INDEX

			Page
PART I	FINANCIAL INFORMATION		3
Item 1.	Financial Statements		3
	Condensed Consolidated Balance Sheets as of September 30, 2010 (Unaudited) and December 31, 2009 (Audited)		3
	Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2010 (Unaudited) and September 30, 2009 (Unaudited)		4
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 (Unaudited) and September 30, 2009 (Unaudited)		5
	Condensed Consolidated Statement of Changes in Stockholders’ Equity for the nine months ended September 30, 2010 (Unaudited)		6
	Notes to Condensed Consolidated Financial Statements (Unaudited)		7-13
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		14-19
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		20
Item 4.	Controls and Procedures		20
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings		20
Item 6.	Exhibits		20
SIGNATURES			21
CERTIFICATIONS

HENRY BROS. ELECTRONICS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

		For the nine months ended
		September 30,
		2010				2009
		(unaudited)				(unaudited)
Cash flows from operating activities:
Net income (loss)		$	1,178,296			$	(136,007	)
Adjustments to reconcile net income from operations
to net cash provided by (used in) operating activities:
Depreciation and amortization			751,853				692,877
Bad debt expense			69,360				292,391
Stock option expense			192,500				266,500
Deferred income taxes			235,723				232,177
Changes in operating assets and liabilities:
Accounts receivable			(6,109,603	)			6,411,725
Inventory			(568,134	)			26,807
Costs in excess of billings and estimated profits			(3,027,987	)			303,892
Retainage receivable			(588,036	)			466,040
Other assets			125,054				(65,172	)
Prepaid expenses and income tax receivable			819,763				(517,176	)
Accounts payable			3,378,417				(2,646,020	)
Accrued expenses			998,489				(1,704,843	)
Taxes payable			106,701				(200,774	)
Billings in excess of costs and estimated profits			1,195,280				(679,666	)
Deferred income			220,658				(100,048	)
Other liabilities			(11,243	)			(96,079	)
Net cash (used in) provided by operating activities			(1,032,909	)			2,546,624
Cash flows from investing activities:
Purchase of businesses			(118,311	)			(50,000	)
Purchase of property and equipment			(86,035	)			(291,026	)
Net cash used in investing activities			(204,346	)			(341,026	)
Cash flows from financing activities:
Proceeds from exercising of stock options - net of fees			-				203,669
Borrowings under revolving loan agreement			3,325,000				1,900,000
Repayments under revolving agreement			(2,600,000	)			(1,750,000	)
Payments of bank loans			-				(103,410	)
Net repayments of other debt			(194,665	)			(238,909	)
Payments of equipment financing			(236,789	)			(211,029	)
Net cash provided by (used in) financing activities			293,546				(199,679	)
(Decrease) increase in cash and cash equivalents			(943,709	)			2,005,919
Cash and cash equivalents - beginning of period			2,917,046				27,704
Cash and cash equivalents - end of period		$	1,973,337			$	2,033,623
Supplemental disclosure of cash flow information:
Amount paid for the period for:
Interest		$	160,793			$	204,881
Taxes			66,400				707,083
Non-cash investing and financing activities:
Equipment financed			191,389				288,140
Issuance of stock to acquire businesses			665,250				103,650

 

See accompanying notes to the condensed consolidated financial statements.

 

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HENRY BROS. ELECTRONCS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

		Common Stock								Additional
		par value $0.01								Paid-in				Accumulated
		Shares				Amount				Capital				Deficit				Total
Balance at December  31, 2009 (audited)			6,035,366			$	60,354			$	18,437,288			$	(2,557,262	)		$	15,940,380
Shares issued in connection with
the acquisition of CIS Security Systems			25,000				250				104,550				-				104,800
Shares issued in connection with
the acquisition of PST			150,000				1,500				580,500								582,000
Amortization of value assigned to
stock option grants			-				-				192,500				-				192,500
Net income			-				-				-				1,178,296				1,178,296
Balance at September 30, 2010 (unaudited)			6,210,366			$	62,104			$	19,314,838			$	(1,378,966	)		$	17,997,976

See accompanying notes to the condensed consolidated financial statements.

