Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995

Statements in this report (including Management's Discussion and Analysis of Financial Condition and Results of Operations) that are not descriptions of historical facts, such as statements about the Company's future prospects and cash requirements, are forward-looking statements and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may vary due to risks and uncertainties, including the Company's very limited capital resources and the possibility that it may be unable to raise additional capital in amounts sufficient to permit it to continue operations; the risk that the Company may lose all or part of the claims covered by its patents as a result of existing and future challenges to its patents; the risk that its patents may be subject to additional reexamination by the U.S. Patent and Trademark Office or challenge by third parties; the possibility that all or some of the holders of the convertible secured notes issued by the Company may take action to collect the amounts outstanding under these notes; the result of ongoing litigation; and unanticipated costs and expenses affecting the Company's cash position. If the Company is not able to raise additional capital, it may be forced to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection. Moreover, if any of the holders of the convertible notes issued by the Company take action to collect the amounts owed by the Company under these notes, the Company will be forced to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection. These and other factors discussed in the Company's filings with the Securities and Exchange Commission, including the information set forth under the caption "Business Risks" in Item 1 of the Company's Annual Report on Form 10-K for the year ended December 31, 2004, may cause actual results to differ materially from those anticipated.

Overview

Affinity Technology Group, Inc. (the "Company") was formed to develop and market technologies that enable financial institutions and other businesses to provide consumer financial services electronically with reduced or no human intervention. Products and services previously offered by the Company include its DeciSys/RT(R) loan processing system, which automated the processing and consummation of consumer financial services transactions; the Affinity Automated Loan Machine (the ALM), which allowed an applicant to apply for and, if approved, obtain a loan in as little as ten minutes; the Mortgage ALM, which allowed an applicant to apply for a mortgage loan; e-xpertLender(R), which permitted a financial institution to make automated lending decisions through its call centers and branches; iDEAL, which permitted automobile lenders to make automobile lending decisions for loan applications originated at automobile dealers; and rtDS, which permitted lenders to deliver credit decisions to applicants over the Internet. Due to capital constraints, the Company has suspended all efforts to further develop, market and operate these products and services. The Company's last processing contract terminated in late 2002, and the Company has no plans in the near term to engage in further sales or other activities related to its products or services, other than to attempt to license certain of the patents that it owns. Currently, the Company's business activities consist exclusively of attempting to enter into license agreements with third parties to license the Company's rights under certain of its patents.

In conjunction with its product development activities, the Company applied for and obtained three patents. The Company has been granted two patents covering its fully-automated loan processing systems (U. S. Patents No. 5,870,721 and 5,940,811). In August 2000, the U.S. Patent and Trademark Office (the "PTO") issued to the Company a patent covering the fully-automated establishment of a financial account, including credit accounts (U. S. Patent No. 6,105,007). In addition, in 1997 the Company acquired a patent that covers the automated processing of an insurance binder through a kiosk (U. S. Patent No. 5,537,315).

Both of the Company's patents covering fully automated loan processing systems have been subject to reexamination by the PTO due to challenges to such patents by third parties. On January 28, 2003, the Company received a Reexamination Certificate (U. S. Patent No. 5,870,721 C1) from the PTO which formally concluded the reexamination of U. S. Patent No. 5,870,721. On March 30, 2005, the Company received a Notice of Intent to Issue Ex Parte Reexamination Certificate from the PTO indicating that the reexamination of its other loan processing patent (U. S. Patent No. 5,940,811) had been completed. The Company expects to receive the Reexamination Certificate for this patent in due course.

On March 26, 2004, the Company was notified by Federated Department Stores, Inc. ("Federated") and Ameritrade Holding Corporation ("Ameritrade") that they had jointly filed a request with the PTO to reexamine U. S. Patent No. 6,105,007. On June 23, 2004, the Company received notification that the PTO had granted the request for reexamination. The Company has lawsuits pending against Federated and Ameritrade in the Columbia Division of the United States District Court for the State of South Carolina (the "Columbia Federal Court") in which it claims that both Federated and Ameritrade infringe U. S. Patent No. 6,105,007. The Company has jointly, with Federated and Ameritrade, requested the Columbia Federal Court to stay the lawsuits against Federated and Ameritrade pending resolution of the reexamination of U. S. Patent No. 6,105,007. It is likely that it will take an extended period of time to complete the reexamination proceedings and the related litigation with Federated and Ameritrade. Moreover, the reexamination of U. S. Patent No. 6,105,007 has adversely affected the Company's patent licensing program and impeded its ability to raise additional capital resources to continue its operations.

