**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 SEPTEMBER 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
            (I.R.S.
                Employerof
                incorporation or organization)
            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 x No o





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





Number
      of
      shares outstanding of each of the issuer's classes of common equity, as of
      the
      latest practicable date: As of November 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**





TABLE
      OF
      CONTENTS




PAGEPART
                I - FINANCIAL INFORMATIONItem
                1.
            Consolidated
                Financial StatementsBalance
                Sheet - September 30, 2006 (unaudited) and December 31, 2005 (audited)
            3Statements
                of Operations-(unaudited) for the three and nine month periods ended
                September 30, 2006 and 2005
            4Statements
                of Cash Flows-(unaudited) for the nine month periods ended September
                30,
                2006 and 2005
            5Notes
                to Consolidated Financial Statements
            6Item
                2.
            Management’s
                Discussion and Analysis or Plan of Operations
            12Item
                  3.
            Controls
                and Procedures
            26PART
                II - OTHER INFORMATIONItem
                1.
            Legal
                Proceedings
            27Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            27Item
                3.
            Defaults
                Upon Senior Securities
            27Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            27Item
                5.
            Other
                Information
            27Item
                6.
            Exhibits
            27SIGNATURES
            
            
            28





**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**




**September
                30,**
            
            **December
                31,****2006**
              **(Unaudited)**
            
            **2005**
              **(Audited)****ASSETS****Current
                assets:**Cash
            
            **$**
            **16,985**
            
            $
            109,090Accounts
                receivable, net of allowance of $53,000 ($53,000 - 2005)
            
            
            **358,931**
            
            
            875,538Notes
                receivable, current portion
            
            
            **5,254**
            
            
            4,746Inventories
            
            
            **3,677**
            
            
            24,664Prepaid
                expenses and other current assets
            
            
            **56,292**
            
            
            49,516Total
                current assets
            
            
            **441,139**
            
            
            1,063,554**Property
                and equipment, net**
            
            
            **89,862**
            
            
            190,520**Software
                development costs, net**
            
            
            **140,907**
            
            
            207,348**Other
                assets:**Notes
                receivable
            
            
            **74,649**
            
            
            78,439Deposits
            
            
            **19,523**
            
            
            16,703Total
                other assets
            
            
            **94,172**
            
            
            95,142Total
                assets
            
            **$**
            **766,080**
            
            $
            1,556,564**LIABILITIES
                AND STOCKHOLDERS’ DEFICIENCY****Current
                liabilities:**Accounts
                payable
            
            
            **237,136**
            
            
            412,100Accrued
                pension and retirement
            
            
            **1,756,657**
            
            
            152,050Accrued
                payroll
            
            
            **275,164**
            
            
            186,863Accrued
                interest payable
            
            
            **163,115**
            
            
            118,913Accrued
                expenses-other
            
            
            **94,295**
            
            
            60,977****Current
                maturities of long-term obligations-bank
            
            
            **53,661**
            
            
            12,778Note
                payable
            
            
            **30,000**
            
            
            30,000****Notes
                payable-related parties
            
            
            **94,550**
            
            
            ******-****Total
                current liabilities**
            
            
            **2,704,578**
            
            
            973,681**Long-term
                obligations:**Bank
                notes payable
            
            
            **-**
            
            
            50,600Notes
                payable-related parties
            
            
            **1,160,124**
            
            
            1,260,124Accrued
                pension expense
            
            
            **1,144,712**
            
            
            2,405,612Total
                liabilities
            
            
            **5,009,414**
            
            
            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
            
            
            **28,869,075**
            
            
            28,523,334Common
                stock, no shares authorized, not issued (175,084 - 2005)
            
            
            **-**
            
            
            56,028Accumulated
                deficit
            
            
            **(30,087,589**
            **)**
            
            (28,685,817
            )Accumulated
                other comprehensive loss
            
            
            **(3,046,855**
            **)**
            
            (3,046,855
            )Total
                stockholders’ deficiency
            
            
            **(4,243,334**
            **)**
            
            (3,133,453
            )Total
                liabilities and stockholders’ deficiency
            
            **$**
            **766,080**
            
            $
            1,556,564





See
        notes
        to consolidated financial statements.
  3


**INFINITE
                GROUP, INC.****Consolidated
                Statements of Operations (Unaudited)**




**Nine
                Months Ended**
            
            **Three
                Months Ended****September
                30,**
            
            **September
                30,****2006**
            
            **2005**
            
            **2006**
            
            **2005****Sales**
            
            **$**
            **4,391,436**
            
            $
            6,370,558
            
            **$**
            **1,427,434**
            
            $
            2,236,008Cost
                of services
            
            
            **3,440,561**
            
            
            4,467,602
            
            
            **1,085,785**
            
            
            1,581,574**Gross
                profit**
            
            
            **950,875**
            
            
            1,902,956
            
            
            **341,649**
            
            
            654,434Costs
                and expenses:General
                and administrative
            
            
            **706,981**
            
            
            912,080
            
            
            **184,559**
            
            
            324,892Defined
                benefit pension plan
            
            
            **342,370**
            
            
            175,778
            
            
            **250,587**
            
            
            52,630Selling
            
            
            **1,243,369**
            
            
            371,500
            
            
            **427,178**
            
            
            231,428Research
                and development
            
            
            **202,719**
            
            
            240,347
            
            
            **62,009**
            
            
            78,423Impairment
                loss
            
            
            **130,767**
            
            
            -
            
            
            **130,767**
            
            
            -Depreciation
                and amortization
            
            
            **73,988**
            
            
            31,593
            
            
            **30,361**
            
            
            7,844Write-off
                of capitalized financing costs
            
            
            ******-**
            
            
            44,857
            
            
            ******-**
            
            
            ******-**Total
                costs and expenses
            
            
            **2,700,194**
            
            
            1,776,155
            
            
            **1,085,461**
            
            
            695,217**Operating
                income (loss)**
            
            
            **(1,749,319**
            **)**
            
            126,801
            
            
            **(743,812**
            **)**
            
            (40,783
            )Other
                income (expense):Interest
                income
            
            
            **700**
            
            
            66,255
            
            
            **199**
            
            
            -Interest
                expense:Related
                parties
            
            
            **(88,164**
            **)**
            
            (68,331
            )
            
            **(30,129**
            **)**
            
            (23,998
            )Other
            
            
            **(55,777**
            **)**
            
            (201,352
            )
            
            **(26,621**
            **)**
            
            (54,703
            )****Total
                interest expense
            
            
            **(143,941**
            **)**
            
            (269,683
            )
            
            **(56,750**
            **)**
            
            (78,701
            )Other
                income-settlement of litigation
            
            
            **498,088**
            
            
            -
            
            
            -
            
            
            -****Gain
                on settlement with terminated employee
            
            
            -
            
            
            191,739
            
            
            -
            
            
            191,739****Gain
                on sale of equipment
            
            
            -
            
            
            8,452
            
            
            -
            
            
            8,452****Total
                other income (expense)
            
