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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington,
D.C. 20549 FORM 10-K


(Mark One)

xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006

OR

oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND 
EXCHANGE ACT OF 1934

Commission File No. 005-62411





HENRY BROS. ELECTRONICS, INC. (EXACT NAME OF
REGISTRANT AS SPECIFIED IN ITS CHARTER)


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|                                                                |                                     
|--------------------------------------------------------------- | ------------------------------------
|Delaware                                                        | 22-3690168                          
|(State or other jurisdiction of incorporation or
 organization) | (I.R.S. Employer Identification No.)
|17-01 Pollitt Drive, Fair Lawn, NJ                              | 07410                               
|(address of principal executive offices)                        | (Zip Code)                          

(201) 794-6500
(Registrants telephone number, including area code)


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Securities registered pursuant to Section 12(b) of the Act: None


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Securities registered pursuant to Section 12(g) of the Act:


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|                              |                                            
|----------------------------- | -------------------------------------------
|Title of each class:          | Name of each exchange on
 which registered:
|Common Stock, $.01 par
 value | American Stock Exchange                    

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Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes o     No x.

Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes o    No x.

Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes o    No x

Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrants knowledge, in definitive proxy or information statements incorporated
by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated
filer and large accelerated filer in Rule 12b-2 of the Securities Exchange Act
of 1934. (Check one): Large accelerated filer o    Accelerated filer o     Non-accelerated
filer x

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Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Securities Exchange Act of 1934). Yes o    No x.

At
June 30, 2006, the last business day of the Registrants most recently
completed second fiscal quarter, the aggregate market value of the voting and
non-voting common equity held by non-affiliates of the Registrant was
$29,775,128 (based on the closing price of the registrants common stock on the
American Stock Exchange on such date).

Indicate
the number of shares outstanding of each of the registrants classes of common
stock, as of the latest practicable date:

|                                        |  |                                  |           | 
|--------------------------------------- |  | -------------------------------- | --------- | 
|Classes:                                |  | Outstanding at September
4, 2007
|                                        |  |                                 
|Common
 Stock, par value $.01 per share |  |                                  | 5,926,065 | 

Documents Incorporated by Reference:None

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HENRY BROS. ELECTRONICS, INC.Table of Contents

|                                                                                                                         |  |   
|------------------------------------------------------------------------------------------------------------------------ |  | --
|PART I                                                                                                                   |  | 2 
|                                                                                                                        
|Item 1. Business                                                                                                         |  | 2 
|                                                                                                                        
|Item 1A. Risk Factors                                                                                                    |  | 8 
|                                                                                                                        
|Item 1B. Unresolved Staff Comments                                                                                       |  | 10
|                                                                                                                        
|Item 2. Properties                                                                                                       |  | 10
|                                                                                                                        
|Item 3. Legal Proceedings                                                                                                |  | 11
|                                                                                                                        
|Item 4. Submission of Matters to a Vote of Security Holders                                                              |  | 11
|                                                                                                                        
|PART II                                                                                                                  |  | 12
|                                                                                                                        
|Item 5. Market for Registrants Common Equity and Related Stockholder
 Matters and Issuer Purchases of Equity Securities |  | 12
|                                                                                                                        
|Item 6. Selected Financial Data                                                                                          |  | 14
|                                                                                                                        
|Item 7. Managements Discussion and Analysis of Financial Condition
 and Results of Operations                           |  | 14
|                                                                                                                        
|Item 7A. Quantitative and Qualitative Disclosures About Market Risk                                                      |  | 24
|                                                                                                                        
|Item 8. Financial Statements and Supplementary Data                                                                      |  | 24
|                                                                                                                        
|Item 9. Changes in and Disagreements with Accountants on Accounting
 and Financial Disclosure                            |  | 25
|                                                                                                                        
|Item 9A. Controls and Procedures                                                                                         |  | 25
|                                                                                                                        
|Item 9B. Other Information                                                                                               |  | 27
|                                                                                                                        
|PART III                                                                                                                 |  | 28
|                                                                                                                        
|Item 10. Directors, Executive Officers and Corporate Governance                                                          |  | 28
|                                                                                                                        
|Item 11. Executive Compensation                                                                                          |  | 31
|                                                                                                                        
|Item 12. Security Ownership of Certain Beneficial Owners and
 Management and Related Stockholders Matters                |  | 39
|                                                                                                                        
|Item 13. Certain Relationships and Related Transactions and Director
 Independence                                       |  | 41
|                                                                                                                        
|Item 14. Principal Accountant Fees and Services                                                                          |  | 41
|                                                                                                                        
|PART IV                                                                                                                  |  | 42
|                                                                                                                        
|Item 15. Exhibits, Financial Statement Schedules                                                                         |  | 42

1

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PART I

Item 1. Business

Business
Development.

In 1950, John,
Ray, and Hartford Henry founded Henry Bros. Electronics. They sold Henry Bros.
Electronics to Communication Group, Inc. (CGI) in 1985. In 1989, Jim Henry,
our Chairman and Chief Executive Officer, and Irvin Witcosky, our former
President and Chief Operating Officer reacquired certain assets, including the
name Henry Bros. Electronics from CGI. In 1991 we acquired the assets of the
former Motorola CCTV division and formed Viscom Products, Inc. (Viscom). In
1999 we formed a company named Integcom Corp. incorporated in Delaware into
which we transferred both HBE and Viscom. In 2001, we changed our name to
Diversified Security Solutions, Inc. and in 2005 we changed our name to Henry
Bros. Electronics, Inc. (HBE). Following is a listing of key business
developments since the inception of HBE:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In November
  2001, we completed our initial public offering, including the underwriters
  over-allotment option of an aggregate of 1,725,000 shares of common stock.
  Our shares are traded on the American Stock Exchange under the ticker symbol
  HBE.                                                                                                                                                       
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | In May 2002,
  we purchased Photo Scan Systems, Inc. (Photo Scan) a security integrator
  located in southern California and changed its name to Henry Bros.
  Electronics, Inc. in December 2002.                                                                                                                                                                                                               
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | In August
  2002, Photo Scan acquired National Safe of California, Inc. which sells and
  services alarm security equipment, lock and timing mechanisms, vault
  security, control and backup systems and high resolution security equipment
  used by commercial banks.                                                                                                                                           
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | In September
  2002, Photo Scan acquired Corporate Security Integration, LLC (CSI) a
  security integrator located in Phoenix, Arizona, and subsequently changed its
  name to Henry Bros. Electronics, LLC.                                                                                                                                                                                                     
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | In April
  2004, we acquired Airorlite Communications, Inc. (Airorlite), a company
  located in New Jersey that specializes in the design, manufacture and
  maintenance of wireless communications equipment used to enhance emergency
  radio frequency services and cellular communication for both fixed and mobile
  applications.                                                                          
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | In October
  2005, we acquired Securus, Inc. a security integrator with offices in Denver
  and Colorado Springs, Colorado.                                                                                                                                                                                                                                                                                        
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  | In October
  2006, we acquired CIS Security Systems Corp. (CIS), a privately-held
  security systems integrator with offices in Baltimore, Maryland and
  Newington, Virginia and acquired certain assets of Southwest Securityscan,
  Inc. (SSI), a privately-held company headquartered in Duncanville, Texas that
  provides installation, service and monitoring of access, surveillance and
  alarm systems.

Our principal executive offices
are located at 17-01 Pollitt Drive, Fair Lawn, New Jersey 07410, and our
telephone number is (201) 794-6500.

2

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Business of
Issuer

We are an
established leader in the electronic physical security industry providing
technology-based integrated electronic security systems, services and emergency
preparedness consultation to commercial enterprises and government agencies.

Security
Distributing and Marketing magazine (SDM) ranks by each of their 2006 revenue
the top 100 largest firms selling closed circuit TV (CCTV), access control
and integrated security systems. We were ranked No. 15 in SDMs Top Systems
Integrators Report published in July 2007. As a single-source/turn-key provider
of diversified technology-based integrated security solutions, we can expedite
project completion and optimize system manpower performance. The continually
evolving security requirements of commercial and government entities, together
with rapidly advancing technology, provides numerous opportunities for us to
assist our clients with their security needs.

We believe
that the following key attributes provide us with a sustainable competitive
advantage:

| |   |                                      
| | - | -------------------------------------
| |  | Experience
  and expertise;          
| |   |                                      
| |  | Technological
  know-how;            
| |   |                                      
| |  | Commitment
  to customer service; and
| |   |                                      
| |  | Strong list
  of references.         

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 have been actively pursuing the strategic acquisition of
synergistic integrators and specialty products and service companies to further
fuel steady growth. Consistent with our expansion strategy, we have acquired
seven companies since May of 2002.

Business Segments

Our operations
are divided into two business segments  Security System Integration
(Integration) and Specialty Products and Services (Specialty). The
Integration segment provides a cradle to grave services for a wide variety of
security, communications and control systems. The Company specializes in
turn-key systems that integrate many different technologies. Systems are
customized to meet the specific needs of its customers. Through the Specialty
segment we provide emergency preparedness programs, and specialized radio
frequency communication equipment and integration. 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.
Customers are primarily medium and large businesses and governmental agencies.
The Company derives a majority of its revenues from project installations and
to a smaller extent, maintenance service revenue.

3

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Integration Segment

At the
beginning of each new client relationship, we designate one member of our
professional staff as the client service contact. This individual is the point
person for communications between the client and us and often serves as the
clients project manager for all of its security needs. Our engagement may
include:

| |   |                                       
| | - | --------------------------------------
| |  | Consulting
  and planning;            
| |   |                                       
| |  | Engineering
  and design;             
| |   |                                       
| |  | Systems
  installation and management;
| |   |                                       
| |  | Systems
  training; and               
| |   |                                       
| |  | Maintenance
  and technical support.  