In November 2003, Household International, Inc. ("Household") filed a declaratory judgment action against the Company in the United States District Court in Wilmington, Delaware (the "Delaware Federal Court"). In its complaint Household requested the Delaware Federal Court to rule that Household was not infringing any of the claims of certain of the Company's patents (U.S. Patent No. 5,870,721 C1, No. 5,940,811, and No. 6,105,007) and that these patents are not valid. The Company filed counterclaims against Household claiming that Household infringes U. S. Patent Nos. 5,870,721 C1, 5,940,811 and 6,105,007. The Company also filed a motion with the Delaware Federal Court to transfer the case to the Columbia Federal Court. In April 2004, the Delaware Federal Court granted the Company's motion to transfer the case to Columbia Federal Court. As discussed above, the PTO has granted the reexamination request filed by Federated and Ameritrade relating to U. S. Patent No. 6,105,007. The Company jointly, with Household, requested and received a stay of the Household action from the Columbia Federal Court pending the resolution of the PTO's reexamination of U. S. Patent No. 6,105,007.

It is possible that third parties may bring additional actions to contest all or some of the Company's patents. The Company can make no assurances that it will not lose all or some of the claims covered by its existing patents.

To date, the Company has generated substantial operating losses and has been required to use a substantial amount of cash resources to fund its operations. At June 30, 2005, the Company had cash and cash equivalents of $26,429. On August 12, 2005, the Company sold an additional $45,000 principal amount of its notes. The Company has informal arrangements with certain vendors and officers under which these vendors and officers have agreed to defer all or part of the amounts payable to them until the Company has adequate resources to do so. The Company must raise additional capital to fund accrued operating expenses and continue its operations. Unless the Company raises additional capital, it will have to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection. Moreover, the Company currently does not have the resources to repay the principal and accrued interest outstanding under its convertible secured notes, which have become due and payable in full as discussed in the following paragraphs. If any of the holders of these notes take action to collect the amounts owed by the Company under these notes, the Company will be forced to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection.

In 2002 the Company initiated a convertible note program under which it is authorized to issue up to $1,500,000 principal amount of its notes. To date, the Company has issued an aggregate of $1,400,336 principal amount of notes under this program, including $45,000 principal amount of notes issued in August 2005 as discussed above. These notes bear interest at 8%, are convertible into the Company's common stock at a conversion rate of $.20 per share, and are secured by the Company's equity interest in decisioning.com, Inc., which owns the Company's patent portfolio. The outstanding notes include a note in the principal amount of $125,000 acquired on June 3, 2002 by the Company's Chief Executive Officer and a note in the principal amount of $100,000 acquired on November 5, 2003 by a subsidiary of The South Financial Group, which owned approximately 12% of the Company's outstanding capital stock. Principal and interest under these notes generally becomes payable in full on the second anniversary of the date on which these notes were issued. However, under the terms of the notes, the full amount of principal and interest under all notes becomes immediately due and payable in certain events, including bankruptcy or similar proceedings involving the Company, a default in the payment of principal and interest under any note, or a change in control of the Company.

On June 2, 2004, notes with a principal amount of $756,336 became due and payable. Additionally, on March 13, 2005 notes with a principal amount of $200,000 became due and payable. The Company has had discussions with the holders of these notes regarding the extension of the maturity date of these notes. However, the Company has not been successful in reaching an agreement with all of the holders of these notes regarding an extension of their maturity date. Because the Company is currently in default regarding payment of principal and interest due under certain of the notes, the full amount of principal and interest outstanding under all notes has become due and payable. Accordingly, the full amount of principal and accrued interest under all of these notes is shown as a current liability of the Company as of June 30, 2005 and December 31, 2004. As of June 30, 2005, and December 31, 2004, the amount of principal and accrued interest outstanding under all of the notes was $1,475,163 and $1,383,149, respectively.

Under the terms of the note purchase agreement that governs the Company's convertible note program, the Company previously was not permitted to issue any additional notes if there was an existing default under any of the notes. As discussed above, because the Company currently is in default regarding payment of principal and interest due under certain of the notes, it was not permitted to issue any additional notes under the note purchase agreement. In May 2005, the note purchase agreement was amended to remove this provision. Following this amendment, in May 2005 and August 2005 the Company issued an additional $75,000 and $45,000, respectively, principal amount of notes.

To remain viable, the Company must generate working capital through the sale of patent licenses or by raising additional capital. To date, the Company generally has been unable to enter into licensing agreements with potential licensees upon terms that are acceptable to the Company. As discussed above, the Company has been forced to become involved in litigation with alleged infringers. The Company believes that these lawsuits may take an extended period of time to complete, and no assurance can be given that the Company will have the resources necessary to complete these lawsuits or that it will be successful in obtaining a favorable outcome. Moreover, the ongoing reexamination of U. S. Patent No. 6,105,007 will likely take an extended period of time to complete and adversely affect the Company's ability to enter into other licensing agreements. Accordingly, to remain viable it is critical that the Company raise additional capital. The uncertainties of these litigation matters, the reexamination of U. S. Patent No. 6,105,007, and other factors affecting the Company's short and long-term liquidity discussed above have impeded and will likely continue to impede the Company's ability to raise additional capital. To maintain the minimal resources necessary to support its current operations, prosecute the reexamination of U. S. Patent No. 6,105,007, and execute a patent licensing strategy, the Company does not believe that substantial additional reductions in its operating expenses are feasible. No assurances can be given that the Company will be able to raise additional capital or generate working capital from its patent licensing business.