            
            **354,847**
            
            
            (3,237
            )
            
            **(56,551**
            **)**
            
            121,490Income
                (loss) from continuing operations beforeincome
                tax expense
            
            
            **(1,394,472**
            **)**
            
            123,564
            
            
            **(800,363**
            **)**
            
            80,707Income
                tax expense
            
            
            **(7,300**
            **)**
            
            (1,300
            )
            
            ******-**
            
            
            -**Income
                (loss) from continuing operations**
            
            
            **(1,401,772**
            **)**
            
            122,264
            
            
            **(800,363**
            **)**
            
            80,707**Discontinued
                operations:**Income
                from discontinued operations
            
            
            ******-**
            
            
            12,233
            
            
            ******-**
            
            
            ******-****Net
                income (loss)**
            
            **$**
            **(1,401,772**
            **)**
            $
            134,497
            
            **$**
            **(800,363**
            **)**
            $
            80,707Net
                income (loss) per share-basic:Income
                (loss) from continuing operations
            
            **$**
            **(.07**
            **)**
            $
            .01
            
            **$**
            **(.04**
            **)**
            $
            .00Income
                (loss) from discontinued operations
            
            
            **.00**
            
            
            .00
            
            
            **.00**
            
            
            .00Net
                income (loss)
            
            **$**
            **(.07**
            **)**
            $
            .01
            
            **$**
            **(.04**
            **)**
            $
            .00Net
                income (loss) per share-diluted:Income
                (loss) from continuing operations
            
            **$**
            **(.07**
            **)**
            $
            .01
            
            **$**
            **(.04**
            **)**
            $
            .00Income
                (loss) from discontinued operations
            
            
            **.00**
            
            
            .00
            
            
            **.00**
            
            
            .00Net
                income (loss)
            
            **$**
            **(.07**
            **)**
            $
            .01
            
            **$**
            **(.04**
            **)**
            $
            .00Weighted
                average number of shares outstanding:Basic
            
            
            **20,949,611**
            
            
            18,946,141
            
            
            **22,034,965**
            
            
            19,206,965Diluted
            
            
            **20,949,611**
            
            
            20,504,570
            
            
            **22,034,965**
            
            
            21,087,499


See
        notes
        to consolidated financial statements.
  4


**INFINITE
                GROUP, INC.****Consolidated
                Statements of Cash Flows (Unaudited)**




**For
                the Nine Months Ended****September
                30,****2006**
            
            **2005****Operating
                activities:**Net
                income (loss)
            
            **$**
            **(1,401,772**
            **)**
            $
            134,497Adjustments
                to reconcile net income (loss) to net cash provided by (used
                in)operating
                activities:Stock
                based compensation
            
            
            **191,471**
            
            
            40,800Depreciation
                and amortization and write-off of capitalized financing
                costs
            
            
            **73,988**
            
            
            76,450Impairment
                loss
            
            
            **130,767**
            
            
            -Income
                from discontinued operations
            
            
            **-**
            
            
            (12,233
            )Gain
                on settlement with terminated employee
            
            
            **-**
            
            
            (191,739
            )Gain
                on sale of equipment
            
            
            **-**
            
            
            (8,450
            )(Increase)
                decrease in:Accounts
                receivable
            
            
            **516,607**
            
            
            (704,642
            )Inventories
            
            
            **(2,013**
            **)**
            
            (23,239
            )Other
                assets
            
            
            **(9,596**
            **)**
            
            (16,267
            )Increase
                (decrease) in:Accounts
                payable
            
            
            **(174,964**
            **)**
            
            193,203Accrued
                expenses
            
            
            **165,821**
            
            
            166,189Accrued
                pension and retirement
            
            
            **343,707**
            
            
            89,100**Net
                cash used in operating activities of continuing
                operations**
            
            
            **(165,984**
            **)**
            
            (256,331
            )**Net
                cash provided by operating activities of discontinued
                operations**
            
            
            **-**
            
            
            854**Net
                cash used in operating activities**
            
            
            **(165,984**
            **)**
            
            (255,477
            )**Investing
                activities:**Purchase
                of property and equipment
            
            
            **(14,656**
            **)**
            
            (81,768
            )Proceeds
                from notes receivable
            
            
            **3,282**
            
            
            2,138,006Decrease
                in restricted funds
            
            
            **-**
            
            
            30,327**Net
                cash provided by (used in) investing activities**
            
            
            **(11,374**
            **)**
            
            2,086,565**Financing
                activities:**Repayments
                of bank notes payable
            
            
            **(9,717**
            **)**
            
            (50,207
            )Borrowings
                of bank notes payable
            
            
            **-**
            
            
            72,982Borrowings
                of notes payable-related parties
            
            
            **120,000**
            
            
            175,000Repayment
                of notes payable-related parties
            
            
            **(25,450**
            **)**
            
            -Proceeds
                from issuance of common stock, net of costs
            
            
            **420**
            
            
            80,000Repayments
                of long-term obligations
            
            
            ******-**
            
            
            (2,126,639
            )**Net
                cash provided by (used in) financing activities**
            
            
            **85,253**
            
            
            (1,848,864
            )Net
                decrease in cash
            
            
            **(92,105**
            **)**
            
            (17,776
            )Cash
                - beginning of period
            
            
            **109,090**
            
            
            97,297Cash
                - end of period
            
            **$**
            **16,985**
            
            $
            79,521Supplemental
                disclosure:Cash
                paid for:Interest
            
            **$**
            **102,440**
            
            $
            119,165Income
                taxes
            
            **$**
            **7,300**
            
            $
            1,300





See
        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 nine month period ended
      September 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 nine months ended
      September 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 nine months ended
      September 30, 2005.





**Note
      4. Stock Option Plans and Share Based Payments**





As
      of
      September 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.