Consulting and Planning

Security
consulting and planning are the initial phases of determining a security
solution for a project. We have developed a planning process that identifies
all systems, policies and procedures that are required for the successful
operation of a security system that will both meet a clients current needs and
accommodate its projected future requirements. Our consulting and planning
process includes the following steps:

| |   |                                                                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Identify the
  clients objectives and security system requirements;                                                                                   
| |   |                                                                                                                                                        
| |  | Survey the
  site(s), including inventory of physical components and software and
  evaluation of clients existing infrastructure and security system;
| |   |                                                                                                                                                        
| |  | Assess and
  prioritize the clients vulnerabilities;                                                                                                  
| |   |                                                                                                                                                        
| |  | Develop and
  evaluate system alternatives;                                                                                                            
| |   |                                                                                                                                                        
| |  | Recommend a
  conceptual security plan design;                                                                                                         
| |   |                                                                                                                                                        
| |  | Estimate the
  cost of implementing the conceptual plan; and                                                                                           
| |   |                                                                                                                                                        
| |  | Develop a
  preliminary implementation schedule.                                                                                                       

As a result of
this process, we provide the client with a master plan for an effective
security solution that addresses routine operating needs as well as emergency
situations.

We believe that our comprehensive planning process enables our
clients to budget for their security requirements on a long-term basis,
identify opportunities for cost reduction and prepare for future risks.

Engineering and Design

The
engineering and design process involves preparation of detailed project
specifications and working drawings by a team of our engineers, systems
designers and computer-aided design system operators. These specifications and
drawings detail the camera sensitivity requirements, layout of the control
center, placement of cameras, card readers and other equipment and electrical
requirements. Throughout our engineering and design process, our goal is to
understand our clients operational preferences in order to design a system
that is functional, cost-effective and accommodates our clients present and
future requirements. In addition, we attempt to incorporate our clients
existing personnel, equipment and other physical resources into the system
design.

When retained as a single-source provider for turn-key security
solutions, we select system components required under the specifications and
drawings. We recommend that our customers buy

4

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proven
off-the-shelf devices and software and resort to custom equipment only when
absolutely necessary.

We have made a strategic decision not to represent any
equipment manufacturer exclusively, thereby maintaining objectivity and
flexibility in equipment selection. We believe that our technical proficiency
with the products available from a wide range of manufacturers enables us to
select components that will best meet a projects requirements.

Systems Installation and Management

Under the
supervision of the manager of the project, our technicians install hardware,
integrate hardware and software, and validate and test the system.
Subcontractors typically perform the aspects of systems integration that do not
require a high level of technical expertise, such as wire installation and
basic construction. Components that may be integrated in a security system
include the following:

| |   |                                                                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Access
  control systems, which are designed to exclude unauthorized personnel from
  specified areas;                                                                      
| |   |                                                                                                                                                                             
| |  | Intrusion
  detection systems, which detect unauthorized door and window openings, glass
  breakage, vibration, motion, noise and alarms and other peripheral equipment;    
| |   |                                                                                                                                                                             
| |  | Closed
  circuit television systems, which monitor and record entry and exit activity
  or provide surveillance of designated areas;                                        
| |   |                                                                                                                                                                             
| |  | Critical
  condition monitoring systems, which provide alarm monitoring and supervision
  of various systems and facilities; and                                            
| |   |                                                                                                                                                                             
| |  | Intercoms,
  public address systems, fire detection signals and network connectivity that
  can expand a local security system into a closely controlled worldwide
  system.

Systems Training

Upon
completion of a systems integration project, we typically will provide the
customer with system documentation and training in the operation and
maintenance of the system.

Maintenance and Technical Support

We provide
maintenance and technical support services on a scheduled, on-call, or emergency
basis. These services include developing and implementing maintenance programs
both for security systems designed, engineered, or integrated by us and for
existing systems.

Specialty Segment

Airorlite
specializes in designing, manufacturing and maintaining wireless communications
equipment used to enhance and extend emergency radio frequency services and
cellular communication for both fixed and mobile applications. Our Diversified
Securities Solutions, Inc. division (formerly our EPP division) works with
high-rise office building management to analyze their specific facilities needs
relating to emergency response plans and the communication and training of such
plans to the building community.

Marketing

Our marketing
activities are conducted on both national and regional levels. We obtain
engagements through direct negotiation with clients, competitive bid processes
and referrals. At the national level, we conduct analyses of various industries
and target those with significant demand for security solutions. At a regional
level, we have developed and implemented a marketing plan

5

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that targets
specific regions of the country. The plan identifies prospective clients within
specific regions of the country and sets forth a strategy for developing relationships
with them.

We have developed expertise in the security regulations applicable
to airports and seaports, high-rise buildings, public transportation systems,
healthcare, financial, educational and other vertical markets. We have
identified several key industries or facility types that we believe have
substantial and increasing requirements for security services, including
corporate campuses and federal facilities.

Customers

We provide our
products and services to customers in the public and private sectors through
direct sales to end-users and through subcontracting agreements and have
provided services to customers representing each of the vertical markets
described under Marketing.

Suppliers

We procure
components and finished products from a variety of suppliers as needed through
purchase orders. We actively manage this process to ensure component quality,
steady supply and best costs. While there could be a short-term disruption in
qualifying vendors, we believe that the components we utilize could be obtained
from alternative sources, or that our products could be redesigned to use
alternative suppliers components, if necessary.

Competition

The security
industry is highly fragmented and competitive. We compete on a local, regional
and national basis with systems integrators, consulting firms and engineering
and design firms. Our competitors include equipment manufacturers and vendors
that also provide security services. Many of our competitors have greater name
recognition and financial resources. We believe that we compete primarily on
our ability to deliver solutions that effectively meet a clients requirements
and, to a lesser extent and primarily in competitive bid situations, on price.
Many of the larger public sector projects require performance bonds, which may
limit our ability to compete with larger competitors as the prime contractor,
depending upon the specifications of the project.

Employees

As of August
24, 2007, we had 198 full time employees, including officers, of whom: 130 were
engaged in engineering, systems installation and maintenance services, 35 in
administration and accounting, and 33 in marketing and sales. None of our
employees are covered by a collective bargaining agreement or are represented
by a labor union. We consider our relationship with our employees to be
satisfactory.

Our business
requires substantial technical capabilities in many disciplines, from mechanics
and computer science to electronics and advanced software. We emphasize
continued training for new and existing technical personnel. Accordingly, we
conduct training classes and seminars in-house, send select employees to
technical schools and avail ourselves of training opportunities offered by
equipment manufacturers and other specialists on a regular basis.

Seasonality

Revenue generated by our services have
typically been seasonal in nature and there could be periods of fluctuations in
revenue volume due to the timing of project installations or factors that are
beyond the Companys control, such as weather and construction delays.

6

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Backlog

At December
31, 2006, the dollar amount of backlog believed to be firm was $27,802,404.
Backlog from acquisitions completed during fiscal 2005 that were not included
as part of the December 31, 2005 backlog accounted for $680,065 of this
backlog. At December 31, 2005, our backlog was $16,002,144. At June 30, 2007,
the dollar amount of backlog believed to be firm was approximately $32,300,000.

All orders are subject to modification or cancellation by the customer with
limited changes. We believe that backlog may not be indicative of actual sales
for the current fiscal year or any succeeding period.

Pricing

We employ a
variety of pricing strategies for our services. Systems integration project
pricing is based upon the estimated cost of the equipment for the project
including a profit margin, plus the estimated hours for each skill set,
required to complete the project multiplied by the fully burdened hourly rate,
plus a profit margin. Pricing for engineering and maintenance services are
determined based on the scope of the specific project and the length of our
engagement. Proposals for consulting and threat assessment services are priced
based on an estimate of hours multiplied by standard selling rates or on a project
basis.

AVAILABLE INFORMATION

We maintain an
Internet website at the following address: www.hbe-inc.com. The information on
our website is not incorporated by reference into this Annual Report on Form
10-K. We make available on or through our website certain reports and
amendments to those reports that we file with or furnish to the Securities and
Exchange Commission (the SEC) in accordance with the Securities Exchange Act
of 1934. These include our annual reports on Form 10-K, our quarterly reports on
Form 10-Q and our current reports on Form 8-K. We make this information
available on our website free of charge as soon as reasonably practicable after
we electronically file the information with, or furnish it to, the SEC.

FORWARD-LOOKING STATEMENTS

This report
includes forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities and
Exchange Act of 1934, as amended. Forward looking statements may be identified
by such words or phrases as believe, expect, intend, estimate,
anticipate, project, will, may and similar expressions. All statements
that address operating performance, events or developments that we expect or
anticipate will occur in the future are forward-looking statements. The
forward-looking statements used herein are not guarantees of future performance
and involve a number of risks and uncertainties. Factors that might cause
actual results to differ materially from the expected results described in or
underlying our forward-looking statements include:

| |   |                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------
| |  | Conditions
  in the general economy and in the markets served by us;                                                  
| |   |                                                                                                                       
| |  | Competitive
  factors, such as price pressures;                                                                       
| |   |                                                                                                                       
| |  | Interruptions
  of suppliers operations or the refusal of our suppliers to provide us with
  component materials; and
| |   |                                                                                                                       
| |  | The risk
  factors listed from time to time in our SEC reports.                                                       

7

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This list is
not exhaustive. Except as required under federal securities laws and the rules
and regulations promulgated by the SEC, we do not have any intention or
obligation to update publicly any forward-looking statements after the filing
of this Annual Report on Form 10-K, whether as a result of new information,
future events, changes in assumptions or otherwise.

Item 1A. Risk Factors

Our business,
operations and financial conditions are subject to various risks. Some of these
are described below. This section does not describe all risks that may be
applied to our Company, our industry or our business and is intended only as a
summary of certain material risk factors.

We are dependent upon a small number of
customers for a large portion of our revenues.

We have a
small number of customers from which we receive a large portion of our
revenues. Our work with the Triborough Bridge & Tunnel Authority accounted
for 9.7% of total revenue during 2006, with our five largest customers
represented approximately 23.6% of our 2006 revenue. Revenues from governmental
agencies accounted for 22.6% in 2006 versus 39% and 20% in 2005 and 2004,
respectively. Consequently, we are often required to replace one customer with
one or more other customers in order to generate the same amount of revenues.
There can be no assurance that we will continue to be able to do so.

Some of our orders and contracts may be
cancelled or modified so there is a risk that our backlog may not be fulfilled.

Some of our
orders and contract backlog are subject to cancellation or modification by our
customers at any time so we cannot be certain that we will fully recognize
revenue from them.At December
31, 2006, our backlog was approximately $27.8 million. At June 30, 2007, the
dollar amount of backlog believed to be firm was approximately $32,300,000.