The Company is a defendant in a lawsuit brought by Temple Ligon, who claims that the Company breached an agreement to give him a 1% equity interest in the Company in consideration of services he claims to have performed in 1993 and 1994 in conjunction with the formation of the Company. In January 2004, this litigation resulted in a jury verdict against the Company of $382,148. Following this verdict, the Company filed post-trial motions with the trial court in which, among other things, it claimed that the jury verdict should be set aside. On July 23, 2004, the trial judge granted the Company's motions, set aside the jury verdict, and ordered entry of a judgment in favor of the Company. The plaintiff has appealed the trial judge's ruling to the South Carolina Court of Appeals. If the Company becomes obligated to pay more than an insignificant amount of damages in connection with this litigation, it will be forced to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection.

Critical Accounting Policies

The Company applies certain accounting policies, which are critical to understanding the Company's results of operations and the information presented in the condensed consolidated financial statements. We consider critical accounting policies to be those that require more significant judgments and estimates in the preparation of our financial statements, the most critical of which pertains to the valuation reserve on net deferred tax assets. The Company records a valuation allowance to reduce its deferred tax assets to the amount that it estimates is more likely than not to be realized. As of June 30, 2005 and December 31, 2004, the Company recorded a valuation allowance that reduced its deferred tax assets to equal its deferred tax liability.

Results of Operations

Revenues

Patent license revenue. The Company recognized patent licensing revenues of $4,412 and $8,824 for the three and six month periods ended June 30, 2005, respectively, compared to $4,412 and $258,824 in the corresponding periods in 2004. During the three and six month periods ended June 30, 2005, and June 30, 2004, the Company recognized $4,412 and $8,824, respectively, related to a three-year license agreement entered into in 2002. Of the revenues recognized during the six-month period ended June 30, 2004, $250,000 was related to a settlement agreement entered into in January 2004 with an institution that formerly maintained a system that permitted consumers to apply for credit cards over the Internet. These revenues are not recurring.

Costs and Expenses

Cost of revenues. Cost of revenues for the three and six month periods ended June 30, 2005 was $441 and $882, respectively, compared to $441 and $63,382 for the corresponding periods in 2004. Cost of revenues consists of commissions paid to the Company's patent licensing representatives. The decrease in cost of revenues during the six months ended June 30, 2005 compared to the corresponding period in 2004 is attributable to a settlement agreement entered into in the first quarter of 2004 for which commissions of $62,500 were paid to the Company's patent licensing representatives.

General and administrative expenses. General and administrative expenses totaled $145,259 and $255,506 for the three and six month periods ended June 30, 2005, respectively, compared to $165,912 and $456,993 in the corresponding periods in 2004. The decrease of $20,653 for the three month period ended June 30, 2005, compared to the same period in 2004 was primarily attributable to legal fees and related expenses incurred in 2004 in conjunction with the Company's patent licensing litigation and general business matters. The decrease of $201,487 for the six month period ended June 30, 2005, compared to the same period in 2004 was primarily attributable to legal fees and related expenses incurred in 2004 in conjunction with the Temple Ligon trial, the Company's patent infringement litigation and general business matters.

Interest expense. Interest expense for the three and six month periods ended June 30, 2005, was $24,042 and $47,452, respectively, compared to $24,127 and $48,209 for the corresponding periods in 2004. Interest expense is related to the Company's convertible notes which accrue interest at 8%. Convertible note principal outstanding at June 30, 2005, December 31, 2004, and June 30, 2004 totaled $1,231,336, $1,181,336, and $1,206,336, respectively.

Liquidity and Capital Resources

The Company has generated net losses of $68,972,987 since its inception and has financed its operations primarily through net proceeds from its initial public offering in May 1996 and cash generated from operations and other financing transactions. Net proceeds from the Company's initial public offering were $60,088,516.