6




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 was 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
      to
      employees under the plans was $77,853 and $174,380, respectively, for the three
      and nine months ended September 30, 2006. The impact of this expense was to
      increase basic and diluted net loss per share from $(.06) to $(.07) for the
      nine
      months ended September 30, 2006 and from $(.03) to $(.04) for the three months
      ended September 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 nine months ended September 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 September 30, 2006 and 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. Each option
      awarded in 2006 has a ten year exercise term and a holding period of ten years
      was assumed. 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 nine months
      ended September 30, 2006.  The
      Company recorded expense for options and warrants issued to employees and
      independent service providers for the three and nine months ended September
      30,
      2006 as follows:





Three
                Months ended
            
            Nine
                Months endedSeptember
                30, 2006
            
            September
                30, 2006Employee
                stock options
            
            $
            77,853
            
            $
            174,380Consultant
                stock options
            
            
            1,504
            
            
            4,513Warrants
            
            
            4,193
            
            
            12,578Total
                expense
            
            $
            83,550
            
            $
            191,471








7




A
      summary
      of all stock option activity for nine months ended September 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
            
            
            1,365,000
            
            $
            .40Options
                expired
            
            
            (933,900
            )
            $
            .15Options
                exercised
            
            
            (3,000
            )
            $
            .14Outstanding
                at September 30, 2006
            
            
            4,449,000
            
            $
            .24
            
            
            8.2
                years
            
            $
            1,434,000Exercisable
                at September 30, 2006
            
            
            3,499,000
            
            $
            .20
            
            
            7.9
                years
            
            $
            1,283,000





The
      weighted average fair value of options granted during the nine months ended
      September 30, 2006 was approximately $.33 ($.11 during the nine months ended
      September 30, 2005). The total intrinsic value of options exercised during
      the
      nine months ended September 30, 2006 was $480 and no options were exercised
      during the nine months ended September 30, 2005.





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




**Nonvested
                Shares**
            
            **Shares**
            
            **Weighted
                Average**
              **Fair
                Value**
              **at
                Grant Date**Nonvested
                at December 31, 2005
            
            
            50,666
            
            $
            .22Granted
            
            
            1,365,000
            
            
            .33Vested
            
            
            (454,999
            )
            
            .33Forfeited
            
            
            (10,667
            )
            
            .28Nonvested
                at September 30, 2006
            
            
            950,000
            
            $
            .32




At
      September 30, 2006, there was approximately $256,000 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 1.7 years.
      The total fair value of shares vested during the nine months ended September
      30,
      2006 was approximately $149,000.




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 nine
      months ended September 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 nine months ended September 30, 2005.





8







Three
                Months Ended September 30, 2005
            
            Nine
                Months Ended September 30, 2005Net
                income (loss) - as reported (000’s)
            
            $
            81
            
            $
            134Total
                stock based employee compensation expense determinedunder
                the fair value method for all awards (000’s)
            
            
            (35
            )
            
            (284
            )Net
                income (loss) - pro forma (000’s)
            
            $
            46
            
            $
            (150
            )Income
                (loss) per share as reported - basic and diluted
            
            $
            .00
            
            $
            .01Income
                (loss) per share pro forma - basic and diluted
            
            $
            .00
            
            $
            (.01
            )




During
      the nine months ended September 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.





**Note
      5. Business Segments**





Prior
      to
      2002, the Company’s business was organized, managed and internally reported as
      several 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. (LF) 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. We
      sold
      or closed our prior businesses on or before December 31, 2004. During the nine
      months ended September 30, 2005, we
      recorded income from discontinued operations of $12,223 from our former
      business, the Photonics Group.





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. We
      are
      now solely focused in one segment, the fields of IT consulting services and
      biometric technology. The
      Company operates entirely within the U.S. There were no revenues from customers
      in foreign countries during 2005 and 2006.





**Note
      6. Supplemental Cash Flow Information**





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




**Nine
                Months Ended****September 30,****2006**
            
            **2005**Conversion
                of notes payable to commonstock
            
            **$**
            **100,000**
            
            $
            -Conversion
                of accounts payable to commonstock
            
            **$**
            **-**
            
            $
            2,250Common
                stock received in connection with settlementagreement
                with terminated employee
            
            **$**
            **-**
            
            $
            175,000Common
                stock contributed to Osley & WhitneyRetirement
                Plan which reduced the balance ofaccrued
                pension expense obligation
            
            **$**
            **-**
            
            $
            175,000






9





**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 periods with net income from continuing operations as
      follows:





Three
                Months EndedSeptember 30, 2005
            
            Nine
                Months EndedSeptember 30, 2005Numerator:Income
                available to common stockholdersfrom
                continuing operations
            
            $
            80,707
            
            $
            122,264Weighted
                average shares outstanding
            
            
            19,206,965
            
            
            18,946,141Denominator
                for diluted income per share:Weighted
                average shares outstanding
            
            
            19,206,965
            
            
            18,946,141Common
                stock options and stock warrants
            
            
            1,880,534
            
            
            1,558,429Weighted
                average shares and conversions
            
            
            21,087,499
            
            
            20,504,570




For
      the
      three and nine months ended September 30, 2006 all outstanding stock options, warrants and convertible
      debt
      have not been considered common stock equivalents because their assumed exercise
      would be anti-dilutive. The convertible debt became eligible for conversion
      during the second quarter of 2006. If the Company had generated earnings during
      the three and nine months ended September 30, 2006, 11,118,008, and 7,963,802
      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 price 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





**Note
      8 - New Accounting Pronouncements**





**Statement
      of Financial Accounting Standards No. 158, Employers’ Accounting for Defined
      Benefit Pension and Other Postretirement Plans**





On
      September 29, 2006, the Financial Accounting Standards Board (FASB) issued
      a new
      standard that will require employers to fully recognize the obligations
      associated with single-employer defined benefit pension, retiree healthcare
      and
      other postretirement plans in their financial statements. Specifically,
      the new standard, Statement
      of Financial Accounting Standards No. 158, Employers’ Accounting for Defined
      Benefit Pension and Other Postretirement Plans (an
      amendment of FASB Statements No. 87, 88, 106, and 132R), requires us
      to:




·
            recognize
                in our balance sheet an asset for our defined benefit plan’s overfunded
                status or a liability for our defined benefit plan’s underfunded status,
                which are measured as the difference between plan assets at fair
                value
                (with limited exceptions) and the benefit
                obligation;





·
            recognize
                changes in the funded status of our defined benefit plan in the year
                in
                which the changes occur by reporting those changes in our comprehensive
                income;





·
            measure
                our defined benefit plan’s assets and obligations that determine our
                funded status as of the end of our fiscal year (with limited exceptions);
                and





·
            disclose
                in our notes to the financial statements additional information about
                certain effects on net periodic cost for the next fiscal year that
                arise
                from delayed recognition of the gains or losses, prior service costs
                or
                credits and transition asset or
                obligation.





The
      requirement to recognize the funded status of our defined benefit plan and
      the
      disclosure requirements are effective for us as of December 31, 2006. The
      requirement to measure plan assets and benefit obligations as of the date of
      our
      fiscal year-end statement of financial position is effective for us as of
      December 31, 2008. We have not evaluated the potential impact from adopting
      this
      statement.




**Statement
      of Financial Accounting Standards No. 157, Fair Value
      Measurements**





On
      September 15, 2006, the FASB issued Statement
      of Financial Accounting Standards No. 157, Fair Value Measurements , that
      provides enhanced guidance for using fair value to measure assets and
      liabilities. The standard responds to investors’ requests for expanded
      information about the extent to which companies measure assets and liabilities
      at fair value, the information used to measure fair value, and the effect of
      fair value measurements on earnings. The standard applies whenever other
      standards require or permit assets or liabilities to be measured at fair value.
      The standard does not expand the use of fair value in any new
      circumstances.