We are dependent on a few vendors and rely on
timely delivery of equipment from outside sources.

There are a
few vendors from whom we obtain devices and software for specific access
control, imaging, remote transmission, smart key and mobile applications. The
loss of any one of these companies as suppliers could have a materially adverse
impact on our business, financial condition and results of operations if we are
unable to develop or acquire new technologies from other sources. We believe
there are alternative vendors to source such products.

Timely vendor
deliveries of equipment meeting our quality control standards from all
suppliers are also important to our business because each installed system
requires the integration of a variety of elements to be fully functional. The
failure to deliver any component when required, in operating condition, can
delay the project, triggering contract penalties, delay in progress payments
and may result in cancellation of the project.

We have not been consistently profitable and
may not be profitable in the future.

For the years ended December
31, 2006 and 2005 our revenues were $42.2 million in both years. Our net loss
was $2.2 million for the year ended December 31, 2006 and our net income was
$1.1 million for the year ended December 31, 2005. Our profit has not been
continuous and we can make no assurances that we will be profitable in the
future.

8

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We experience intense competition for
business from a variety of sources.

In systems
integration, we compete for new business with large construction firms,
electrical contractors and consultants in the security business and other
systems integrators. Many of our competitors are much larger and have greater
resources. In order to effectively compete in the future, we may have to charge
less for our services, which may result in lower profit margins.

We rely on a key executive.

James E. Henry
is vital to our business. Losing him could have a materially adverse impact on
our business, financial condition or results of operations.

Our business and growth will suffer if we are
unable to hire and retain highly skilled personnel.

Competition
for highly skilled employees is intense in our industry. The design and
manufacture of equipment, and the installation of our systems, requires
substantial technical capabilities in many disparate disciplines from mechanics
and computer science to electronics and advanced software. Our future success
depends on our ability to attract, train, motivate and retain highly skilled
employees. If we are unable to hire and retain skilled personnel, our growth
may be restricted, the quality of our products and services diminished and our
revenues and the value of your investment reduced. There is no assurance that
we will be able to retain our skilled employees or attract, assimilate and
retain other highly skilled employees in the future.

Lengthy revenue cycles.

Revenue from
our services and products frequently involves a substantial commitment of
resources to evaluate a potential project and prepare a proposal. In addition,
approval of proposals often involves a lengthy process due to clients internal
procedures and capital expenditure approval processes. We may not be awarded a
project that we have prepared a proposal for and, even if we are, a substantial
period of time may elapse from when we make a proposal to when we can recognize
revenues from the project.

Seasonality.

Revenues of
our services have typically been seasonal in nature and there could be periods
of fluctuations in revenue volume due to the timing of project installations or
factors that are beyond the Companys control, such as weather and construction
delays.

We may make acquisitions or form joint
ventures that are unsuccessful.

Part of our
growth strategy involves acquisitions or joint ventures with other system
integrators. This strategy is subject to the following risks, the occurrence of
which could have a materially adverse impact on our business, financial
condition or results of operations:

| |   |                                                                                                                                                                                                                                                 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | We may not
 be able to identify suitable acquisition and joint venture candidates.                                                                                                                                                              
| |   |                                                                                                                                                                                                                                                 
| |  | If the
 purchase price of an acquisition includes cash, we may need to use a
 significant portion of our available cash or credit facility with our bank.                                                                                       
| |   |                                                                                                                                                                                                                                                 
| |  | We could
 have difficulty assimilating the acquired companys operations and personnel
 or working with the joint venture. These difficulties could disrupt our ongoing
 business, distract our management and employees and increase our costs.

9

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| |   |                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | We may not
 be able to retain key employees of the acquired companies or maintain good
 relations with its customers or suppliers.                          
| |   |                                                                                                                                                             
| |  | We may be
 required to incur additional debt.                                                                                                               
| |   |                                                                                                                                                             
| |  | We may be
 required to issue equity securities to pay for such acquisition, which will
 dilute existing shareholders.                                       
| |   |                                                                                                                                                             
| |  | We may have
 to incur significant accounting charges, such as for an impairment of
 intangible assets, which may adversely affect our results of operations.

The trading volume in our common stock
fluctuates and as a result you may find it difficult to sell your shares of our
common stock.

Our common
stock is listed on the American Stock Exchange. Trading in our common stock
fluctuates and on some days is minimal. Failure to maintain an active trading
market in our common stock could negatively affect the price of our common
stock and your ability to sell our common stock.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

A description
of the facilities we lease follows:

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 31,801
 square foot sales, office, training and warehouse facility that also serve as
 our corporate office in Fair Lawn, New Jersey. This facility is a portion of
 a single-story, cinder block building in a commercial and industrial park.
 The lease on this space terminates on October 31, 2016, and provides for an
 annual rent of $214,657 (escalates yearly) until that date, payable in equal
 monthly installments of $17,888, plus taxes of approximately $5,414 per
 month. We are also responsible for the cost of property tax increases,
 utilities, repairs, maintenance, alterations, cleaning and insurance.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | 9,553 square
 foot sales, office and warehouse facility in Fullerton, California. A
 two-story, concrete building in an office complex, this space is leased until
 November 15, 2011 at an average annual rent of $128,108 payable in equal
 monthly installments of $10,675, with additional costs for maintenance,
 insurance, repairs and alterations, utilities, property tax increases and
 cleaning.                                                                                                                                                                                                                       
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | 4,200 square
 foot sales, office and warehouse facility in Grand Prairie, Texas near the
 Dallas-Fort Worth Airport. A single-story, cinder block building in an office
 complex, this space is leased until February 28, 2008 at an annual average
 rental of $39,600, payable in equal monthly installments of $3,300, with
 additional costs for insurance, repairs and alterations, utilities, property
 taxes and cleaning.                                                                                                                                                                                                  
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | 3,906 square
 foot sales, office and warehouse facility in Phoenix, Arizona near the
 Phoenix Airport. A single-story, concrete building in an office complex, this
 space is leased until August 2011 at an average annual rental of $63,072,
 payable in average monthly installments of $5,256, with additional costs for
 insurance, repairs and alterations, utilities, taxes increases and cleaning.                                                                                                                                                                                                                        

10

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|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 2,200 square
 foot office space in New York City for sales and project management
 personnel. This lease commenced on December 29, 2006, with an annual rental
 of $68,962, payable in monthly installments of $5,747, not including
 utilities. Lease escalates yearly and expires February 29, 2012.                                                                                                                                            
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | 16,045
 square foot sales, office and warehouse facility in Denver, Colorado. This
 facility is in a single-story, cinder block building in a commercial and
 industrial park. The lease on this space terminates April 2010 and provides
 for an annual rent of $88,248 until that date, payable in equal monthly
 installments, with additional costs for property taxes, utilities, repairs,
 maintenance, alterations, cleaning and insurance.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | 3,500 square
 feet of sales, office and warehouse space in Colorado Springs, Colorado which
 terminates December 2010 and provides for an annual rent of $24,780, payable
 in equal monthly installments, with additional costs for property taxes,
 utilities, repairs, maintenance, alterations, cleaning and insurance.                                                                                                                        
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | 4,800 square
 foot sales, office and warehouse facility in Newington, Virginia. The annual
 rent is $76,632 and has an annual escalation clause. The lease expires on
 July 31, 2010. The lease includes utilities.                                                                                                                                                                                                                               
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | 2,400 square
 foot sales office facility in Baltimore, Maryland. The annual rent is $26,327
 and has an annual escalation clause. The lease expires on August 31, 2008.
 There are additional charges for trash removal, gas and common area
 maintenance.                                                                                                                                                                                        

These
facilities or similar facilities should meet our operational needs for the
foreseeable future.

Item 3. Legal Proceedings

We know of no
material litigation or proceeding, pending or threatened, to which we are or
may become a party.

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

At our 2006
Annual Meeting of Stockholders held on November 1, 2006, the following
individuals, constituting all of the members of the Board of Directors, were
elected. For each elected director, the results of the voting were:

|                    |  |                      |  |                          
|------------------- |  | -------------------- |  | -------------------------
|Name                |  | Number of
 Votes For |  | Number of
 Votes Withheld
|                    |  |                      |  |                          
|James E Henry       |  | 5,680,520            |  | 48,570                   
|Irvin F. Witcosky   |  | 5,674,810            |  | 54,460                   
|Brian Reach         |  | 5,614,356            |  | 114,914                  
|Joseph P. Ritorto   |  | 5,668,490            |  | 60,780                   
|Robert L. Delia Sr. |  | 5,611,336            |  | 117,934                  
|David Sands         |  | 5,678,090            |  | 51,180                   
|James W. Power      |  | 5,678,090            |  | 51,180                   

Stockholders
also approved the Companys 2006 Stock Option Plan. The results of the voting
for this proposal were 3,743,950 in favor, 132,561 against and 27,788
abstentions.

11

---



The
stockholders also voted to ratify the selection of Demetrius & Company,
L.L.C. as our independent auditors for 2006. The results of the voting for this
proposal were 5,677,332 in favor, 20,545 against and 31,393 abstentions.