To date, the Company has generated substantial operating losses and has been required to use a substantial amount of cash resources to fund its operations. At June 30, 2005, the Company had cash and cash equivalents of $26,429. On August 12, 2005, the Company sold an additional $45,000 principal amount of its notes. The Company has informal arrangements with certain vendors and officers under which these vendors and officers have agreed to defer all or part of the amounts payable to them until the Company has adequate resources to do so. The Company must raise additional capital to fund accrued operating expenses and continue its operations. Unless the Company raises additional capital it will have to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection. Moreover, the Company currently does not have the resources to repay the principal and accrued interest outstanding under its convertible secured notes, which have become due and payable in full as discussed in the following paragraphs. If any of the holders of these notes takes action to collect the amounts owed by the Company under these notes, the Company will be forced to consider alternatives for winding down its business, which may include offering its patents for sale or filing for bankruptcy protection.

In 2002 the Company initiated a convertible note program under which it is authorized to issue up to $1,500,000 principal amount of its notes. To date, the Company has issued an aggregate of $1,400,336 principal amount of convertible secured notes under this program, including $45,000 principal amount of notes issued in August 2005 as discussed above. These notes bear interest at 8%, are convertible into the Company's common stock at a conversion rate of $.20 per share, and are secured by the Company's equity interest in decisioning.com, Inc., which owns the Company's patent portfolio. The outstanding notes include a note in the principal amount of $125,000 acquired on June 3, 2002 by the Company's Chief Executive Officer and a note in the principal amount of $100,000 acquired on November 5, 2003 by a subsidiary of The South Financial Group, which owned approximately 12% of the Company's outstanding capital stock. The full amount of principal and interest under these notes generally becomes payable in full on the second anniversary of the date on which these notes were issued. However, under the terms of the notes, the full amount of principal and interest under all notes becomes immediately due and payable in certain events, including bankruptcy or similar proceedings involving the Company, a default in the payment of principal and interest under any note, or a change in control of the Company.

On June 2, 2004, notes with a principal amount of $756,336 became due and payable. Additionally, on March 13, 2005 notes with a principal amount of $200,000 became due and payable. The Company has had discussions with the holders of these notes regarding the extension of the maturity date of these notes. However, the Company has not been successful in reaching an agreement with all of the holders of these notes regarding an extension of their maturity date. Because the Company is currently in default regarding payment of principal and interest due under certain of the notes, the full amount of principal and interest outstanding under all notes has become due and payable. Accordingly, the full amount of principal and accrued interest under all of these notes is shown as a current liability of the Company as of June 30, 2005 and December 31, 2004. As of June 30, 2005, and December 31, 2004, the amount of principal and accrued interest outstanding under all of the notes was $1,475,163 and $1,383,149, respectively.

Under the terms of the note purchase agreement that governs the Company's convertible note program, the Company previously was not permitted to issue any additional notes if there was an existing default under any of the notes. As discussed above, because the Company currently is in default regarding payment of principal and interest due under certain of the notes, it was not permitted to issue any additional notes under the note purchase agreement. In May 2005, the note purchase agreement was amended to remove this provision. Following this amendment, in May 2005 and August 2005 the Company issued an additional $75,000 and $45,000, respectively, principal amount of notes.

To remain viable, the Company must generate working capital through the sale of patent licenses or by raising additional capital. To date, the Company generally has been unable to enter into licensing agreements with potential licensees upon terms that are acceptable to the Company. As discussed above, the Company has been forced to become involved in litigation with alleged infringers. The Company believes that these lawsuits may take an extended period of time to complete, and no assurance can be given that the Company will have the resources necessary to complete these lawsuits or that it will be successful in obtaining a favorable outcome. Moreover, the ongoing reexamination of U. S. Patent No. 6,105,007 will likely take an extended period of time to complete and adversely affect the Company's ability to enter into other licensing agreements. Accordingly, to remain viable it is critical that the Company raise additional capital. The uncertainties of these litigation matters, the reexamination of U. S. Patent No. 6,105,007, and other factors affecting the Company's short and long-term liquidity discussed above have impeded and will likely continue to impede the Company's ability to raise additional capital. To maintain the minimal resources necessary to support its current operations, prosecute the reexamination of U. S. Patent No. 6,105,007, and execute a patent licensing strategy, the Company does not believe that substantial additional reductions in its operating expenses are feasible. No assurances can be given that the Company will be able to raise additional capital or generate working capital from its patent licensing business.

Net cash used during the six months ended June 30, 2005, to fund operations was approximately $111,000, compared to approximately $304,000 used to fund operations for the same period in 2004. The decrease in cash used to fund operations in the first six months of 2005 primarily reflects increased deferral in the payment of certain operating expenses, which is reflected as an increase in accounts payable and accrued expenses on the June 30, 2005 balance sheet compared to the December 31, 2004 balances, and a reduction in prepaid expenses during the six- month period. At June 30, 2005 cash and liquid investments were $26,429, as compared to $62,756 at December 31, 2004. At June 30, 2005 working capital was a deficit of $1,785,288 as compared to a deficit of $1,524,772 at December 31, 2004.