Under
      this standard, fair value refers to the price that would be received to sell
      an
      asset or paid to transfer a liability in an orderly transaction between market
      participants in the market in which the reporting entity transacts. The standard
      clarifies the principle that fair value should be based on the assumptions
      market participants would use when pricing the asset or liability. In support
      of
      this principle, the standard establishes a fair value hierarchy that prioritizes
      the information used to develop those assumptions. The fair value hierarchy
      gives the highest priority to quoted prices in active markets and the lowest
      priority to unobservable data, for example, the reporting entity’s own data.
      Under the standard, fair value measurements would be separately disclosed by
      level within the fair value hierarchy.





This
      Statement is effective for us as of December 31, 2007, and interim periods
      within that year. We have not evaluated the potential impact from adopting
      this
      statement.




11


**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.





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





Since
      our
      sale of our former business, Osley & Whitney, Inc. (O&W), in 2002, we
      have remained the sponsor of the O&W Retirement Plan. At September 30, 2006,
      the O&W defined benefit pension plan had an accrued pension obligation
      liability of $2,494,712 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
      $3,504,314 at September 30, 2006. The increase was comprised of an investment
      return of $513,817 offset by payment of benefits of $303,845 and expenses paid
      of $21,182 during the nine months ended September 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 of $1,350,000. 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 in 2006
      and 2005 professional services and interest costs and in 2006 penalties for
      failing to make plan contributions) associated with the O&W defined benefit
      retirement plan of approximately $342,370 and $175,778 for the nine months
      ended
      September 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 the three months ended
      September 30, 2006, we received a reply from the Department of the Treasury
      denying our request for waivers of the minimum funding standard for the 2005
      and
      2004 plan years. As a result of these denials and our inability to fund pension
      plan contributions which were due in September 2006, during the three months
      ended September 30, 2006 we recorded $200,000 of expense for excise taxes and
      related interest for each of these years on unfunded contributions to the
      pension plan and reclassified $1,350,000 of accrued pension expense to current
      liabilities. Since the waivers were not granted we are examining and evaluating
      alternatives as the sponsor of this plan.




During
      2006, we changed the investment manager with the objective of improving the
      plan’s investment performance.




**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.





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 September 2006 to encompass 85 different labor
      categories for a three year term.




12





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
      in
      2005 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 TouchThruTM incorporating
      that technology. We intend to market and sell that product 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 to certain prospective customers in two industries
      and are engaging in other marketing activities.





Our
      TouchThruTM unit was designed around Ultra-Scan’s unique ultrasonic scanner. We
      anticipate that Ultra-Scan will improve the technology by designing a next
      generation scanner that will be smaller, lighter and less costly. Indications
      are that the next generation components are expected to be available in
      2007.  We expect this will result in a substantial reduction in the costs
      of components to build our TouchThruTM unit and accordingly a substantial
      reduction in our sales price.  We expect to re-design our TouchThruTM unit
      based on the next generation of this technology and offer for sale a newly
      designed unit when it is completed.  As a result of the evolution of our
      business strategy, during the three months ended September 30, 2006, we recorded
      an impairment loss of $130,767 for a portion of capitalized software development
      costs, all of the capitalized tooling costs and the related
      inventory.




**Future
      Trends**




We
      believe that our operations, as currently structured, will result in improved
      financial performance in future years. We expect to raise additional debt or
      equity capital to fund our operations during the periods in which we incur
      losses and develop new business opportunities. We issued additional short-term
      notes to related parties of $120,000 during the three months ended September
      30,
      2006 to fund our operations.




There
      is
      no assurance that our current resources will be adequate to fund the liabilities
      of 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.




During
      the three months ended September 30, 2006, we received purchase orders for
      new
      and expanded consulting services under new and existing subcontracts. We began
      to perform a portion of these services during the three months ended September
      30, 2006 and expect to record additional sales in future periods as new
      employees are hired and assigned to these new projects. We have received and
      are
      continuing to receive modifications to purchase orders to add specific new
      employees as approvals are obtained from the prime contractor.




13





**Results
      of Operations**





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





The
      following table compares our statement of operations data for the three months
      ended September 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.


Three
                  Months Ended September 30,As
                  a % of
              
              
              
              As
                  a % of
              
              Increase2006
              
              Sales
              
              2005
              
              Sales
              
              (Decrease)Sales
              
              $
              1,427,434
              
              
              100.0
              %
              $
              2,236,008
              
              
              100.0
              %
              
              (36.2
              )%Cost
                  of services
              
              
              1,085,785
              
              
              76.1
              
              
              1,581,574
              
              
              70.7
              
              
              (31.3
              )Gross
                  profit
              
              
              341,649
              
              
              23.9
              
              
              654,434
              
              
              29.3
              
              
              (47.8
              )General
                  and administrative
              
              
              184,559
              
              
              12.9
              
              
              324,892
              
              
              14.5
              
              
              (43.2
              )Defined
                  benefit pension plan
              
              
              250,587
              
              
              17.6
              
              
              52,630
              
              
              2.4
              
              
              376.1Selling
              
              
              427,178
              
              
              29.9
              
              
              231,428
              
              
              10.4
              
              
              84.6Research
                  and development
              
              
              62,009
              
              
              4.3
              
              
              78,423
              
              
              3.5
              
              
              (20.9
              )Impairment
                  loss
              
              
              130,767
              
              
              9.2
              
              
              -
              
              
              0.0Depreciation
                  and amortization
              
              
              30,361
              
              
              2.1
              
              
              7,844
              
              
              0.4
              
              
              287.1Total
                  operating expenses
              
              
              1,085,461
              
              
              76.0
              
              
              695,217
              
              
              31.1
              
              
              56.1Operating
                  loss
              
              
              (743,812
              )
              
              (52.1
              )
              
              (40,783
              )
              
              (1.8
              )
              
              1,723.8Net
                  interest expense
              
              
              (56,551
              )
              
              (4.0
              )
              
              (78,701
              )
              
              (3.5
              )
              
              (28.1
              )Other
                  income
              
              
              -
              
              
              
              
              
              200,191
              
              
              9.0Net
                  income (loss)
              
              $
              (800,363
              )
              
              (56.1
              )%
              $
              80,707
              
              
              3.6
              %
              
              (1,091.7
              )%Net
                  income (loss) per share-basic
              
              $
              (0.04
              )
              
              
              
              $
              .00


**Sales**





Sales
      for
      the three months ended September 30, 2006 were $1,427,434 which was a decrease
      of $808,574 or 36.2% as compared to sales for the three months ended September
      30, 2005 of $2,236,008. Compared to the prior three months ended June 30, 2006,
      this is an increase of $86,868 or 6.5% over sales of $1,340,566. This recent
      increase is due to our completion of new agreements and the receipt of new
      and
      expanded consulting services purchase orders during the three months ended
      September 30, 2006. Beginning in August 2006, we began to staff new projects
      and
      will continue to staff those projects with new employees in future
      months.