PART II

Item 5. Market for Registrants Common Equity
and Related Stockholder Matters and Issuer Purchases of Equity Securities

Our Common
Stock is traded on the American Stock Exchange under the Symbol HBE.

| |     |                                                                          
| | --- | -------------------------------------------------------------------------
| | (a) | The
 following table indicates high and low stock prices for each period.

|                |  |      |      |     |   |      | 
|--------------- |  | ---- | ---- | --- | - | ---- | 
|2006            |  | High |      | Low |  
|                |  |      |      |     |  
|First
 Quarter  |  | $    | 6.98 |     | $ | 4.55 | 
|Second
 Quarter |  | $    | 6.65 |     | $ | 4.94 | 
|Third
 Quarter  |  | $    | 5.05 |     | $ | 3.29 | 
|Fourth
 Quarter |  | $    | 3.79 |     | $ | 3.29 | 
|                |  |      |      |     |   |      | 
|2005            |  |      |      |     |   |      | 
|                |  |      |      |     |   |      | 
|First
 Quarter  |  | $    | 5.75 |     | $ | 4.45 | 
|Second
 Quarter |  | $    | 5.05 |     | $ | 3.10 | 
|Third
 Quarter  |  | $    | 6.85 |     | $ | 3.89 | 
|Fourth
 Quarter |  | $    | 5.95 |     | $ | 4.20 | 

| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (b) | Number of
 Holders of Common Stock. The number of holders of record of our Common Stock
 on December 31, 2006 was 33. Since a portion of the shares of the common
 stock are held in street or nominee name, it is believed that there are
 significant number of additional number of beneficial owners of common stock.                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | (c) | Dividends.
 There were no cash dividends or other cash distributions made by us during
 the year ended December 31, 2006. Future dividend policy will be determined
 by our Board of Directors based on our earnings, financial condition, capital
 requirements and other existing conditions. It is anticipated that cash
 dividends will not be paid to the holders of our common stock in the
 foreseeable future.                                                                                                                                                                                                                                                                                                                                      
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | (d) | In
 connection with the acquisition of Securus Inc. on October 10, 2005, the
 Company issued an aggregate of 150,001 shares of its common stock of which
 150,001 are being held in escrow pursuant to the stock purchase escrow
 agreement between the Company and the selling shareholders of Securus, Inc.
 The issuance of the shares of restricted stock in connection with the
 aforementioned transaction was made in reliance upon the exemption provided
 in section 4(2) of the Securities Act of 1933, as amended.                                                                                                                                                                                                                               
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | (e) | In
 connection with the acquisition of all the capital stock of CIS on October 2,
 2006, the Company issued an aggregate of 20,000 shares of its common stock.
 The Company issued an additional 10,000 shares of its restricted common stock
 to CISs selling shareholder after CIS met certain performance targets for
 the quarters ended March 31, and June 30, 2007. The issuance of the shares of
 restricted stock in connection with the aforementioned transactions were made
 in reliance upon the exemption provided in section 4(2) of the Securities Act
 of 1933, as amended. The selling shareholder may earn an additional 70,000
 shares of the Companys common stock if CIS achieves certain performance
 targets through December 2011.

12

---



| |     |                                                                     
| | --- | --------------------------------------------------------------------
| | (f) | Securities
 authorized for issuance under equity compensation plans.

See Item 12 of
this Annual Report on Form 10-K for information about our equity compensation
plans.

PERFORMANCE GRAPH

The following
line graph compares the yearly percentage change in the cumulative total
shareholder return on the Common Stock from December 31, 2001 through December
31, 2006 with the cumulative total return of the Dow Jones Wilshire 5000 (our
Major Market Index) and the Dow Jones Wilshire Electrical Components &
Equipment Index (our Industry Index). The graph below assumes that $100 was
invested on December 31, 2001 in our Common Stock, the Dow Jones Wilshire 5000
and the Dow Jones Wilshire Electrical Components & Equipment Index.
Dividend reinvestment has been assumed and, with respect to companies in the
Dow Jones Wilshire 5000 and the Dow Jones Wilshire Electrical Components &
Equipment Index, the returns of such companies have been weighted at each
measurement point to reflect relative stock market capitalization.

COMPARISON OF 5 YEAR
CUMULATIVE TOTAL RETURN*
Among Henry Bros. Electronics, Inc., The Dow Jones Wilshire 5000 Index 
And The DJ Wilshire Electrical Components & Equipment Index

(LINE GRAPH)

| |  |                                                                                                                    
| |  | -------------------------------------------------------------------------------------------------------------------
| |  | *
 $100 invested on 12/31/01 in stock or index-including reinvestment of
 dividends.Fiscal year ending December 31.

|                                              |  |        |  |       |  |        |  |        |  |        |  |        | 
|--------------------------------------------- |  | ------ |  | ----- |  | ------ |  | ------ |  | ------ |  | ------ | 
|                                              |  |        |  |       |  |        |  |        |  |        |  |        | 
|                                              |  | 12/01  |  | 12/02 |  | 12/03  |  | 12/04  |  | 12/05  |  | 12/06  | 
|                                              |  |        |  |       |  |        |  |        |  |        |  |        | 
|                                              |  |        |  |       |  |        |  |        |  |        |  |        | 
|Henry Bros. Electronics, Inc.                 |  | 100.00 |  | 90.53 |  | 74.67  |  | 66.00  |  | 59.73  |  | 50.53  | 
|Dow Jones Wilshire 5000                       |  | 100.00 |  | 79.14 |  | 104.18 |  | 117.33 |  | 124.75 |  | 144.56 | 
|DJ Wilshire Electrical Components & Equipment |  | 100.00 |  | 55.54 |  | 90.24  |  | 85.88  |  | 91.12  |  | 103.85 | 

The
performance graph above shall not be deemed filed for purposes of Section 18
of the Securities Exchange Act of 1934, as amended (The Exchange Act), or
otherwise subject to the liability of that section. This graph will not be
deemed incorporated by reference into any filing under the Securities Act of
1933, as amended, or the Exchange Act, whether made before or after the date
hereof, regardless of any general incorporation language in such filing.

13

---



Item 6. Selected Financial Data

|                                          |  |                           |            |             |   |             |  |             |            |             |   |            |   |   |            | 
|----------------------------------------- |  | ------------------------- | ---------- | ----------- | - | ----------- |  | ----------- | ---------- | ----------- | - | ---------- | - | - | ---------- | 
|                                          |  | Years
 ended December 31, |           
|                                          |  |                           |           
|                                          |  | 2006                      |            | 2005        |   | 2004        |  | 2003        |            | 2002        |  
|                                          |  |                           |            | (Corrected) |   | (Corrected) |  | (Corrected) |            | (Corrected) |  
|                                          |  |                           |            |             |   |             |  |             |            |             |  
|Results of operations:                    |  |                           |            |             |   |             |  |             |            |             |   |            |   |   |            | 
|Net sales                                 |  | $                         | 42,132,852 |             | $ | 42,156,188  |  | $           | 29,725,718 |             | $ | 18,261,065 |   | $ | 18,830,093 | 
|Cost of revenue                           |  |                           | 31,586,736 |             |   | 31,581,187  |  |             | 22,305,632 |             |   | 14,908,700 |   |   | 12,485,362 | 
|Selling, general and administrative       |  |                           | 11,952,477 |             |   | 8,422,193   |  |             | 6,943,885  |             |   | 8,339,337  |   |   | 5,750,578  | 
|Net (loss) income                         |  |                           | (2,260,138 | )           |   | 1,137,974   |  |             | 169,639    |             |   | (3,068,182 | ) |   | 205,276    | 
|                                          |  |                           |            |             |   |             |  |             |            |             |   |            |   |   |            | 
|Per common share:                         |  |                           |            |             |   |             |  |             |            |             |   |            |   |   |            | 
|Net (loss) income                         |  |                           |            |             |   |             |  |             |            |             |   |            |   |   |            | 
|Basic                                     |  | $                         | (0.39      | )           | $ | 0.20        |  | $           | 0.03       |             | $ | (0.60      | ) | $ | 0.04       | 
|Diluted                                   |  |                           | (0.39      | )           |   | 0.20        |  |             | 0.03       |             |   | (0.60      | ) |   | 0.04       | 
|Cash dividends declared                   |  |                           |           |             |   |            |  |             |           |             |   |           |   |   |           | 
|                                          |  |                           |            |             |   |             |  |             |            |             |   |            |   |   |            | 
|Financial position at year-end:           |  |                           |            |             |   |             |  |             |            |             |   |            |   |   |            | 
|Total assets                              |  | $                         | 31,371,609 |             | $ | 25,161,530  |  | $           | 23,372,371 |             | $ | 17,700,408 |   | $ | 20,252,474 | 
|Long term debt, net of current maturities |  |                           | 3,463,236  |             |   | 727,961     |  |             | 168,989    |             |   | 1,922,597  |   |   | 2,017,403  | 
|Shareholders equity                      |  |                           | 14,010,618 |             |   | 15,982,966  |  |             | 14,653,786 |             |   | 11,068,285 |   |   | 14,273,576 | 

Item 7. Managements
Discussion and Analysis of Financial Condition and Results of Operations

Overview

We are an established leader in the
electronic physical security industry, specializing in integrated security
systems and emergency preparedness.

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 have been actively pursuing the strategic
acquisition of synergistic integrators and specialty products and service
companies to further fuel steady growth. Consistent with our expansion strategy,
we acquired seven companies since May of 2002, which include the two
acquisitions made in October 2006 (See Note 17 to the Consolidated Financial
Statements included in this Annual Report on Form 10-K).

To finance our
acquisitions, we have used a combination of internally generated cash, company
common stock and bank debt. We currently have a $5 million credit facility with
TD Banknorth, which includes a $1 million term loan of which $531,122 and
$377,795 was outstanding at December 31, 2006 and September 30, 2007,
respectively. As part of our credit facility we also have a $4 million revolving
    credit

14

---



facility.
Borrowings under the revolving credit facility were $2,847,897 and $3,635,897
at December 31, 2006, and August 31, 2007, respectively. 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, or the sale
of equity securities, or the sale of existing Company assets.

Trends

We anticipate
that the overall average operating margins for our business to be slightly
negative for 2007, as compared to operating margins of (6.1)%, 5.0% and 1.3%
for years 2006, 2005 and 2004, respectively.

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 cost control measures and sales
initiatives to improve operating margins.

During the
fourth quarter 2006, the Company began incurring costs related to the
implementation of Sarbanes-Oxley. While not significant in 2006, the spending
will be significant in 2007 and 2008.

Our operations
are divided into two business segments  Security System Integration
(Integration) and Specialty Products and Services (Specialty). The Integration
segment provides cradle to grave services for a wide variety of security,
communications and control systems. The Company specializes in turn-key systems
that integrate many different technologies. Systems are customized to meet the
specific needs of its customers. Through the Specialty segment we provide
emergency preparedness programs, and specialized radio frequency communication
equipment and integration. Each of the Companys segments markets nationwide
with an emphasis in the Arizona, California, Colorado, Maryland, New Jersey,
New York, Texas and Virginia. Customers are primarily medium and large
businesses and governmental agencies. The Company derives a majority of its
revenues from project installations and to a smaller extent, maintenance
service revenue.

