ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS

EXECUTIVE OVERVIEW

We are a development stage company engaged principally in designing, engineering and manufacturing Bend Sensor(R) technology and equipment. Our planned operations have not commenced and our activities primarily include acquiring equipment and technology, organizing activities, obtaining financing and seeking manufacturing contracts.

During the past quarter we have focused our efforts on third party testing of our technology as required in our protocol for Stage II development of our technology. In June 2006 we announced our Pedestrian Impact Detection System was tested by MGA Research and this research confirmed results of our internal testing. This system is placed in the vehicles' front bumper to detect crash impact. Within milliseconds of contact, the system can differentiate between a human leg and an inanimate object and trigger a safety response in accordance with the manufacturer's specifications.

We also announced that we had entered into a cooperative testing agreement with Faurecia Automotive ("Faurecia") in June 2006. Faurecia is the second largest automotive supplier in Europe and it supplies components to large automotive manufacturers, such as BMW, Toyota, Ford, Daimler-Chrysler and others. This agreement will allow both companies to use their resources, knowledge and capabilities to develop a working prototype of the Pedestrian Impact Detection System.

Our production of the medical bed has been delayed as a result of waiting for a final design and configuration of the medical bed from R&D Products. Flexpoint is prepared to produce the sensors under the terms of the agreement as soon as R&D Products determines the final design and configuration of the bed.

Negotiations for potential automotive applications using our Bend Sensors technology are in process, but we have not yet entered into a major contract for the sale of our automotive products. We are also continuing to develop new products that we may sell or license to an industrial control company.

Finalizing a major contract with a customer remains our greatest challenge. We must continue to obtain funding to operate and expand our operations so that we can deliver our product to the market. Management believes that even though we are making positive strides forward with our business plan, it is likely that significant progress may not occur for the next four to six months. Accordingly, we cannot guarantee that we will realize significant revenues or that we will become profitable within the next twelve months.

LIQUIDITY AND CAPITAL RESOURCES

Our revenues are not to a level to support our operations. Our revenues are primarily from design, contract and

testing services. For the past twelve months we have relied on proceeds from the private placement we completed in March 2005 to satisfy our cash shortfalls. We conducted the private placement during the first quarter of 2005 to raise funds for operations. We realized net proceeds of $3,907,207 from this private placement and as a result we have cash to continue our operations and business development. In this private placement we issued an aggregate of 2,836,335 units to purchasers and 140,000 units were issued to the placement agent. Each unit consisted of one share and one warrant to purchase one share at an exercise price of $3.00.

Management believes that our current cash burn rate is $150,000 per month and that the remaining proceeds from the private placement will fund our operations for at least the next six months. For the six month period ended June 30, 2006 ("2006 six month period") net cash used by operating activities was $800,238 compared to $699,346 for the six month period ended June 30, 2005 ("2005 six month period").

Another source of cash for the 2006 six month period was the exercise of warrants. On June 27, 2006, Summit Resource Group exercised warrants to purchase 300,000 common shares at an exercise price of $0.70 per share and we received $210,000 proceeds from the exercise of these warrants. We issued these warrants to Summit Resource Group on March 3, 2004, as part of a consulting agreement with that company to provide investor relations services. The underlying common shares were registered under a Form SB-2 registration statement declared effective August 18, 2005.

We may receive additional funds in the future from warrants issued in the private placement. If all of the warrants issued in the private placement are exercised, then we may realize an additional $8,929,005, based on an exercise price of $3.00 per warrant. Except for a "call" provision, the warrant holders have total discretion as to when or if the warrants are exercised. If the closing bid price of our common stock is greater than $4.00 per share for five consecutive trading days after October 1, 2005 and during the exercise term of the warrant, then we have the right to call the warrant in whole or in part, forcing the investor to exercise the warrant within fifteen trading days or the warrant is forfeited. We cannot guarantee that the price of our common stock will reach $4.00 and, in that case, the warrant holders will determine when and if the warrants are exercised.