The
      principal reason for the decrease in sales in 2006 compared to 2005 relates
      to
      one subcontract. 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 contracts, contract terminations occur when
      projects are completed or when appropriations of funds are exhausted and new
      appropriations are not approved. We have submitted proposals and have identified
      opportunities for other new contracts to replace sales that did 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.




14





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.





Early
      successes in our 2006 initiatives are evident in the preferred relationships
      we
      have earned with several large systems integrators and one major technology
      company. In addition, we are a member of one of only seven teams that in March
      2006 won the U.S. Army’s 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 September 30, 2006 was
      $1,085,785 or 76.1% of sales as compared to $1,581,574 or 70.7% of sales for
      the
      three months ended September 30, 2005. Gross profit was $341,649 or 23.9% of
      sales for the three months ended September 30, 2006 compared to $654,434 or
      29.3% of sales for the three months ended September 30, 2005. Compared to the
      three months ended June 30, 2006, this is an improvement in gross profit of
      $50,000 or 17.1% from $291,649 (21.8% of sales).





The
      decrease in gross profit from 2006 compared to 2005 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
      $3,776 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% or
      more, 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 September 30, 2006 were $184,559 which was a decrease of
      $140,333 or 43.2% as compared to $324,892 for the three months ended September
      30, 2005. As a percentage of sales, general and administrative expenses were
      12.9% for the three months ended September 30, 2006 as compared to 14.5% for
      the
      three months ended September 30, 2005. We anticipate that general and
      administrative expenses as a percent of sales will decrease as we continue
      to
      implement our business strategy and grow our sales. 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 $1,463 as expense for the three months ended September 30, 2006 as
      a
      result of adopting SFAS 123R. We reclassified defined benefit pension plan
      expense from general and administrative expense to a separate line item
      beginning with this report.





15




**Defined
      Benefit Pension Plan Expenses**





Defined
      benefit pension expenses include expenses (including professional services
      and
      interest costs) associated with the O&W defined benefit retirement plan of
      $250,587 for the three months ended September 30, 2006 and $52,630 for the
      three
      months ended September 30,2005, an increase of $197,957. During the three months
      ended September 30, 2006 we received a reply from the Department of the Treasury
      denying our request for waivers of the minimum funding standard for the 2005
      plan year of $513,551 and for the 2004 plan year of $979,328. As a result of
      these denials and our inability to fund pension plan contributions which were
      due in September 2006, we recorded $200,000 of expense for excise taxes and
      related interest for each of these years on unfunded contributions to the
      pension plan. Since the waivers were not granted we are examining and evaluating
      other alternatives as the sponsor of this plan.





**Selling
      Expenses**





For
      the
      three months ended September 30, 2006, we incurred selling expenses of $427,178
      associated with growing business in our IT Services Group as compared to
      $231,428 for the three months ended September 30, 2005, an increase of 84.6%.
      Selling expenses consist of our business development staff including salaries,
      benefits, sales consultants, and travel expenses. We recorded $72,614 as expense
      for the three months ended September 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 **.** 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
      incurred additional expenses in 2006 associated with our new business
      development efforts in the Gulf Coast region. We employ one person full-time
      and
      use a lobbying firm in the Gulf Coast region. These individuals work closely
      with our Chief Operations Officer to develop business opportunities in the
      region.





We
      added
      one business development employee during August 2006, who formerly represented
      us as a business development consultant. We believe that our current staffing
      is
      adequate to manage the existing volume of business and development
      efforts.





**Research
      and Development and Impairment Loss**





For
      the
      three months ended September 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 $62,009 of expense compared
      to $78,423 for the three months ended September 30, 2005, a decrease of $16,414.
      Expenses are related to the development of the TouchThruTM access control
      terminal including product testing and documentation. Also included are expenses
      incurred to examine new business opportunities. During the three months ended
      September 30, 2006, we eliminated one engineering position since a portion
      of
      the product development was complete.





During
      the three months ended September 30, 2006, we recorded an impairment loss of
      $130,767 related to the carrying costs of TouchThruTM capitalized software
      development costs, tooling costs and inventory. Our TouchThruTM unit was designed
      around Ultra-Scan’s unique ultrasonic scanner. We anticipate that Ultra-Scan
      will improve the technology by designing a next generation scanner that will
      be
      smaller, lighter and less costly. Indications are that the next generation
      components are expected to be available in 2007.  We expect this will
      result in a substantial reduction in the costs of components to build our
      TouchThruTM unit and accordingly a substantial reduction in our sales
      price.  We expect to re-design our TouchThruTM unit based on the next
      generation of this technology and offer for sale a newly designed unit when
      it
      is completed. As a result of the evolution of our business strategy, during
      the
      three months ended September 30, 2006, we recorded an impairment loss for a
      portion of capitalized software development costs, all of the capitalized
      tooling costs and the related inventory.





When
      the
      product development phase of TouchThruTM is completed, including the re-design of
      our TouchThruTM product, we expect related development expenses to decrease. We
      expect to incur more substantial selling and marketing expenses in the future
      as
      we develop sales of a newly designed TouchThruTM product that is based on
      Ultra-Scan’s next generation scanner.




16





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 is the first biometric product that we are introducing.
      Although we are in a position to market and sell that product, we have revised
      our strategy based on Ultra-Scan’s development of a next generation scanner that
      is expected to replace the current scanner. We plan to market and sell a
      re-designed TouchThruTM unit. However, we will expend limited resources on our
      current product version to introduce the capabilities of this product to the
      market. The TouchThruTM unit will be marketed 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
      September 30, 2006, we delivered demonstration units for trial to certain
      prospective customers in two industries.





**Depreciation
      and Amortization**





Depreciation
      and amortization expense was $30,361 (including $14,250 of amortization of
      software development costs) for the three months ended September 30, 2006
      compared to $7,844 for the three months ended September 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.





**Operating
      Loss**





For
      the
      three months ended September 30, 2006 our operating loss was $(743,812) compared
      to an operating loss of $(40,783) for the three months ended September 30,
      2005;
      an increase of $703,029.





The
      increase in operating loss of $703,029 is principally attributable to:




·
            a
                decrease in gross profit of $312,785 incurred as a result of a decrease
                in
                sales of $808,574 and a decline in gross profit margin from 29.3%
                to
                23.9%;





·
            recording
                an impairment loss of $130,767 related to the carrying values of
                TouchThruTM assets;





·
            an
                increase in selling expenses of $195,750 as we increased efforts
                to grow
                sales;





·
            recording
                $200,000 of expense related to the O&W defined benefit retirement plan
                upon receiving a reply from the Department of the Treasury denying
                our
                request for waivers of the minimum funding standard and our inability
                to
                make required pension plan contributions;
                and





·
            an
                offset in part by a decrease in general and administrative expense
                of
                $140,333.