 

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HENRY BROS. ELECTRONICS, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL

STATEMENTS (UNAUDITED)

1.   Description of Business and Basis of Presentation

Interim Financial Statements:

The information presented as of September 30, 2010 and for the three and nine month periods ended September 30, 2010 and 2009 are unaudited, and reflect all adjustments (consisting only of normal recurring adjustments) which Henry Bros. Electronics, Inc. and its Subsidiaries (the “Company” or “HBE”) considers necessary for the fair presentation of the Company’s financial position as of September 30, 2010, the results of its operations for the three and nine month periods ended September 30, 2010 and 2009, and cash flows and changes in stockholders’ equity for the nine month period ended September 30, 2010. The Company’s December 31, 2009 balance sheet information was derived from the audited consolidated financial statements for the year ended December 31, 2009, which are included as part of the Company’s Annual Report on Form 10-K.

The condensed consolidated financial statements included herein have been prepared in accordance with U.S. generally accepted accounting principles and the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted. It is suggested that these condensed financial statements be read in conjunction with the Company’s financial statements and notes thereto included in the Company’s latest shareholders’ annual report.

As of September 30, 2010, there have been no material changes to any of the significant accounting policies described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

Description of Business:

Henry Bros. Electronics, Inc. is an established player in the electronic physical security industry, specializing in integrated security systems, and emergency preparedness.

HBE provides products and services to customers in the public and private sectors. Customers include transit authorities, seaports, airports, universities, office-buildings, hospitals and airlines. Each of the Company’s segments markets its products and services nationwide with an emphasis in Arizona, California, Colorado, Maryland, New Jersey, New York, Texas and Virginia.

The company operates through two primary operating segments:

1.	Security Systems Integration

2.	Specialty Product and Services

The Security Systems Integration business operates under the name Henry Bros. Electronics, Inc. and its approach to client service is core to all of its businesses. At the beginning of each new client relationship, HBE designates one member of its professional staff as the client service contact. This individual is the point person for communications between the client and HBE and often acts as the client's project manager for all of its security needs, which ensures that clients receive the best possible security solution to meet its needs. The Company derives a majority of its revenues from project installations and to a smaller extent, maintenance service revenue.

The Specialty Products and Services segment includes three separate businesses:

1. Evacuation planning

2. Mobile digital recording

3. Airorlite Communications

The Evacuation Planning business operates under the Diversified Security Solutions, Inc. name and works with managers of high-rise office buildings to analyze their specific facilities’ needs with emergency preparedness plans. This division provides demonstrations, training and recommendations to clients; develops emergency plans and procedures; and communicates building strategy to the tenants to increase building community unity, awareness and confidence.

The Mobile Digital Recording business operates under the name Viscom Products, Inc. and has developed an integrated standard solution for the deployment of mobile digital recorders on municipal buses and trains.

The Airorlite Communications business provides specialized communications product design, development and engineering related to RF transmission.

 

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HENRY BROS. ELECTRONICS, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL

STATEMENTS (UNAUDITED) – (continued)

  The table below shows the sales percentages by geographic location for the following periods:

		Nine months ended September 30,
		2010				2009
New Jersey/New York			54	%			50	%
California			18	%			18	%
Texas			7	%			5	%
Arizona			5	%			8	%
Colorado			6	%			11	%
Virginia / Maryland			7	%			8	%
Integration segment			97	%			100	%
Specialty segment			4	%			3	%
Inter-segment			-1	%			-3	%
Total revenue			100	%			100	%

HENRY BROS. ELECTRONICS, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL

STATEMENTS (UNAUDITED) – (continued)

  

3.  Earnings Per Share

 

The computation of basic earnings per share is based upon the weighted average number of shares of common stock outstanding during the period. When applicable, the computation of diluted earnings per share includes the dilutive effects of common stock equivalents, less the shares that may be repurchased with the funds received from their exercise and the effect of adding back unrecognized future stock compensation expense. Potentially dilutive common stock equivalents include shares issuable upon exercise of options. Contingent shares are excluded from basic earnings per share.