We will require additional financing to fund our long-term cash needs and we may be required to rely on debt financing, loans from related parties, and private placements of our common stock for additional funding. However, we cannot assure you that we will be able to obtain financing, or that sources of financing, if any, will continue to be available, and if available, that they will be on terms favorable to us. We intend to use revenue and our cash to purchase and install equipment and develop our ISO/TS-16949 certified facility.

As we enter into new technology agreements in the future, we must ensure that those agreements provide adequate funding for any pre-production research and development and manufacturing costs. If we are successful in establishing agreements with adequate initial funding, management believes that our operations for the long term will be funded by revenues, licensing fees and royalties related to these agreements. However, we have formalized only a few additional agreements during the past year and there can be no assurance that agreements will come to fruition in the future or that a desired technological application can be brought to market.

COMMITMENTS AND CONTINGENCIES

Our principal commitments consist of total current liabilities of $42,734 at June 30, 2006, and our operating lease. The operating lease has average monthly payments of $8,718, including common area maintenance and a 2% annual increase. The total future minimum payments under this lease as of December 31, 2005 were $395,889.

Our total current liabilities include accounts payable of $4,202 related to normal operating expenses, including health insurance, utilities, production supplies and travel expense; also expenses for professional fees regarding audit fees and legal fees related to the defense of patent rights. Accrued liabilities at June 30, 2006, were $38,532 and were related to payroll tax liabilities, accrued audit and tax expenses, accrued lease expense and accrued Paid Time Off, a combination vacation-sick leave policy.

In January 2006 we initiated a legal action for patent encroachment and we anticipated that this legal action would result in legal costs of approximately $100,000; however, the cost of this action has been higher than anticipated and we now estimate that this legal action will result in legal costs of approximately $200,000. Management believes it is critical to protect our patents and will divert a portion of our financial resources to continue this legal matter.

OFF-BALANCE SHEET ARRANGEMENTS

None.

CRITICAL ACCOUNTING ESTIMATES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Estimates of particular significance in our financial statements include goodwill and the annual tests for impairment of goodwill and valuing stock option compensation.

We annually test goodwill for impairment or when a triggering event occurs. Impairment is indicated if undiscounted cash flows are less then the carrying value of the assets. The amount of impairment is measured using a discounted-cash-flows model considering future revenues, operating costs and risk-adjusted discount rate and other factors. We performed a goodwill impairment test during 2005 and concluded there was no impairment of goodwill.

We account for stock options under Statement of Financial Accounting Standards No. 123(R), effective January 1, 2006. Statement 123(R) requires that recognition of the cost of employee services received in exchange for stock options and awards of equity instruments be based on the grant-date fair value of such options and awards, over the period they vest. The fair value of the options we have granted is estimated at the date of grant using the Black-Scholes American option-pricing model. Option pricing models require the input of highly sensitive assumptions, including expected stock volatility. Also, our stock options have characteristics significantly different from those of traded options, and changes in the subjective input assumptions can materially affect the fair value estimate. Management believes the best input assumptions available were used to value the options and that the resulting option values are reasonable. During the 2006 first quarter we recognized $529,953 of stock-based compensation expense for our stock options.

RESULTS OF OPERATIONS

The following discussions are based on the consolidated operations of Flexpoint Sensor and its subsidiary, Sensitron, and should be read in conjunction with our unaudited financial statements the three and six month periods ended June 30, 2006 and 2005. These financial statements are included in this report at Part I, Item 1, above.

                   Three month     Three month    Six month      Six month
                   period ended    period ended   period ended   period ended
                   June 30, 2006   June 30, 2005  June 30, 2006  June 30, 2005
                   --------------  -------------  -------------  -------------

Revenue            $      52,784   $      2,087   $     53,526   $     18,365

Total operating
costs and expenses      (960,372)      (418,584)    (1,529,438)      (800,696)

Net other income          12,194         19,390         24,422         18,757


Net loss           $    (895,394)  $   (397,107)  $ (1,451,490)  $   (763,574)

Basic and diluted
loss per share     $       (0.04)  $      (0.02)  $      (0.06)  $      (0.03)

Revenue from research and development engineering contracts is recognized as the services are provided and accepted by the customer. Revenue from contracts to license technology to others is deferred until all conditions under the contract are met and then the sale is recognized as licensing royalty revenue over the remaining term of the contract. Revenue from the sale of a product is recorded at the time of shipment to the customer.