Included
      in the above are expenses totaling $77,853 as a result of adopting SFAS 123R
      in
      2006 and $5,697 as a result of warrants and stock options issued to
      consultants.





**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 $56,551 for the three months ended September 30, 2006 compared
      to
      net interest expense of $78,701 for the three months ended September 30, 2005.
      The reduction in net interest expense of $22,150 was principally due to a
      decrease in the volume of accounts receivable invoices that were financed in
      2006 compared to 2005.




**Other
      Income**





Other
      income for the three months ended September 30, 2005 is a gain on settlement
      with a terminated employee of $191,739, which consists of his return to us
      of
      500,000 shares of our common stock less legal expense that we incurred in
      connection with the settlement. The shares were valued at the fair value on
      the
      date the settlement agreement was executed. Another component of other income
      for the three months ended September 30, 2005 consists of a gain on the sale
      of
      office equipment of $8,452 in connection with the relocation and sublease of
      office space in the Washington, D.C. area. These total $200,191.





17




**Net
      Income (Loss)**





For
      the
      three months ended September 30, 2006, ** we
      recorded a net loss each in the amount of $(800,363) or $(.04) per share. This
      compares to net income of $80,707 or $.00 per share for the three months ended
      September 30, 2005 *.*





The
      decrease of $881,070 from net income to a net loss is principally attributable
      to:




·
            a
                decrease in gross profit of $312,785 incurred as a result of a decrease
                in
                sales of $808,574 and a decline in gross profit margin from 29.3%
                to
                23.9%;





·
            recording
                an impairment loss of $130,767 related to the carrying values of
                TouchThruTM assets;





·
            an
                increase in selling expenses of $195,750 as we increased efforts
                to grow
                sales;





·
            recording
                $200,000 of expense related to the O&W defined benefit retirement plan
                upon receiving a reply from the Department of the Treasury denying
                our
                request for waivers of the minimum funding standard and our inability
                to
                make required pension plan contributions;





·
            an
                offset in part by a decrease in general and administrative expense
                of
                $140,433; and





·
            a
                decrease in other income of $200,191 that was earned in
                2005.





Included
      in the above are expenses totaling $77,853 as a result of adopting SFAS 123R
      in
      2006 and $5,697 as a result of warrants and stock options issued to
      consultants.




18





****** **Comparison
      of Nine Months ended September 30, 2006 and 2005**





The
      following table compares our statement of operations data for the nine months
      ended September 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.


Nine
                  Months Ended September 30,As
                  a % of
              
              
              
              As
                  a % of
              
              Increase2006
              
              Sales
              
              2005
              
              Sales
              
              (Decrease)Sales
              
              $
              4,391,436
              
              
              100.0
              %
              $
              6,370,558
              
              
              100.0
              %
              
              (31.1
              )%Cost
                  of services
              
              
              3,440,561
              
              
              78.3
              
              
              4,467,602
              
              
              70.1
              
              
              (23.0
              )Gross
                  profit
              
              
              950,875
              
              
              21.7
              
              
              1,902,956
              
              
              29.9
              
              
              (50.0
              )General
                  and administrative
              
              
              706,981
              
              
              16.1
              
              
              912,080
              
              
              14.3
              
              
              (22.5
              )Defined
                  benefit pension plan
              
              
              342,370
              
              
              7.8
              
              
              175,778
              
              
              2.8
              
              
              94.8Selling
              
              
              1,243,369
              
              
              28.3
              
              
              371,500
              
              
              5.8
              
              
              234.7Research
                  and development
              
              
              202,719
              
              
              4.6
              
              
              240,347
              
              
              3.8
              
              
              (15.7
              )Impairment
                  loss
              
              
              130,767
              
              
              3.0
              
              
              -
              
              
              0.0Depreciation
                  and amortization
              
              
              73,988
              
              
              1.7
              
              
              31,593
              
              
              0.5
              
              
              134.2Write-off
                  of capitalized financing costs
              
              
              -
              
              
              0.0
              
              
              44,857
              
              
              0.7Total
                  operating expenses
              
              
              2,700,194
              
              
              61.5
              
              
              1,776,155
              
              
              27.9
              
              
              52.0Operating
                  income (loss)
              
              
              (1,749,319
              )
              
              (39.8
              )
              
              126,801
              
              
              2.0
              
              
              (1,479.6
              )Net
                  interest expense
              
              
              (143,241
              )
              
              (3.3
              )
              
              (203,428
              )
              
              (3.2
              )
              
              (29.6
              )Other
                  income
              
              
              498,088
              
              
              11.3
              
              
              200,191
              
              
              3.1
              
              
              148.8Income
                  tax expense
              
              
              (7,300
              )
              
              (0.2
              )
              
              (1,300
              )
              
              (0.0
              )
              
              461.5Net
                  income (loss) from continuing operations
              
              
              (1,401,772
              )
              
              (31.9
              )
              
              122,264
              
              
              1.9
              
              
              (1,246.5
              )Income
                  from discontinued operations
              
              
              -
              
              
              0.0
              
              
              12,233
              
              
              0.2
              
              
              (100.0
              )Net
                  income (loss)
              
              $
              (1,401,772
              )
              
              (31.9
              )%
              $
              134,497
              
              
              2.1
              %
              
              (1,142.2
              )%Net
                  income (loss) per share-basic and diluted
              
              $
              (0.07
              )
              
              
              
              $
              0.01




**Sales**





Sales
      for
      the nine months ended September 30, 2006 were $4,391,436 which was a decrease
      of
      $1,979,122 or 31.1% as compared to sales for the nine months ended September
      30,
      2005 of $6,370,558. 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 did not continue in the ordinary course of business, as
      well
      as to increase our sales. During the three months ended September 30, 2006
      we
      completed new agreements and received new and expanded consulting services
      purchase orders. Beginning in August 2006, we began to staff new projects and
      will continue to staff those projects with new employees in future
      months.





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.




19





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.





Early
      successes in our 2006 initiatives are evident in the preferred relationships
      we
      have earned with several large systems integrators and one major technology
      company. In addition, we are a member of one of only seven teams that in March
      2006 won the U.S. Army’s 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 nine months ended September 30, 2006 was
      $3,440,561 or 78.3% of sales as compared to $4,467,602 or 70.1% of sales for
      the
      nine months ended September 30, 2005. Gross profit was $950,875 or 21.7% of
      sales for the nine months ended September 30, 2006 compared to $1,902,956 or
      29.9% of sales for the nine months ended September 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 $20,334 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% or more, 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
      nine months ended September 30, 2006 decreased by $205,099 or 22.5%. 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 expenses were 16.1% for the
      nine
      months ended September 30, 2006 and 14.3% for the nine months ended September
      30, 2005. We anticipate that general and administrative expenses as a percent
      of
      sales will decrease as we continue to implement our business strategy and grow
      our sales. In addition, we recorded $8,524 as expense for the nine months ended
      September 30, 2006 as a result of adopting SFAS 123R. We reclassified defined
      benefit pension plan expense from general and administrative expense to a
      separate line item beginning with this report.