 4.  Stock Based Compensation

 

 For the three months ended September 30, 2010 and 2009, the Company charged $60,000 and $73,500, respectively, to operations for stock based compensation expense.  For the nine months ended September 30, 2010 and 2009, the Company charged $192,500 and $266,500, respectively, to operations for stock based compensation expense.  A modification to a stock option, previously issued to an executive officer, extending the term for one year, resulted in an expense in the second quarter of 2009, equal to the net increase in the fair value of the modified stock option of $49,000.

    

A summary of stock option activity for the nine months ended September 30, 2010 under the Company’s various Stock Option Plans’ follows:

										Weighted Average Exercise
		Number of Shares								Price
		Outstanding				Exercisable				Outstanding			Exercisable
December 31, 2009 (audited)			997,799				628,866			$	4.96			$	5.17
Granted at market			113,000								3.86
Exercised			-								-
Forfeited or expired			(110,300	)							7.01
September 30, 2010 (unaudited)			1,000,499				626,232			$	4.61			$	4.72

Stock based compensation is being amortized over the vesting period of up to five years. The fair value of the Company’s stock option awards was estimated assuming no expected dividends and the following weighted-average assumptions for the nine months ended September 30, 2010 follows:

Expected Life (years)			5.86
Expected volatility			50.6	%
Risk-free interest rates			1.9	%
Dividend yield			-
Weighted-average grant-date fair value		$	1.67

 

There were 113,000 options issued during the nine month period ending September 30, 2010.

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

OVERVIEW

 Henry Bros. Electronics, Inc. is an established player in the electronic physical security industry, specializing in integrated security systems, and emergency preparedness.

HBE provides products and services to customers in the public and private sectors. Customers include transit authorities, seaports, airports, universities, office-buildings, hospitals and airlines. Each of the Company’s segments markets its products and services nationwide with an emphasis in Arizona, California, Colorado, Maryland, New Jersey, New York, Texas and Virginia.

The company operates through two primary operating segments:

1.	Security Systems Integration

2.	Specialty Product and Services

The Security Systems Integration business operates under the name Henry Bros. Electronics, Inc. and its approach to client service is core to all of its businesses. At the beginning of each new client relationship, HBE designates one member of its professional staff as the client service contact. This individual is the point person for communications between the client and HBE and often acts as the client's project manager for all of its security needs, which ensures that clients receive the best possible security solution to meet its needs. The Company derives a majority of its revenues from project installations and to a smaller extent, maintenance service revenue.

The Specialty Products and Services segment includes three separate businesses:

1. Evacuation planning

2. Mobile digital recording

3. Airorlite Communications

The Evacuation Planning business operates under the Diversified Security Solutions, Inc. name and works with managers of high-rise office buildings to analyze their specific facilities’ needs with emergency preparedness plans. This division provides demonstrations, training and recommendations to clients; develops emergency plans and procedures; and communicates building strategy to the tenants to increase building community unity, awareness and confidence.

The Mobile Digital Recording business operates under the name Viscom Products, Inc. and has developed an integrated standard solution for the deployment of mobile digital recorders on municipal buses and trains.

The Airorlite Communications business provides specialized communications product design, development and engineering related to RF transmission.

Subsequent Event – Merger Agreement

On October 5, 2010, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with Kratos Defense & Security Solutions, Inc., a Delaware corporation ("Parent"), and Hammer Acquisition Inc., a Delaware corporation and a wholly owned subsidiary of Parent ("Merger Sub"). The Merger Agreement provides that, upon the terms and subject to the conditions set forth in the Merger Agreement, Merger Sub will be merged with and into the Company, with the Company continuing as the surviving corporation and a wholly-owned subsidiary of Parent (the "Merger").

 

At the effective time of the Merger (the "Effective Time"), by virtue of the Merger and without any action on the part of the holders of any Shares, each outstanding Share (other than Shares owned by Parent, Merger Sub, or the Company's stockholders, if any, who have perfected statutory dissenters' rights under Delaware law) will be converted into the right to receive $7.00 in cash, without interest.  In addition, at the Effective Time all outstanding options to purchase the Company's common stock will be assumed by Parent and converted into options to purchase common stock of Parent (the "Assumed Options").  The number of shares of Parent common stock subject to each Assumed Option and the exercise price of each such option will be appropriately adjusted based on the exchange ratio, which shall be equal to 0.6552.

