporting. There
      were no changes in our internal controls over financial reporting that occurred
      during our fiscal second quarter that has materially affected, or is reasonably
      likely to materially affect, our internal control over financial
      reporting.




21




**PART
      II**




**OTHER
      INFORMATION**




**Item
      1.**  **Legal
      Proceedings.**




We
      are
      not presently involved in any material legal proceedings.




**Item
      2.**  **Unregistered
      Sales of Equity Securities and Use of Proceeds.**




On
      May
      19, 2006, Dr. Allan Robbins, a member of our board of directors, and Northwest
      Hampton Holdings, LLC each converted $50,000 of principal of our outstanding
      notes payable to them (a total of $100,000) into 1,000,000 shares of common
      stock in accordance with the terms of their respective notes payable. In
      connection with such conversions, we issued a total of 2,000,000 unregistered
      shares of our common stock. These issuances were made in reliance upon the
      exemptions from registration set forth in Sections 4(2) and 4(6) of the
      Securities Act of 1933, as amended.




On
      May 1,
      2006, we engaged the services of a consultant and issued it a warrant to acquire
      50,000 shares of our common stock, exercisable at $.35 per share which expires
      on April 30, 2016. The warrant is only exercisable if we realize sales of
      $500,000 or more as a result of the consultant’s efforts on our behalf. The
      issuance of this warrant was made in reliance upon the exemptions from
      registration set forth in Sections 4(2) and 4(6) of the Securities Act of 1933,
      as amended.





No
      underwriter was involved in these transactions.





**Item
      3.**  **Defaults
      Upon Senior Securities.**





None.





**Item
      4.**  **Submission
      of Matters to a Vote of Security Holders.**





None.





**Item
      5.**  **Other
      Information.**





None.





**Item
      6.**  **Exhibits.**




Exhibit
                  No.
              
              Description31.1
              
              Certification
                  of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
                  Act of 2002.*31.2
              
              Certification
                  of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
                  Act of 2002.*32.1
              
              Certification
                  of Chief Executive Officer and Chief Financial Officer pursuant
                  to Section
                  906 of the Sarbanes-Oxley Act of
                  2002.*




*Filed herewith


22




**SIGNATURES**




In
      accordance with the requirements of the Exchange Act, the registrant caused
      this
      report to be signed on its behalf by the undersigned, thereunto duly
      authorized.


**Infinite
                Group, Inc.**
              (Registrant)Date:
                August 11, 2006
            By:
            /s/
                Michael S. SmithChief
                Executive Officer


Date:
                  August 11, 2006
            By:
            /s/
                Michael S. SmithChief
                Financial Officer
              (Principal
                  Financial Officer)




23