RECENT ACCOUNTING PRONOUNCEMENTS:

Recently Adopted
Accounting Pronouncements

In May 2005,
the FASB issued SFAS No. 154, Accounting Changes and Error Corrections. This
new standard replaces APB Opinion No. 20, Accounting Changes, and SFAS No. 3,
Reporting Accounting Changes in Interim Financial Statements, and represents
another step in the FASBs goal to converge its standards with those issued by
the IASB. Among other changes, SFAS No. 154 requires that a voluntary change in
accounting principle be applied retrospectively with all prior period financial
statements presented on the new accounting principle, unless it is
impracticable to do so. SFAS No. 154 also provides that (1) a change in method
of depreciating or amortizing a long-lived non-financial asset be accounted for
as a change in estimate (prospectively) that was effected by a change in
accounting principle, and (2) correction of errors in previously issued
financial statements should be termed a restatement. The new standard is
effective for accounting changes and correction of errors made in fiscal years
beginning after December 15, 2005. Early adoption of this standard is permitted
for accounting changes and correction of errors made in fiscal years beginning
after June 1, 2005. The adoption of SFAS No. 154 did not have a material effect
on

15

---



the Companys
financial position or results of operations.

On September
13, 2006, the Securities Exchange Commission (SEC) staff issued Staff
Accounting Bulletin (SAB) Topic No. 108, Financial Statements  Considering
the Effects of Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements (SAB 108). SAB 108 addresses how a
registrant should evaluate whether an error in its financial statements is
material. The SEC staff concludes in SAB 108 that materiality should be
evaluated using both the rollover and iron curtain methods. Registrants are
required to comply with the guidance in SAB 108 in financial statements for
fiscal years ending after November 15, 2006. After analyzing the materiality of
the impact arising from the deficiencies related to the accounting for income
taxes in accordance with the provisions of SAB 108, management concluded that
the financial statements for the years ended December 31, 2005 and 2004
included as part of this Annual Report on Form 10-K, and the Selected Financial
Data included as Item 6 of this Annual Report on Form 10-K should be corrected
to reflect the proper accounting. The impact resulting from these
corrections for income tax accounting that had an income statement impact was
to increase (decrease) tax expense by$(29,696), $(125,618), $111,080, and
$99,776, for the years ended December 31, 2005, 2004, 2003 and 2002,
respectively, with a corresponding increase or decrease to net tax liabilities.
The impact resulting from these corrections for income tax accounting that only
had a balance sheet impact was to increase net deferred tax liabilities by
$549,262, $580,032, $533,648, and $533,648 for the years ended December 31,
2005, 2004, 2003 and 2002, respectively, with a corresponding net increase to
goodwill. Unadjusted differences were not material to 2006 or individually to
the prior years.

Recently
Issued Accounting Pronouncements

In September
2006, the FASB issued No. 157, Fair Value Measurements. This new standard
provides guidance for using fair value to measure assets and liabilities. The
FASB believes the standard also 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. Statement 157 applies whenever other
standards require (or permit) assets or liabilities to be measured at fair
value but does not expand the use of fair value in any new circumstances.

Under
Statement 157, 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. In this standard, the
FASB 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, Statement 157 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.

The provisions
of Statement 157 are effective for financial statements issued for fiscal years
beginning after November 15, 2007, and interim periods within those fiscal
years. Earlier application is encouraged, provided that the reporting entity
has not yet issued financial statements for that fiscal year, including any
financial statements for an interim period within that fiscal year. The Company
is currently quantifying the impact of SFAS No. 157.

On July 13,
2006, Financial Accounting Standards Board Interpretation No. 48 (FIN 48),
Accounting for Uncertainty in Income Taxes - An Interpretation of FASB
Statement No. 109, was

16

---



issued. FIN 48
clarifies the accounting for uncertainty in income tax recognized in an
enterprises financial statements in accordance with FASB Statement No. 109,
Accounting for Income Taxes (SFAS No. 109). FIN 48 also prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in
a tax return. The new FASB standard also provides guidance on de-recognition, classification,
interest and penalties, accounting in interim periods, disclosure, and
transition.

The evaluation
of a tax position in accordance with FIN 48 is a two-step process. The first
step is a recognition process whereby the enterprise determines whether it is
more likely than not that a tax position will be sustained upon examination,
including resolution of any related appeals or litigation processes, based on
the technical merits of the position. In evaluating whether a tax position has
met the more-likely-than-not recognition threshold, the enterprise should
presume that the position will be examined by the appropriate taxing authority
that has full knowledge of all relevant information. The second step is a
measurement process whereby a tax position that meets the more-likely-than-not
recognition threshold is calculated to determine the amount of benefit to
recognize in the financial statements. The tax position is measured at the
largest amount of benefit that is greater than 50% likely of being realized
upon ultimate settlement. The provisions of FIN 48 are effective for fiscal
years beginning after December 15, 2006. Earlier application is permitted as
long as the enterprise has not yet issued financial statements, including
interim financial statements, in the period of adoption. The provisions of FIN
48 are to be applied to all tax positions upon initial adoption of this
standard. Only tax positions that meet the more-likely-than-not recognition
threshold at the effective date may be recognized or continue to be recognized
upon adoption of FIN 48. The cumulative effect of applying the provisions of
FIN 48 should be reported as an adjustment to the opening balance of retained
earnings of the year adopted (or other appropriate components of equity or net
assets in the statement of financial position) for that fiscal year. The
Company is currently quantifying the impact of FIN 48.

In February
2007, FASB issued FAS No. 159, The
Fair Value Option for Financial Assets and Financial Liabilities Including an
Amendment of FASB Statement No. 115 (FAS 159). FAS 159 permits
entities to choose to measure many financial instruments and certain other
items at fair value. FAS 159 is effective for fiscal years beginning after
November 15, 2007. The Company is currently evaluating the impact of adopting
FAS 159 on its financial statements.

The FASB is
currently working on amendments to the existing accounting standards governing
asset transfers and fair value measurements in business combinations and
impairment tests, among other issues. Upon completion of these standards, the
Company will need to reevaluate its accounting and disclosures. Due to the
ongoing deliberations of the standard setters, the Company is unable to
accurately determine the effect of future amendments or proposals at this time.

Critical
Accounting Policies

The Companys
consolidated financial statements have been prepared in conformity with
generally accepted accounting principles in the United States of America, which
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities, at the date of the financial statements and the reported amount of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. Management uses its best judgment in valuing these
estimates and may, as warranted, solicit external professional advice. The
following critical accounting policies, some of

17

---



which are
impacted significantly by judgments, assumptions and estimates, affect the
Companys consolidated financial statements.

Revenue Recognition

Revenue
from a project integration in either the Integration or Specialty segments are
recognized on the percentage of completion method, whereby revenue and the
related gross profit are determined based upon the actual costs incurred to
date for the project to the total estimated project costs at completion.
Project costs generally include all material and shipping costs, the Companys
direct labor, subcontractor costs and an allocation of indirect costs related
to the direct labor. Changes in the project scope, site conditions, staff
performance and delays or problems with the equipment used on the project can
result in increased costs that may not be billable or accepted by the customer
and results in a loss or lower profit from what was originally anticipated at
the time of the proposal.

Estimates for
the costs to complete the project is continuously updated by management during
the performance of the project. Provision for changes in estimated costs and
losses, if any, on uncompleted projects are made in the period in which such
losses are determined. In general, we determine
a project to be substantially completed after:

| |                                                                                                         
| | --------------------------------------------------------------------------------------------------------
| | 1. The scope of work is
 completed which includes installing the equipment as required in the
 contract.
|
| | 2. System is functional
 and has been tested.                                                           
|
| | 3. Training has been
 provided.                                                                         

The majority
of the Companys projects are completed within a year. Revenue from product
sales are recognized when title and risk of loss passes to the customer.

Service
contracts, which are generally separate and distinct agreements from project
agreements, are billed either monthly or quarterly on the last day of the month
covered by the contract. Accordingly, revenue from service contracts are
recognized ratably over the length of the agreement. In 2005 and 2006, the
Company did not bundle any significant service contracts with our systems
installation work.

The Diversified
Security Solutions, Inc. division provides emergency planning services to
commercial real estate owners and managers. In general, project labor is the
predominant cost associated with the completion of these projects. The Company utilizes labor as the output
measure in order to recognize revenue and believes this to be an accurate
matching of costs and revenue.

Trade Receivables and Allowance for Doubtful
Accounts

Trade
receivables are stated at net realizable value. This value includes an appropriate
allowance for estimated uncollectible accounts. The allowance is evaluated on a
regular basis by management and is based upon historical experience with the
customer, the aging of the past due amounts and the relationship with and
economic status of our customers. The evaluation is based upon estimates taking
into account the facts and circumstances at the time of the evaluation. Actual
uncollectible accounts could exceed our estimates and changes to its estimates
will be accounted for in the period of change. Account balances are charged
against the allowance after all means of collection have been exhausted and the
potential for recovery is considered remote. Our trade receivables are not
collateralized.

18

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Inventory Valuation

Inventories
are stated at the lower of cost or market value. Cost has been determined using
the first-in, first-out method. Inventory quantities on-hand are regularly
reviewed, and where necessary, reserves for excess and obsolete inventories are
recorded

Warranty

The Company
offers warranties on all products, including parts and labor that range from
one year to three years depending upon the type of product concerned. For
products made by others, the Company passes along the manufacturers warranty
to the end user.

Intangible Assets

The Companys
intangible assets include goodwill and other intangibles that consist of the
fair value of acquired customer lists, service contracts acquired, trade names,
and covenants not to compete. Goodwill represents the excess of purchase price
over fair value of net assets acquired at the date of acquisition.

Effective
January 1, 2002, the Company adopted the provisions of Statement of Financial
and Accounting Standards (SFAS) 142 Goodwill and Other Intangible Assets. In
accordance with that statement goodwill and intangible assets with indefinite
lives are not amortized, but are tested at least annually for impairment. Prior
to January 1, 2002, the Company had not recorded goodwill or other intangible
assets of indefinite lives. Intangible assets with estimable useful lives,
consisting primarily of acquired customer lists, service contracts and
covenants not to compete are amortized on a straight-line basis over their
estimated useful lives of three to fifteen years and are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount
of an asset or asset group may not be recoverable. If the intangible assets
remaining useful life is changed, the intangible asset will be amortized over
the remaining useful life. If the asset being amortized is determined to have
an indefinite useful life, the asset will be tested for impairment. The
impairment test will consist of measuring its fair value with its carrying
amount. If the carrying amount of the intangible assets exceeds its fair value,
an impairment loss is recognized for an amount equal to the excess and the
adjusted carrying amount is recognized as its new accounting basis.