 

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The completion of the Merger is subject to various customary conditions, including, among other things:  (i) the adoption of the Merger Agreement by stockholders holding at least a majority of the outstanding common stock of the Company; (ii) subject to certain materiality exceptions, the accuracy of the representations and warranties made by each of Parent and the Company and the compliance by each of Parent and the Company with their respective obligations under the Merger Agreement and (iii) the absence of any pending or threatened legal proceedings challenging or seeking to restrain the consummation of the Merger.  In addition, certain of the Company's shareholders and each member of the board of directors, who collectively held approximately 60% of the Company's issued and outstanding common stock as of October 5, 2010, have entered into voting agreements whereby they have agreed to vote all shares of the Company's common stock held by them in favor of the Merger, subject to termination of such agreements if the Merger Agreement is terminated.

 

The Merger Agreement contains customary representations, warranties and covenants, including covenants obligating the Company to continue to conduct its business and the business of its subsidiaries in the ordinary course, hold a meeting of its stockholders for the purpose of considering the approval and adoption of the Merger Agreement and to cooperate on seeking regulatory approvals and providing access to information regarding the Company and its subsidiaries.  The Merger Agreement also contains a "go-shop" provision and a "no-shop" provision.

This transaction is a disposal of a business and until all conditions of the merger have been met, including shareholder’s vote, the business should continue to be shown in the results from operations of the Company and not as assets held for disposal.

On November 3, 2010, a putative shareholder class action lawsuit was filed in the Superior Court of New Jersey, Bergen County, against the Company, its directors and Kratos Defense & Security Solutions, Inc. purportedly on behalf of holders of the Company's common stock.  Atoll Advisors v. James E. Henry, et al., alleges that the individual defendants breached their fiduciary duties owed to the Company's stockholders in an attempt to sell the Company to Hammer Acquisition Inc., a wholly-owned subsidiary of Kratos, and Kratos at an unfair price and through an unfair and self serving process and by omitting material information in the preliminary proxy statement the Company filed with the Securities and Exchange Commission on October 25, 2010.  The lawsuit further alleges that the Company and Kratos aided and abetted the Company's directors in their alleged breaches of fiduciary duty.  The complaint seeks, among other relief, class certification, unspecified damages and plaintiff's costs, disbursements and reasonable attorneys' and experts' fees.  The Company and the other defendants have not yet responded to the complaint.  Based on the Company's review of the lawsuit, it believes that the claims are without merit and it intends to vigorously defend against them.  Regardless of the merits or eventual outcome, the lawsuit may cause a diversion of the Company's management's time and attention and the expenditure of legal fees and expenses.

 

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OUR VISION AND STRATEGY

Our vision is to maintain our leadership position in security technology. We intend to do this in part by:

	·	Providing advice on product selection and system design;
	·	Examining and thoroughly testing each security product as it would be set up for use in our customers’ facilities; and,
	·	Using only systems and components that are reliable and efficient to use.

In addition to growing the business organically, we are opportunistically open to the possibility of pursuing the strategic acquisition of synergistic integrators and specialty products and service companies.  To finance our acquisitions, we have used a combination of internally generated cash, the sale of Company common stock and bank debt. We currently have an $8 million revolving credit facility, subject to certain borrowing base limitations, with TD Bank.  Borrowings under the revolving credit facility were $5,060,898 at September 30, 2010. It is our expectation and intent to use cash and to incur additional debt as appropriate to finance future working capital and acquisitions.  Additionally, to fund future acquisitions we would consider the issuance of subordinated debt, the sale of equity securities, or the sale of existing Company assets. 

TRENDS

There are several factors impacting operating margins, including levels of competition for a particular project and the size of the project.  As a significant amount of our costs are relatively fixed, such as  labor costs, increases or decreases in revenues can have a significant impact on operating margins.  The Company continually monitors costs and pursues various cost control measures and sales initiatives to improve operating margins. 