20





**Defined
      Benefit Pension Plan Expenses**





Defined
      benefit pension expenses include expenses (including professional services
      and
      interest costs) associated with the O&W defined benefit retirement plan of
      $342,370 for the nine months ended September 30, 2006 and $175,778 for the
      nine
      months ended September 30,2005, an increase of $166,592. During the three months
      ended September 30, 2006 we received a reply from the Department of the Treasury
      denying our request for waivers of the minimum funding standard for the 2005
      plan year of $513,551 and for the 2004 plan year of $979,328. As a result of
      these denials and our inability to fund pension plan contributions which were
      due in September 2006, we recorded $200,000 of expense for excise taxes and
      related interest for each of these years on unfunded contributions to the
      pension plan. Since the waivers were not granted we are examining and evaluating
      other alternatives as the sponsor of this plan.





**Selling
      Expenses**





For
      the
      nine months ended September 30, 2006, we incurred selling expenses of $1,243,369
      associated with growing business in our IT Services Group compared to $371,500
      for the nine months ended September 30, 2005, an increase of $871,869. We
      recorded $145,522 as expense for the nine months ended September 30, 2006 as
      a
      result of adopting SFAS 123R. Selling expenses consist of our business
      development staff including salaries, benefits, sales consultants, and travel
      expenses.





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 **.** 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
      incurred additional expenses in 2006 associated with our new business
      development efforts in the Gulf Coast region. We employ one person full time
      and
      use a lobbying firm in the Gulf Coast region. These individuals work closely
      with our Chief Operations Officer to develop business opportunities in the
      region.





We
      added
      one business development employee during August 2006, who formerly represented
      us as a business development consultant. We believe that our current staffing
      is
      adequate to manage the existing volume of business and development
      efforts.





**Research
      and Development and Impairment Loss**





For
      the
      nine months ended September 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 $202,719 of expense compared
      to $240,347 for the nine months ended September 30, 2005, a decrease of $37,628.
      Expenses are related to the development of the TouchThruTM access control
      terminal including product testing and documentation. Also included are expenses
      incurred to examine new business opportunities. During the three months ended
      September 30, 2006, we eliminated one engineering position since a portion
      of
      the product development was complete.





During
      the three months ended September 30, 2006 we recorded an impairment loss of
      $130,767 related to the carrying costs of TouchThruTM capitalized software
      development costs, tooling costs and inventory. Our TouchThruTM unit was designed
      around Ultra-Scan’s unique ultrasonic scanner. We anticipate that Ultra-Scan
      will improve the technology by designing a next generation scanner that will
      be
      smaller, lighter and less costly. Indications are that the next generation
      components are expected to be available in 2007.  We expect this will
      result in a substantial reduction in the costs of components to build our
      TouchThruTM unit and accordingly a substantial reduction in our sales
      price.  We expect to re-design our TouchThruTM unit based on the next
      generation of this technology and offer for sale a newly designed unit when
      it
      is completed.  As a result of the evolution of our business strategy,
      during the three months ended September 30, 2006, we recorded an impairment
      loss
      for a portion of capitalized software development costs, all of the capitalized
      tooling costs and the related inventory.





When
      the
      product development phase of TouchThruTM is completed, including the re-design of
      our TouchThruTM product, we expect related development expenses to decrease. We
      expect to incur more substantial selling and marketing expenses in the future
      as
      we develop sales of a newly designed TouchThruTM product that is based on
      Ultra-Scan’s next generation scanner.




21





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 is the first biometric product that we are introducing.
      Although we are in a position to market and sell that product, we have revised
      our strategy based on Ultra-Scan’s development of a next generation scanner that
      is expected to replace the current scanner. We plan to market and sell a
      re-designed TouchThruTM unit. However, we will expend limited resources on our
      current product version to introduce the capabilities of this product to the
      market. The TouchThruTM unit will be marketed 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
      September 30, 2006, we delivered demonstration units for trial to certain
      prospective customers in two industries.





**Depreciation
      and Amortization**





Depreciation
      and amortization expense was $73,988 (including $31,215 of amortization of
      software development costs) for the nine months ended September 30, 2006
      compared to $31,593 for the nine months ended September 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 our prior
      business, 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.





**Operating
      Income (Loss)**





For
      the
      nine months ended September 30, 2006 our operating loss was $(1,749,319)
      compared to operating income of $126,801 in the comparable period of 2005.





The
      decrease of $1,876,120 from net income to a net loss is principally attributable
      to:




·
            a
                decrease in gross profit of $952,081 incurred as a result of a decrease
                in
                sales of $1,979,122 and a decline in gross profit margin from 29.9%
                to
                21.7%;





·
            recording
                an impairment loss of $130,767 related to the carrying values of
                TouchThruTM assets;





·
            an
                increase in selling expenses of $871,869 as we increased efforts
                to grow
                sales, including expense of $145,522 as a result of adopting SFAS
                123R in
                2006;





·
            recording
                $200,000 of expense related to the O&W defined benefit retirement plan
                upon receiving a reply from the Department of the Treasury denying
                our
                request for waivers of the minimum funding standard and our inability
                to
                make required pension plan contributions;
                and





·
            an
                offset in part by a decrease in general and administrative expense
                of
                $205,099.





Included
      in the above are expenses of $174,380 as a result of adopting SFAS 123R in
      2006
      and $17,091 as a result of warrants and stock options issued to
      consultants.





The
      non-recurring write off of capitalized financing costs of $44,857 recorded
      in
      the nine months ended September 30, 2005 contributed to the reduction of
      operating income for the nine months ended September 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 $143,241 for the nine months ended September 30, 2006 compared
      to
      $203,428 for the nine months ended September 30, 2005. The reduction in net
      interest expense of $60,187 was principally due to a decrease in the volume
      of
      accounts receivable invoices that were financed in 2006 compared to
      2005.




22





**Other
      Income**





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 we received and recorded
      other income of $498,088, net of legal fees and expenses of $164,412, in the
      first quarter of 2006.





Other
      income for the nine months ended September 30, 2005 is a gain on settlement
      with
      a terminated employee of $191,739, which consists of his return to us of 500,000
      shares of our common stock less legal expense that we incurred in connection
      with the settlement. The shares were valued at the fair value on the date the
      settlement agreement was executed. Another component of other income for the
      nine months ended September 30, 2005 consists of a gain on the sale of office
      equipment of $8,452 in connection with the relocation and sublease of office
      space in the Washington, D.C. area. These total $200,191.