Our revenue for the 2006 and 2005 interim periods was from design, contract and testing services. The increase in revenue for the three month period ended June 30, 2006 (the "2006 second quarter") and for the 2006 six month period compared to the 2005 comparable periods was the result of increases in revenue from design engineering work. Management does not anticipate that revenues will increase until we finalize a major contract.

Total operating costs and expenses increased for the 2006 interim periods compared to the 2005 interim periods primarily as a result of increases in administrative and marketing expenses and research and development expense. Administrative and marketing expenses increased in the 2006 interim periods due to litigation fees and compensation expense recognized for share-based option compensation according to SFAS No. 123(R), discussed above. In addition, research and development expense increased in the 2006 interim periods as we moved forward with the Stage II development of our technology. Due to a change in account methodology we directly expensed research and development costs in the 2006 interim periods, rather than including them in cost of revenue.

Total other income for the 2006 and 2005 interim periods was primarily the result of interest income related to interest on the proceeds of the private placement offering which were deposited in a savings account. Interest expense for the 2005 interim periods was primarily the result of interest expense related to loans.

Due to minimal revenues and increased operating costs and expenses, we recorded a net loss for both the 2006 and 2005 interim periods. Management expects losses to continue in the short term.

                                     June 30, 2006    December 31, 2005
                                     --------------   -----------------
Cash and cash equivalents            $   1,371,987    $   1,964,487

Total current assets                     1,401,593        1,999,148

Total assets                             9,550,284       10,304,149

Total current liabilities                   42,734           85,062

Deficit accumulated during              (7,732,236)      (6,280,746)
the development stage

Total stockholders equity            $   9,507,550    $  10,219,087

Cash and cash equivalents decreased 30.1% at June 30, 2006, compared to December 31, 2005 because we had minimal revenue in the 2006 six month period to provide cash. Until our revenue increases, our cash will continue to decrease.

Our non-current assets decreased at June 30, 2006, due to adjustments for depreciation and amortization. These assets include property and equipment valued at $1,158,577, patents and proprietary technology of $1,627,200, goodwill of $5,356,414, and long-term deposits of $6,500.

Total current liabilities decreased at June 30, 2006, primarily as a result of decreases in accounts payable and accrued liabilities.

Factors Affecting Future Performance

We have a history of losses and may never become profitable.

We are unable to fund our day-to-day operations from revenues and the lack of revenues for continued growth may cause us to delay our business development. For the 2006 six month period, we incurred a net loss of $1,451,490 and had negative cash flows from operating activities of $800,238. We anticipate proceeds from our private placement completed in March 2005 will fund our operations for at least the next six months; however, we expect that revenue will not increase until late 2006 or early 2007. In addition, if we decide to expand our business activities outside the automotive market in the next twelve months, we anticipate needing more than approximately $1,000,000 in additional funding.

We may not have adequate experience to successfully manage anticipated growth.

In January 2005 we restructured our management team and brought in an experienced group of executive level management personnel to direct the growth of our business operations. However, we may not be equipped to successfully manage any possible future periods of rapid growth or expansion, which could be expected to place a significant strain on our managerial, operating, financial and other resources. Our future performance will depend, in part, on our ability to manage growth effectively, which will require us to:
. improve existing, and implement new, financial controls and systems, management information systems, operating, administrative, financial and accounting systems and controls,
. maintain close coordination between engineering, programming, accounting, finance, marketing, sales and operations, and
. attract and retain additional qualified technical and marketing personnel.

There is intense competition for management, technical and marketing personnel in our business. The loss of the services of any of our key employees or our failure to attract and retain additional key employees could have a material adverse effect on our ability to continue as a going concern.

We may not have adequate manufacturing capacity to meet anticipated manufacturing contracts.

Based on projected business development, we will need to complete a second production line and have it installed and approved in 2008. The second manufacturing line is expected to result in increased manufacturing capacity and manufacturing efficiencies. We have completed installation of our first production line and are in the process of qualifying our own manufacturing facility for ISO/TS-16949 certification. However, we cannot assure you that we will satisfy ISO/TS-16949 qualification or that the production lines will produce product in the volumes required or that the production lines will satisfy the requirements of our customers.