In February 2008, the Company entered into a subcontractor agreement with Global Security & Engineering Solutions, a division of L-3 Services, Inc. (the “L-3 Contract”) pursuant to which L-3 would issue task orders under its Indefinite Quantity Firm Fixed Price Contract with the U.S. Marine Corp Systems Command to deliver a Tactical Video Capture System (“TVCS”).  TVCS is used for real-time visualization and situational awareness while Marine units are conducting military operations in urban terrain training exercises.  The performance period of the contract is three years.  In the first nine months of 2010, the revenue recognized under this contract represented $4.1 million, compared to $4.8 million in the first nine months of 2009. There were outstanding task orders included in our backlog of approximately $6.1 million at September 30, 2010.   During the third quarter, we completed one site under the L-3 Contract and are close to completion on the second.  The additional four sites that were scheduled to begin before the year-end are coming online slower than anticipated, but are now in progress.  As a result, we project our 2010 revenue to come in at range of $68 million - $70 million, down from the previously disclosed range of $70 million-$75 million, with the operating margin continuing to be between 5% and 6%.

Booked orders increased 57.2% to $20,755,320 in the third quarter of 2010, as compared to $13,199,733 in same quarter of 2009.  Booked orders increased 69.7% to $70,326,095 in the first nine months of 2010, as compared to $41,441,455 in the first nine months of 2009.

The Company’s backlog of $51,410,584 at September 30, 2010 increased 116.4% from the September 30, 2009 backlog of $23,753,469.  The principal drivers of this increase were increased bookings in our New Jersey / New York, TVCS, California, Airorlite and Texas operations.

Three Months Ended September 30, 2010 compared to September 30, 2009

 

		Three months ended September 30,
		2010				2009				% change
Revenue		$	19,345,013			$	12,109,037				59.8	%
Cost of revenue			13,608,160				9,086,980				49.8	%
Gross profit			5,736,853				3,022,057				89.8	%
Operating expenses:
Selling, general & administrative expenses			3,947,944				3,452,480				14.4	%
Merger and acquisition costs			539,846				-
Operating profit (loss)			1,249,063				(430,423	)			390.2	%
Interest income			14,335				11,986				19.6	%
Other income (expense)			(16	)			13,481				-100.1	%
Interest expense			(63,089	)			(56,926	)			10.8	%
Income (loss) before income tax expense			1,200,293				(461,882	)			359.9	%
Income tax expense (benefit)			473,188				(104,500	)			552.8	%
Net income (loss)		$	727,105			$	(357,382	)			303.5	%

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Revenue - Revenue for the three months ended September 30, 2010 was $19,345,013, representing an increase of $7,235,976 or 59.8%, as compared to revenue of $12,109,037 for the three months ended September 30, 2009. Our New Jersey/New York and California operations each experienced significant revenue increases in the third quarter of 2010 compared with the third quarter of 2009.  Although the overall market continues to be very price competitive as a result of the slowly recovering U.S. economy, a significant amount of the New Jersey/New York increase in revenue in the third quarter of 2010 relates to revenue driven from the public sector transportation vertical market. The California integration operation benefited from a strong booking performance during the first half of 2010, which allowed us to enter the third quarter with an increased installation revenue backlog.  In addition, revenues recognized under the L-3 Contract increased by $1.3 million in the third quarter of 2010 compared to the same period in 2009.  Currently, two sites are in progress and four additional sites are scheduled to begin in the fourth quarter of 2010 and the first quarter of 2011.   Partially offsetting these increases were declines in our Colorado and Arizona operations.

Cost of Revenue and Gross Profit - Cost of revenue for the three months ended September 30, 2010 was $13,608,160, as compared to $9,086,980 for the three months ended September 30, 2009. Gross profit for the three months ended September 30, 2010 was $5,736,853 as compared to gross profit of $3,022,057 for the three months ended September 30, 2009. The gross profit margin for the three months ended September 30, 2010 was 29.7% as compared to 25.0% for the three months ended September 30, 2009.   The increase in gross profit was directly related to the higher revenues discussed above. A significant driver of the gross profit as a percentage of revenue (“gross profit margin”) increase in the third quarter of 2010 compared to the third quarter of 2009 came from the restructuring of our California operations that began in 2009.