The Companys
goodwill impairment test is based on a two part procedure consistent with the
requirements of SFAS 142. The first test consists of determining the fair value
of the reporting unit and comparing it to the carrying value of the reporting
unit. If the carrying value of the reporting unit exceeds the fair value of the
reporting unit, a second test is performed. In step two, the implied fair value
of the goodwill (which is the excess of the fair value of the reporting unit
over the fair value of the net assets) is compared to the carrying value of the
goodwill. An impairment loss is recognized for any excess value of goodwill
over the implied value. We determined the reporting unit by analyzing
geographic regions, as management evaluates the Companys performance in this
manner. We identified five separate and distinct operating units for the
testing requirements of SFAS 142, and evaluate each reporting unit for
impairment.

Income Taxes

Deferred taxes are provided on
an asset and liability method whereby deferred tax assets are recognized for
deductible temporary differences and operating loss carry forwards and deferred
tax liabilities are recognized for taxable temporary differences. Temporary
differences are the differences between the reported amounts of assets and
liabilities and their tax basis. Deferred tax

19

---



assets are
reduced by a valuation allowance when, in the opinion of management, it is more
likely than not that some portion or all of the deferred tax assets will not be
realized. Deferred tax assets and liabilities are adjusted for the effects of
changes in tax laws and rates on the date of enactment.

Comparison of the year ended December 31,
2006 to the year ended December 31, 2005

Analysis of consolidated statement of
operations

HENRY BROS. ELECTRONICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

|                                               |  |                                  |            |             |   |            |   |  |        |  
|---------------------------------------------- |  | -------------------------------- | ---------- | ----------- | - | ---------- | - |  | ------ | -
|                                               |  | For the years ended December 31, |           
|                                               |  |                                 
|                                               |  | 2006                             |            | 2005        |   |            |  
|                                               |  |                                  |            | (Corrected) |   | % change  
|                                               |  |                                  |            |             |   |           
|Revenue                                        |  | $                                | 42,132,852 |             | $ | 42,156,188 |   |  | 0.1    | %
|Cost of revenue                                |  |                                  | 31,586,736 |             |   | 31,581,187 |   |  |       |  
|                                               |  |                                  |            |             |   |            |   |  |        |  
|Gross profit                                   |  |                                  | 10,546,116 |             |   | 10,575,001 |   |  | 0.3    | %
|                                               |  |                                  |            |             |   |            |   |  |        |  
|Operating expenses:                            |  |                                  |            |             |   |            |   |  |        |  
|Selling, general & administrative expenses     |  |                                  | 11,952,477 |             |   | 8,422,193  |   |  | 41.9   | %
|Goodwill & intangible asset impairment charges |  |                                  | 1,191,000  |             |   | 44,999     |   |  | 2546.7 | %
|                                               |  |                                  |            |             |   |            |   |  |        |  
|Operating (loss) profit                        |  |                                  | (2,597,361 | )           |   | 2,107,809  |   |  | -223.2 | %
|                                               |  |                                  |            |             |   |            |   |  |        |  
|Interest income                                |  |                                  | 19,515     |             |   | 12,507     |   |  | 56.0   | %
|Other expense                                  |  |                                  | (674       | )           |   | (3,780     | ) |  | -82.2  | %
|Interest expense                               |  |                                  | (103,923   | )           |   | (84,985    | ) |  | 22.3   | %
|                                               |  |                                  |            |             |   |            |   |  |        |  
|Income (loss) before tax expense               |  |                                  | (2,682,443 | )           |   | 2,031,551  |   |  | -232.0 | %
|                                               |  |                                  |            |             |   |            |   |  |        |  
|Tax expense (benefit)                          |  |                                  | (422,305   | )           |   | 893,577    |   |  | -147.3 | %
|                                               |  |                                  |            |             |   |            |   |  |        |  
|Net (loss) income after taxes                  |  | $                                | (2,260,138 | )           | $ | 1,137,974  |   |  | -298.6 | %
|                                               |  |                                  |            |             |   |            |   |  |        |  

Revenue-Revenue for the year ended December 31,
2006 was $42,132,852 representing a slight decrease as compared to $42,156,188
for the year ended December 31, 2005. In 2006, the New Jersey, Viscom and Texas
Divisions experienced declines in revenues. The decline in New Jersey resulted
from the wind down of two large projects in the New York metro area. Lower
revenue from our Viscom group was attributable to a large project with the
Santa Clara Valley Transportation Authority in 2005 that was not replaced in
2006. In response to the decline in revenues in our Texas Division changes in
management were made to more effectively take advantage of the opportunities
that exist in this market. These declines in revenues were offset by revenue
from Securus (Colorado operations) acquired in October 2005 and CIS Security
Systems Corp. (CIS) (Virginia and Maryland operations) acquired in October
2006 and higher revenue from our California and Arizona regions. Revenues from CIS were $1,774,493 for the
year ended December 31, 2006. Revenues from governmental agencies represented
22.6% and 39% of total revenues, for the years ended December 31, 2006 and
2005, respectively.

Booked orders
doubled to $26.6 million in the year ended December 31, 2006 as compared to
$13.3 million in the corresponding period of 2005.

Cost of Revenue-Cost of revenue for the year ended
December 31, 2006 was $31,586,736 as

20

---



compared to
$31,581,187 for the year ended December 31, 2005. The gross profit margin for
the year ended December 31, 2006 was 25.0% as compared to 25.1% for the year
ended December 31, 2005. Higher gross profit dollars arising from the Securus
and CIS acquisitions, as well as higher gross margins and dollars in our
Diversified Security Solutions, Inc. division and the Arizona region for the
year ended December 31, 2006 were offset by the decline in gross profit at our Viscom
and Airorlite Divisions. The decline in Viscom gross profit margins was a
direct result of wind down of the Santa Clara VTA project discussed in the
Revenue section above and the $0.3 million write-down of slow moving
inventory associated with the Viscom product line. Poor performance from the
Texas Division contributed to the decline in gross profit margin. The decline
at Airorlite largely resulted from the investment that was made by this division
to support a project for a large legacy customer. This investment resulted in a
solution for Time Delay Interference (TDI) in In-Building wireless systems.
This solution for TDI is expected to have wider commercial application
potential.

Selling, General and Administrative Expenses-Selling, general and administrative
expense was $11,952,477 for the year ended December 31, 2006, as compared to
$8,422,193 for the year ended December 31, 2005. This increase of 41.9% or
$3,530,284 was primarily attributed to
costs associated with the Securus acquisition made in October 2005, the CIS
acquisition made in October 2006, lower utilization rates due in part to the
move to our new offices in Fair Lawn, NJ, additional accruals related to our
paid time off liability and higher commissions.

Goodwill and Intangible Asset Impairment
ChargesBased
upon our goodwill evaluation under the requirements of SFAS 142, the Company
took a charge to operations of $1,191,000 (or $.21 per diluted share)
associated with goodwill impairment associated with our California banking
vertical market for the year ended December 31, 2006. For the year ended
December 31, 2005, the Company recorded a $44,999 impairment charge for the
write-down of customer lists and service contract rights.

Interest IncomeInterest income for the year ended
December 31, 2006 was $19,515, as compared to $12,507 for the year ended
December 31, 2005.

Interest Expense-Interest expense for the year ended
December 31, 2006 was $103,923, as compared to $84,985 for the year ended
December 31, 2005. Average outstanding debt balance was considerably higher in
the twelve month period ended December 31, 2006 versus for the year ended
December 31, 2005, accounting for the higher interest expense in 2006.

Tax Expense  Principally as a result of the loss before tax incurred by the Company for
the year ended December 31, 2006, there was an overall tax benefit of $422,305.
This benefit was partially offset by state income taxes for those jurisdictions
that were profitable during the period. The write-off of the goodwill discussed
above is a permanent difference under FASB 109, Accounting for Income Taxes.
Accordingly, there was no tax benefit taken for this write-off. For the year
ended December 31, 2005, the company recorded a tax provision of $893,577,
which is an effective tax rate of 44%.

Net Income - As a
result of the above noted factors our net loss was $2,260,138 for the year
ended December 31, 2006 and our net income was $1,137,974 for the year ended
December 31, 2005. This resulted in diluted loss per share of $0.39 on weighted
average common shares outstanding of 5,746,065 for the year ended December 31,
2006, as compared to diluted earnings per share of $0.20 on weighted average
common shares outstanding of 5,773,097 for the year ended December 31, 2005.

21

---



Comparison of the year ended December 31,
2005 to the year ended December 31, 2004

Analysis of consolidated statement of
operations

HENRY BROS. ELECTRONICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

|                                               |  |                                  |            |             |   |            |   |       |   | 
|---------------------------------------------- |  | -------------------------------- | ---------- | ----------- | - | ---------- | - | ----- | - | 
|                                               |  | For the years ended December 31, |           
|                                               |  |                                  |           
|                                               |  | 2005                             |            | 2004        |   |            |   |      
|                                               |  | (Corrected)                      |            | (Corrected) |   | % change   |  
|                                               |  |                                  |            |             |   |            |  
|Revenue                                        |  | $                                | 42,156,188 |             | $ | 29,725,718 |   | 41.8  | % | 
|Cost of revenue                                |  |                                  | 31,581,187 |             |   | 22,305,632 |   | 41.6  | % | 
|                                               |  |                                  |            |             |   |            |   |       |   | 
|Gross profit                                   |  |                                  | 10,575,001 |             |   | 7,420,086  |   | 42.5  | % | 
|                                               |  |                                  |            |             |   |            |   |       |   | 
|Operating expenses:                            |  |                                  |            |             |   |            |   |       |   | 
|Selling, general & administrative expenses     |  |                                  | 8,422,193  |             |   | 6,943,885  |   | 21.3  | % | 
|Goodwill & intangible asset impairment charges |  |                                  | 44,999     |             |   | 77,000     |   | -41.6 | % | 
|                                               |  |                                  |            |             |   |            |   |       |   | 
|Operating (loss) profit                        |  |                                  | 2,107,809  |             |   | 399,201    |   | 428.0 | % | 
|                                               |  |                                  |            |             |   |            |   |       |   | 
|Interest income                                |  |                                  | 12,507     |             |   | 12,624     |   | -0.9  | % | 
|Other expense                                  |  |                                  | (3,780     | )           |   |           |   |       |   | 
|Interest expense                               |  |                                  | (84,985    | )           |   | (94,039    | ) | -9.6  | % | 
|                                               |  |                                  |            |             |   |            |   |       |   | 
|Income (loss) before tax expense               |  |                                  | 2,031,551  |             |   | 317,786    |   | 539.3 | % | 
|                                               |  |                                  |            |             |   |            |   |       |   | 
|Tax expense (benefit)                          |  |                                  | 893,577    |             |   | 148,147    |   | 503.2 | % | 
|                                               |  |                                  |            |             |   |            |   |       |   | 
|Net (loss) income after taxes                  |  | $                                | 1,137,974  |             | $ | 169,639    |   | 570.8 | % | 
|                                               |  |                                  |            |             |   |            |   |       |   | 