**Income
      Taxes**





Income
      tax expense was $7,300 and $1,300 for the nine months ended September 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 nine months
      ended September 30, 2005. The income is the result of our former business,
      the
      Photonics Group, which was reclassified as discontinued operations.





**Net
      Income (Loss)**





For
      the
      nine months ended September 30, 2006, ** we
      recorded a loss from continuing operations and a net loss of $(1,401,772),
      or
      $(.07) per share. This compares to income from continuing operations of $122,264
      or $.01 per share and net income of $134,497 or $.01 per share for the nine
      months ended September 30, 2005 *.*





The
      decrease of $1,536,269 from net income to a net loss is principally attributable
      to:




·
            a
                decrease in gross profit of $952,081 incurred as a result of a decrease
                in
                sales of $1,979,122 and a decline in gross profit margin from 29.9%
                to
                21.7%;





·
            recording
                an impairment loss of $130,767 related to the carrying values of
                TouchThruTM assets;





·
            an
                increase in selling expenses of $871,869 as we increased efforts
                to grow
                sales, including $145,522 a result of adopting SFAS 123R in
                2006;





·
            recording
                $200,000 of expense related to the O&W defined benefit retirement plan
                upon receiving a reply from the Department of the Treasury denying
                our
                request for waivers of the minimum funding standard and our inability
                to
                make required pension plan
                contributions;





·
            an
                offset in part by a decrease in general and administrative expense
                of
                $205,099 and net interest expense of $60,187;
                and





·
            an
                offset in part due to an increase in other income of $297,897 from
                $200,191 in 2005 to $498,088 in
                2006.





Included
      in the above are expenses of $174,380 as a result of adopting SFAS 123R in
      2006
      and $17,091 as a result of warrants and stock options issued to
      consultants.





23




**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.




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 was 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
      September 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 $77,853 for the three-months ended September 30,
      2006 and $174,380 for the nine months ended September 30, 2006. The impact
      of
      this expense was to increase basic and diluted net loss per shares from $(.06)
      to $(.07) for the nine months ended September 30, 2006 and from $(.03) to $(.04)
      for the three months ended September 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 nine months ended September 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 $77,853 for employee stock options and $5,697 for warrants
      and stock options issued to consultants for the three months ended September
      30,
      2006. We recorded expense of $174,380 for employee stock options and $17,091
      for
      warrants and stock options issued to consultants for the nine months ended
      September 30, 2006.





**Liquidity
      and Capital Resources**





At
      September 30, 2006, we had cash of $16,985 available for our working capital
      needs and planned capital asset expenditures. At September 30, 2006, we had
      a
      working capital deficit of approximately $2,263,000, which includes
      approximately $1,700,000 of accrued pension liabilities, penalties and accrued
      interest for contributions to the O&W plan that we are not able to fund.





Our
      objective is to improve our working capital position by generating profits
      from
      operations, by raising additional cash from long-term debt or private placements
      of equity securities and by evaluating alternatives to address the unfunded
      defined benefit pension plan contributions. 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. As we incur operating losses or net losses, we will
      experience working capital shortages that may impair our business operations
      and
      growth strategy. We expect to raise additional debt or equity capital to fund
      our operations during the periods in which we incur losses and develop new
      business opportunities. 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. We issued additional short-term notes to related parties of $120,000
      during the three months ended September 30, 2006 to fund our
      operations.




24





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 September 30, 2006, we had
      approximately $360,000 of availability under this line of which we could finance
      up to approximately $80,000 based on selected accounts receivable at September
      30, 2006.





We
      have
      used our common stock to provide compensation to certain employees and
      consultants and to fund liabilities. During the nine months ended September
      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.





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 aggregate
      $1,350,000. 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 $342,370 and $175,778 for the nine months ended September 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 the three months ended September
      30, 2006 we received a reply from the Department of the Treasury denying our
      request for waivers of the minimum funding standard for the 2005 and 2004 plan
      years. As a result of these denials and our inability to fund pension plan
      contributions which were due in September 2006, we recorded $200,000 of expense
      for excise taxes and related interest for each of these years on unfunded
      contributions to the pension plan and reclassified $1,350,000 of accrued pension
      expense to current liabilities. Since the waivers were not granted we are
      examining and evaluating other alternatives as the sponsor of this plan. During
      2006, we changed the investment manager with the objective of improving the
      plan’s investment performance.





**Risk
      Factors**




There
      have been no material changes to the Risk Factors included in our Annual Report
      on Form 10-KSB for the year ended December 31, 2005, except that the following
      risk factor **** related
      to our business has been updated to reflect developments subsequent to the
      filing of that report.





**We
      have significant liabilities related to the O&W pension plan.**





At
      September 30, 2006, the O&W pension plan had an accrued pension obligation
      liability of $2,494,712 and an accumulated other comprehensive loss of
      $3,046,855. The market value of plan assets was $3,504,314 at September 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 plan’s deficiency. We
      did not make contributions during 2004 and 2006 and we currently do not have
      the
      funds available to make currently required contributions of approximately
      $1,350,000.





In
      March
      2005, we filed a funding waiver application with the Department of the Treasury
      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 the three months ended September
      30, 2006, we received a reply from the Department of the Treasury denying our
      request for waivers of the minimum funding standard for the 2005 and 2004 plan
      years. As a result of these denials and our inability to fund pension plan
      contributions which were due in September 2006, during the three months ended
      September 30, 2006 we recorded $200,000 of expense for excise taxes and related
      interest for each of these years on unfunded contributions to the pension plan
      and reclassified $1,350,000 of accrued pension expense to current liabilities.
      Since the waivers were not granted we are examining and evaluating alternatives
      as the sponsor of this plan. During this time we are required to record
      penalties and interest based on the required outstanding plan contributions
      of
      approximately $1,350,000 which we have not funded. We will continue to be
      subject to additional penalties and interest until the plan is funded; a new
      waiver application is made and approved (there is no assurance that a new waiver
      application will be approved if requested); the plan is terminated (which
      termination requires approval by the Pension Benefit Guarantee Corporation
      and
      there is no assurance that an approval will be obtained if requested); or the
      liability is otherwise satisfied. We expect to record increased expenses in
      future periods as a result of the liabilities associated with the O&W
      pension plan. If we are unable to satisfy or otherwise settle our plan
      contribution obligations, then our business, financial condition and results
      of
      operations could be materially adversely affected.





25





**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 the period covered by this report that have materially affected, or
      are
      reasonably likely to materially affect, our internal control over financial
      reporting.




26




**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.**




None.





**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




27




**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:
                November 10, 2006
            
            /s/
                Michael S. SmithChief
                Executive OfficerDate:
                November 10, 2006/s/
                Michael S. SmithChief
                Financial Officer
              (Principal
                Financial Officer)





28