Selling, General and Administrative Expenses - Selling, general and administrative expense (“SG&A”) was $3,947,944 ­­for the three months ended September 30, 2010 as compared to $3,452,480 for the three months ended September 30, 2009.  This increase of $495,464 or 14.4% was mainly attributable to higher compensations costs resulting from higher commissions and performance incentive driven by the increased profitability of the Company.

Merger and Acquisition Costs -Included in merger and acquisition costs for the three months ended September 30, 2010 are $515,999 of legal and professional fees related to the Merger discussed above (also see Note 13 of these Condensed Consolidated Financial Statements filed in this Quarterly Report), and $23,847 of legal and professional fees related to the acquisition of Professional Security Technologies LLC (see Note 12 to the Condensed Consolidated Financial Statements included in this Quarterly Report).

Interest Income – Interest income for the three months ended September 30, 2010 was $14,335 as compared to $11,986 for the three months ended September 30, 2009.  This increase was attributable to higher average cash balances during the three month period ended September 30, 2010 versus the same period in the prior year.

Interest Expense - Interest expense for the three months ended September 30, 2010 was $63,089 as compared to $56,926 for the three months ended September 30, 2009.  The increase is due to the average outstanding revolving debt balance being $1,491,031 higher in the three month period ended September 30, 2010 versus that in the three months ended September 30, 2009.

 

Tax  Expense – The Company recognized income tax expense for the three months ended September 30, 2010 of $473,188, based upon  income  before income taxes of $1,200,293, compared with an income tax benefit of $104,500 for the three months ended September 30, 2009, based upon a loss before income taxes of $461,882.   Income tax expense for interim reporting is based on an annual effective income tax rate forecast, which includes estimates and assumptions that could change during the year.  The differences between the effective income tax rate and the U.S. federal statutory rate of 34% principally result from state and local taxes, and differences between the book and tax treatment of certain items, such as incentive stock options. The effective income tax rate for the three months ended September 30, 2010 was 39.4%, compared to a tax benefit at an effective income tax rate of 22.6% for the three months ended September 30, 2009.

Net Income - As a result of the above noted factors our net income was $727,105 for the three months ended September 30, 2010, compared to a net loss of $357,382 for the three months ended September 30, 2009. This resulted in diluted income per share of $0.12 on weighted average diluted common shares outstanding of 6,179,659 for the three months ended September 30, 2010, as compared to diluted loss per share of $0.06 on weighted average diluted common shares outstanding of 5,877,798 for the three month period ended September 30, 2009.

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Nine Months Ended September 30, 2010 compared to September 30, 2009

		Nine months ended September 30,
		2010				2009				% change
Revenue		$	46,937,305			$	41,389,229				13.4	%
Cost of revenue			33,502,994				30,255,049				10.7	%
Gross profit			13,434,311				11,134,180				20.7	%
Operating expenses:
Selling, general & administrative expenses			10,710,057				11,015,124				-2.8	%
Merger and acquisition costs			539,846				-
Operating profit (loss)			2,184,408				119,056				1734.8	%
Interest income			70,668				21,023				236.1	%
Other income (expense)			4,449				29,274				-84.8	%
Interest expense			(174,874	)			(222,333	)			-21.3	%
Income (loss) before income tax expense			2,084,651				(52,980	)			4034.8	%
Income tax expense (benefit)			906,355				83,027				991.6	%
Net income (loss)		$	1,178,296			$	(136,007	)			966.3	%