Revenues -Revenues
for the year ended December 31, 2005 were $42,156,188, representing an increase
of $12,430,470 or 41.8%, as compared to $29,725,718 for the year ended December
31, 2004. The increase in revenue was principally related to an increase of
$12,616,752 in the Companys integration business. The New Jersey/New York
region accounted for approximately $11.5 million of the increased Integration
revenue of which a single customer project represented approximately $5.2
million. Our backlog for this single customer project at December 31, 2005 was approximately
$3.2 million as compared to $6.8 million at December 31, 2004. In October 2005,
the Company acquired Securus, Inc., a provider of security integration systems.
Revenues for Securus were $1,101,509 for the period October 11, 2005 through
December 31, 2005. Revenues from governmental agencies represented 39% and 20%
of total revenues, for the years ended December 31, 2005 and 2004,
respectively.

Cost of Revenues -
Cost of revenues for the year ended December 31, 2005 was $31,581,187, as
compared to $22,305,632 for the year ended December 31, 2004. This was an
increase of $9,275,555 or 41.6%. Gross profit margin was 25.1% for the year
ended December 31, 2005, as compared to 25.0 % for the year ended December 31,
2004. Direct labor for our Integration segment decreased as a percent of
revenue accounting for most of the increase in this segments gross profit
margin. Our specialty segment gross profit margin decreased to 32.4% for the
year ended December 31, 2005 versus 43.3% for the same period of the prior
year. The decrease on a flat revenue comparison is due to a change in the
revenue mix from Airorlite to Viscom.

Selling, General and Administrative Expenses
- Selling, general and administrative expenses increased to $8,422,193 for the
year ended December 31, 2005, from $6,943,885 for the year ended

22

---



December 31,
2004. Selling, general and administrative expenses as a percentage of revenues
decreased to 20.0% for the year ended December 31, 2005 versus 23.4% for the
year ended December 31, 2004. This increase of $1,478,308, or 21.3%, was
primarily attributable to increased headcount and staff costs. As the Companys
revenues increased in 2005, our corporate expenses decreased as a percent of
our consolidated revenue to 3.3% for the year ended December 31, 2005 as
compared with 4.4% for the same period of the prior year.

Interest Income -
Interest income for the year ended December 31, 2005 was $12,507, as compared
to $12,624 for year ended December 31, 2004.

Interest Expense -
Interest expense for the year ended December 31, 2005 was $84,985, as compared
to $94,039 for the year ended December 31, 2004. The decrease of $9,054 was
attributable to having an average lower debt balance of approximately
$1,279,468 for the year ended December 31, 2005 as compared to $1,783,342 for
the year ended December 31, 2004. This decrease was partially offset by
increases in interest rates as the weighted average prime rate increased to
6.4% for the year ended December 31, 2005 versus 4.6% for the same period of the
prior year.

Net Income - As a
result of the factors noted above, for the year ended December 31, 2005 our net
income was $1,137,974, as compared to a net income of $169,639 for the year
ended December 31, 2004. This resulted in diluted earnings per share of $0.20
on weighted average common shares outstanding of 5,773,097 for the year ended
December 31, 2005, as compared to diluted earnings per share of $0.03 on
weighted average common shares outstanding of 5,411,964 for the year ended
December 31, 2004.

Liquidity and Capital Resources
 As of December 31, 2006, we had cash and cash equivalents of $199,853.
Our net current assets were $10,001,109 at December 31, 2006 versus $10,947,799
at December 31, 2005. Total debt at December 31, 2006 was $3,968,264 compared
to the December 31, 2005 balance of $1,024,627.

Cash used in operating
activities used $1,642,610 during
the year ended December 31, 2006. In addition to the poor operating performance
of the company resulting in a net loss of $2,260,138, the most significant use
of cash resulted from an increase accounts receivable of $3,071,303 due
to strong fourth quarter 2006 revenues.
This was partially offset by a decrease in accounts payable of $1,930,035
and accrued expenses of $2,285,202.

Cash from investing
activities used $3,059,364.
The most significant expenditures were used for the: (1) funding of the
CIS and SSI acquisitions (see Note 17 to the Consolidated Financial
Statements); (2) capital costs associated with the consolidation of our New
Jersey office and warehouse facilities into a new larger location; and (3)
improvements to our information technology infrastructure.

Cash from financing
activities provided $2,724,141 representing borrowing against the revolving credit facility, slightly
offset by repayments of bank loans and capitalized lease payments.

Borrowings
under the revolving credit facility at September 30, 2007 were $3,635,897. The
    Company is required to maintain certain financial and reporting covenants
    and restrictions on dividend payments under the terms of the Loan Agreement
    with TD Banknorth, N.A. (See Note 8 to the Consolidated Financial Statements
    included in this Annual Report on Form 10-K). The Company was not in compliance
    with certain of these bank covenants at December 31, 2006. TD Banknorth,
    N.A. provided the Company with a waiver associated with the bank covenants
    in default on October 11, 2007. As a condition of the waiver, the Company
    agreed to grant  TD Banknorth a first security interest on its accounts receivable.

DIVIDENDS

We have not
declared cash dividends on our common equity. The payment of dividends is

23

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prohibited under
the existing credit agreement with TD Banknorth. We may, in the future, declare
dividends under certain circumstances.

SEASONALITY

Revenues
generated by our services have typically been seasonal in nature and there
could be periods of fluctuations in revenue volume due to the timing of project
installations or factors that are beyond the Companys control, such as weather
and construction delays.

INFLATION

Our revenues
generally have kept pace with inflation.

OFF BALANCE SHEET ARRANGEMENTS

We do not have
any financial partnerships with unconsolidated entities, such as entities often
referred to as structured finance, special purpose entities or variable
interest entities which are often established for the purpose of facilitating
off-balance sheet arrangements or other contractually narrow or limited
purposes. Accordingly, we are not exposed to any financing, liquidity, market
or credit risk that could arise if we had such relationships.

AGGREGATE CONTRACTUAL OBLIGATIONS

As of December
31, 2006, the Companys contractual obligations, including payments due by
period, are as follows:

|                                      |  |                       |         |      |   |           |  |      |         |      |   |            |  |       |   |  |  |   |   |  |  |   |           | 
|------------------------------------- |  | --------------------- | ------- | ---- | - | --------- |  | ---- | ------- | ---- | - | ---------- |  | ----- | - |  |  | - | - |  |  | - | --------- | 
|                                      |  | Payment due by period |        
|                                      |  |                       |        
|                                      |  | 2007                  |         | 2008 |   | 2009      |  | 2010 |         | 2011 |   | Thereafter |  | Total |  
|                                      |  |                       |         |      |   |           |  |      |         |      |   |            |  |       |  
|Long -Term Debt Obligations           |  | $                     | 214,048 |      | $ | 3,081,524 |  | $    | 108,365 |      | $ |           |  | $     |  |  |  | $ |  |  |  | $ | 3,403,937 | 
|Interest Obligation on Long-term debt |  |                       | 14,539  |      |   | 251,051   |  |      | 7,382   |      |   |            |  |       |   |  |  |   |   |  |  |   | 272,972   | 
|Capital Lease Obligations             |  |                       | 161,009 |      |   | 157,386   |  |      | 99,379  |      |   | 46,090     |  |       |  |  |  |   |  |  |  |   | 463,864   | 
|Short-term debt                       |  |                       | 162,397 |      |   |          |  |      |        |      |   |           |  |       |  |  |  |   |  |  |  |   | 162,397   | 
|                                      |  |                       |         |      |   |           |  |      |         |      |   |            |  |       |   |  |  |   |   |  |  |   |           | 
|                                     
|Total                                 |  | $                     | 551,993 |      | $ | 3,489,961 |  | $    | 215,126 |      | $ | 46,090     |  | $     |  |  |  | $ |  |  |  | $ | 4,303,170 | 
|                                      |  |                       |         |      |   |           |  |      |         |      |   |            |  |       |   |  |  |   |   |  |  |   |           | 

Item 7A. Quantitative and
Qualitative Disclosures about Market Risk

We have one
revolving credit facility for which the interest rate on outstanding borrowings
is variable and is based upon the prime rate of interest. At December 31, 2006
and 2005, there was $2,847,897, and $0, respectively, outstanding under this
revolving credit facility.

Item 8. Financial Statements
and Supplementary Data

Refer to pages F-1 through
F-35.

24

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Item 9. Changes in and Disagreements with
Accountants on Accounting and Financial Disclosure

During the
year ended December 31, 2006, there were no changes in or disagreements with
the Companys principal independent accountant on accounting or financial disclosure.

Item 9A. Controls and Procedures

Controls and Procedures

(a) The Company carried out an
evaluation, under the supervision and with the participation of the Companys
management, including the Companys Chief Executive Officer, Chief Operating Officer
and Chief Financial Officer, of the design and operation of the Companys
disclosure controls and procedures, as defined under Rule 13a-15(e) of the
Securities and Exchange Act of 1934, as of the end of the period covered by
this report. Based on
this evaluation, the Chief Executive Officer Chief Operating Officer and Chief
Financial Officer concluded that, as of December 31, 2006, the design and
operation of the Companys disclosure controls and procedures were not
effective because of the material weakness in the Companys internal control
over financial reporting described in the following paragraphs.