Our success is dependent on our intellectual property rights which are difficult to protect.

Our future success depends on our ability to protect our intellectual property. We use a combination of patents and other intellectual property arrangements to protect our intellectual property. There can be no assurance that the protection provided by our patents will be broad enough to prevent competitors from introducing similar products or that our patents, if challenged, will be upheld by courts of any jurisdiction. Patent infringement litigation, either to enforce our patents or defend ourselves from infringement suits, will be expensive and could divert our resources from other planned uses. Patent applications filed in foreign countries and patents in these countries are subject to laws and procedures that differ from those in the U.S. and may not be as favorable to us. We also attempt to protect

our confidential information through the use of confidentiality agreements and by limiting access to our facilities. There can be no assurance that our program of patents, confidentiality agreements and restricted access to our facilities will be sufficient to protect our confidential information from competitors.

Research and development may result in problems which may become insurmountable to full implementation of production.

Customers request that we create prototypes and perform pre-production research and development. As a result, we are exposed to the risk that we may find problems in our designs that are insurmountable to fulfill production. In that event, we will be unable to recover the costs of the pre-production research and development. However, we are currently unaware of any insurmountable problems with ongoing research and development that may prevent further development of an application.

Our products must satisfy governmental regulations in order to be marketable

During the past several years, the automotive industry has been subject to increased government safety regulation. Among other things, proposed regulations from the National Highway Transportation and Safety Administration required automakers to incorporate advanced air bag technology into vehicles beginning in 2005 with the phase-in to be completed by 2008. Our products may not meet the proposed National Highway Transportation and Safety Administration standards or the standards may be modified. These proposals call for upgraded air bag system performance tests for passenger cars and light trucks. The new testing requirements are intended to improve the safety of infants, children and out-of-position adults, and maximize the protection of properly seated adults. The National Highway Transportation and Safety Administration tests are similar to conditions that we have already been using to test our Seat Mat System and we believe that our Seat Mat System will meet the standards as proposed. In addition, automakers may react to these proposals and the uncertainty surrounding these proposals by curtailing or deferring investments in new technology, including our Bend Sensor(R) technology, until final regulatory action is taken. We cannot predict what impact, if any, these proposals or reforms might have on our financial condition and results of operations.

Because we are significantly smaller than the majority of our competitors, we may lack the financial resources needed to capture increased market share.

The market for sensor devices is extremely competitive, and we expect that competition will intensify in the future. There can be no assurance that we will be able to compete successfully against current or future competitors or that competitive pressures we face will not materially adversely affect our business, operating results or financial condition. Our primary competitors in the air bag market are International Electronics and Engineering, Siemens, Robert Bosch GmbH, Denso, Inc., Breed Technologies, TRW Automotive, Delphi Corporation, Autoliv Inc., Takata and Temic. We believe that none of our competitors have a product that is superior to our Bend Sensor(R) technology at this time. However, many of our competitors and potential competitors have substantially greater financial, technical and marketing resources, larger customer bases, longer operating histories, greater name recognition and more established relationships than we do. These competitors may be able to undertake more extensive marketing campaigns, adopt more aggressive pricing policies and devote substantially more resources to developing new products and markets than we can.

Ongoing industry consolidation among worldwide automotive parts suppliers and financial difficulties of U.S. auto makers may limit the market potential for our products.

In the automotive parts industry, there is a trend of consolidation through business combinations and acquisitions of complementary technologies among worldwide suppliers as these suppliers seek to build stronger customer relationships with automobile manufacturers. Automobile manufacturers look to Tier 1 suppliers (major suppliers) to provide fully engineered systems and pre-assembled combinations of components rather than individual components. This trend of consolidation of suppliers may result in fewer Tier 1 suppliers and thus limit the marketing opportunities for our Bend Sensor(R) technology. In addition, in recent months large U.S. auto makers

have announced plans to close plants and reduce their work force, some Tier 1 suppliers are in bankruptcy or in financial difficulty, and two automobile manufacturers have reported increased financial difficulties. These industry trends may limit the market for our products.