Revenue - Revenue for the nine months ended September 30, 2010 was $46,937,305, representing an increase of $5,548,076 or 13.4%, as compared to revenue of $41,389,229 for the nine months ended September 30, 2009. While our New Jersey/New York, California, Texas and Airorlite operations each experienced significant revenue increases in the first nine months of 2010 compared with the first nine months of 2009, the overall market continues to be very price competitive as a result of the slowly recovering U.S. economy, which contributed to revenue declines in our Colorado, Arizona and Mid-Atlantic operations.  The wind down of a large project in our Colorado operation in 2009 that did not repeat in 2010 was a significant contributor to the decline in that operation.  The L-3 Contract generated $0.7 million lower revenue in the first nine months of 2010 compared to the same period in 2009.  Revenues under the L-3 Contract slowed in 2010 due to the government adopting the Unified Facilities Criteria (“UFC”) in the first quarter of 2010.  The UFC called for enhancing existing installation drawing packages prior to construction approval.   Currently, two sites are in progress and four additional sites are scheduled to begin in the fourth quarter of 2010 and the first quarter of 2011.

Cost of Revenue and Gross Profit - Cost of revenue for the nine months ended September 30, 2010 was $33,502,994, as compared to $30,255,049 for the nine months ended September 30, 2009. Gross profit for the nine months ended September 30, 2010 was $13,434,311 as compared to gross profit of $11,134,180 for the nine months ended September 30, 2009. The gross profit margin for the nine months ended September 30, 2010 was 28.6% as compared to 26.9% for the nine months ended September 30, 2009.  The increase in gross profit was directly related to the higher revenues discussed above. A significant driver of the gross profit as a percentage of revenue (“gross profit margin”) increase in the third quarter of 2010 compared to the third quarter of 2009 came from the restructuring of our California operations that began in 2009, as well as from higher gross profit margins from our Airorlite operations.

Selling, General and Administrative Expenses - Selling, general and administrative expense was $10,710,057 ­­for the nine months ended September 30, 2010 as compared to $11,015,124 for the nine months ended September 30, 2009. This decrease of $305,067 or 2.8% was mainly attributable to lower personnel costs, (partially offset by higher commissions and performance incentive costs driven by the increased profitability of the Company), lower facility and insurance costs and overall cost containment.

Merger and Acquisition Costs -Included in merger and acquisition costs for the nine months ended September 30, 2010 are $515,999 of legal and professional fees related to the Merger discussed above (also see Note 13 of these Condensed Consolidated Financial Statements filed in this Quarterly Report), and $23,847 of legal and professional fees related to the acquisition of Professional Security Technologies LLC (see Note 12 to the Condensed Consolidated Financial Statements included in this Quarterly Report).

Interest Income – Interest income for the nine months ended September 30, 2010 was $70,668 as compared to $21,023 for the nine months ended September 30, 2009.  This increase was attributable to interest earned on an income tax refund and higher average cash balances during the nine month period ended September 30, 2010 versus the same period in the prior year.

Interest Expense - Interest expense for the nine months ended September 30, 2010 was $174,874 as compared to $222,333 for the nine months ended September 30, 2009.  The decrease is due to the average outstanding revolving debt balance being $1,723,912 lower in the nine month period ended September 30, 2010 versus that in the nine months ended September 30, 2009.

 

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Tax Expense – The Company recognized income tax expense for the nine months ended September 30, 2010 of $906,355, based upon income before income taxes of $2,084,651, compared with income tax expense of $83,027 for the nine months ended September 30, 2009, based upon a loss before income taxes of $52,980.   Income tax expense for interim reporting is based on an annual effective income tax rate forecast, which includes estimates and assumptions that could change during the year.  The differences between the effective income tax rate and the U.S. federal statutory rate of 34% principally result from state and local taxes, and differences between the book and tax treatment of certain items, such as incentive stock options. The effective income tax rate for the nine months ended September 30, 2010 was 43.5%.

Net Income - As a result of the above noted factors, our net income was $1,178,296 for the nine months ended September 30, 2010, compared to a net loss of $136,007 for the nine months ended September 30, 2009. This resulted in diluted income per share of $0.19 on weighted average diluted common shares outstanding of 6,124,694 for the nine months ended September 30, 2010, as compared to diluted loss per share of $0.02 on weighted average diluted common shares outstanding of 5,859,400 for the nine month period ended September 30, 2009.