As
a result of these weaknesses, we performed extensive detail testing and
reconciliation of past transactions in order to be able to determine the proper
presentation of our financial information for past and current periods. These
weaknesses in our internal disclosure controls and procedures were the cause of
the delay in filing of this Annual Report on Form 10-K.

We learned that the Company did not maintain
adequate policies and reconciliation procedures over the accounting for
intercompany clearing and cash accounts and income taxes. These weaknesses
resulted in the following errors in the annual and interim consolidated
financial statements:

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The Companys intercompany
 clearing and cash accounts were not properly reconciled for 2006 which led to
 an imbalance in the consolidated financial statements. Over the course of the
 last six months, with the addition of a new Corporate Controller and the
 assistance of an outside public accounting firm, the Company evaluated every
 material transaction and discovered a number of significant deficiencies in
 internal controls that have been adjusted for the year ended December 31,
 2006. Certain of these adjustments affected prior quarters in 2006 and those
 corrections have been made in Note 19 in this Annual Report on Form 10-K and
 will be reflected in subsequent quarterly filings on the Companys Quarterly
 Reports on Form 10-Q.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | The Company had certain
 errors in its accounting for income tax under SFAS No. 109 for the years 2002
 through 2005. Specifically, the Company:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |   | o                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         | Did not properly account
 for the stock acquisitions that occurred between 2002 and 2005. The Company
 did not record a deferred tax liability and corresponding increase to
 goodwill related to the differences in book and tax basis on acquired assets
 other than goodwill. In addition, the Company did not record a deferred tax
 asset and corresponding decrease to goodwill related to acquired net
 operating loss carryforwards of these acquired companies.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |   | o                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         | Recorded an adjustment for the
 understatement of current tax liabilities resulting from the erroneous
 amortization of acquired intangibles for which there was no tax                                                                                                                                                                                                                                                                                                  

25

---



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | basis. The Company also recorded an
 adjustment for the net operating loss carrybacks and carryforwards that
 rectified the understatement of tax liabilities in prior periods.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |   | o                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | Recorded an
 adjustment that resulted from the additional provision that should have been
 recorded related to SFAS No. 123(R) compensatory expense associated with
 Qualified (Statutory) Stock Options. Under SFAS No. 123(R), compensation
 expense is recorded through the income statement based on the fair market
 value of the compensation associated with the granting of stock options. To
 the extent that the Company will realize a tax deduction at the time of
 exercise, a corresponding amount of tax benefit is recorded through the
 income statement at the time the SFAS No. 123(R) deduction is reflected and
 is then trued-up when actually exercised. Since pursuant to the tax laws there is generally no tax deduction
 associated with the exercise of statutory options, (e.g. Incentive Stock
 Options), no tax benefit is recorded at the time of the SFAS No. 123(R)
 deduction; the book deduction is treated as a permanent difference. If
 there is a subsequent disqualifying disposition of the statutory option that
 gives rise to a tax deduction (e.g. employee sells the exercised shares
 before one year from the date of exercise), a tax benefit is taken at that
 time.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | After analyzing the
 materiality of the impact arising from these weaknesses in accordance with
 the provisions of SAB 108, management concluded that the financial statements
 for the years ended December 31, 2005 and 2004 included as part of this
 Annual Report on Form 10-K, and the Selected Financial Data included as Item
 6 of this Annual Report on Form 10-K should be corrected to reflect the
 proper accounting related to income taxes. The impact resulting from these
 corrections for income tax accounting that had an income statement impact was
 to increase (decrease) tax expense by $(29,696), $(125,618), $111,080, and
 $99,776, for the years ended December 31, 2005, 2004, 2003 and 2002,
 respectively, with a corresponding increase or decrease to net tax
 liabilities. The impact resulting from these corrections for income tax
 accounting that only had a balance sheet impact was to increase net deferred
 taxes by $549,262, $580,032, $533,648 and $533,648 for the years ended
 December 31, 2005, 2004, 2003 and 2002, respectively, with a corresponding
 net increase to goodwill. Unadjusted differences were not material to 2006 or
 individually to the prior years.

While we are in the process of
implementing a more efficient and reliable system of disclosure controls and
procedures, we have, on an immediate basis, instituted interim compensating
controls and procedures to ensure that information required to be disclosed in
this Annual Report on Form 10-K has been recorded, processed, summarized and
reported to our senior management. The steps that we have taken to ensure that
all material information about our company is accurately disclosed in this
report include:

| |  |   |                                                                                                                                                            
| |  | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | - | the
 appointment of a new Chief Financial Officer in August 2006;                                                                                          
| |  |   |                                                                                                                                                            
| |  | - | the
 appointment of a new Chief Operating Officer (COO) in August 2006. The COO
 then assumed the additional responsibilities of President in March 2007;
| |  |   |                                                                                                                                                            
| |  | - | the
 appointment of a new Corporate Controller in April 2007;                                                                                              
| |  |   |                                                                                                                                                            
| |  | - | the
 appointment of a new Controller for our California operations in April 2007;                                                                          

26

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| |  |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | - | the
 engagement of an outside accounting firm to assist management in the
 preparation of our financial statement income tax provision in February 2007;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | - | the
 performance of an extensive review of our financial statements for the years
 ended December 31, 2006 and December 31, 2005; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | - | the
 engagement of outside professionals specializing in accounting to assist our
 management in the collection, substantiation and analysis of the information
 contained in this report.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | - | changed the accounting process of recording and reconciling accounts
        that resulted in either a significant deficiency or material weakness;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |  |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | - | implemented revised accounting procedures for recording and reconciling
    intercompany clearing and cash accounts and designed changes within the Companys
    financial reporting system to ensure all intercompany accounts eliminate
    in consolidation. These changes substantially do away with the use of spreadsheets
    as the tool to ensure that all intercompany accounts eliminate in consolidation,
    which are inherently more difficult to ensure compliance with the Companys
    internal control policies. Eliminating the use of spreadsheets also allows
    for fuller use of the Companys financial reporting system and the internal
    control safeguards built into the financial reporting software;
| |  |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | - | designed changes within the Companys financial reporting system to allow the financial reporting system to be the sole source of the consolidation of financial results of the Company.  This change eliminated the use of spreadsheets, which was the method formerly used to
consolidate the Companys financial results; and                                                                                                                                                                                                                                                                                                                                                                                                         

Nonetheless,
a control system, no matter how well designed and operated, cannot provide
absolute assurance that the objectives of the control system are met, and no
evaluation of controls can provide absolute assurance that all control issues
have been detected.

(b) Change in Internal Controls over Financial Reporting:

As required by Rule 13a-15(d),
the Companys executive management including the Chief Executive Officer, the
Chief Operating Officer and the Chief Financial Officer, also conducted an
evaluation of the companys internal controls over financial reporting to
determine whether any change occurred during the Companys last fiscal quarter that
has materially affected, or is reasonably likely to materially affect, the
Companys internal controls over financial reporting. Based on that evaluation,
in order to correct the weaknesses described above and to improve our internal
disclosure and control procedures on a going forward basis, we have:

| |  |   |                                                                                                         
| |  | - | --------------------------------------------------------------------------------------------------------
| |  | - | implemented
 consolidated financial and operational review procedures, with each operating
    unit; and
| |  |   |                                                                                                         
| |  | - | hired
 additional qualified accounting personnel.                                                       

We intend to
continue to evaluate our internal disclosure controls and procedures and
implement improvements as required.

Item
9B. Other Information

There
were no events requiring disclosure that had not been made under Form 8-K in
the fourth quarter of our fiscal year.

27

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PART III

Item 10. Directors, Executive Officers and Corporate

Identification of Directors
(ages are as of September 4, 2007)

|                    |  |     |  |                                                                            |  |                  | 
|------------------- |  | --- |  | -------------------------------------------------------------------------- |  | ---------------- | 
|Name                |  | Age |  | Position(s) with the Company                                               |  | Director 
 Since
|                    |  |     |  |                                                                            |  |                 
|                   
|James E.
 Henry     |  | 53  |  | Chairman,
 Chief Executive Officer, Treasurer and Director                 |  | 1999             | 
|Brian Reach.        |  | 52  |  | Vice
 Chairman, President, Chief Operating Officer, Secretary and Director |  | 2004             | 
|Joseph P.
 Ritorto  |  | 75  |  | Director                                                                   |  | 2002             | 
|Robert L. De Lia Sr |  | 59  |  | Director                                                                   |  | 2004             | 
|David Sands         |  | 50  |  | Director                                                                   |  | 2005             | 
|James W. Power      |  | 77  |  | Director                                                                   |  | 2005             | 

Identification of Executive
Officers (ages are as of September 4, 2007)

|                 |  |     |  |                                        |  |                | 
|---------------- |  | --- |  | -------------------------------------- |  | -------------- | 
|Name             |  | Age |  | Position(s) with the Company           |  | Officer
 Since
|                 |  |     |  |                                        |  |               
|                
|James E.
 Henry  |  | 53  |  | Chief
 Executive Officer and Treasurer |  | 1999           | 
|Brian Reach      |  | 52  |  | President                              |  | 2007           | 
|                 |  |     |  | Chief
 Operating Officer               |  | 2006           | 
|                 |  |     |  | Vice-Chairman,
 Secretary              |  | 2004           | 
|John P.
 Hopkins |  | 47  |  | Chief Financial Officer                |  | 2006           | 
|Brian J.
 Smith  |  | 52  |  | Corporate
 Controller                  |  | 2007           | 

James E. Henry
co-founded the Companys predecessor company in 1989 and served as President
and Chief Executive Officer until December 2001 when he was elected Chairman of
the Board. Mr. Henry continues to serve as Chief Executive Officer and is
also the Companys Treasurer. Mr. Henry graduated from the University of
New Hampshire with a Bachelor of Science degree in electrical engineering. In
addition to his other responsibilities, Mr. Henry has continued to design,
install, integrate and market security and communications systems as well as
manage the Companys research and development.

Brian Reach,
in addition to his prior duties, was named Chief Operating Officer in August
2006 and President in March 2007. Mr. Reach has been a member of the Companys
Board of Directors since February 2004 and has served as the Companys
Vice-Chairman since June 2004 and as its Secretary since November 2004. From
September 1999 until April 2002, Mr. Reach was the Chief Financial Officer
of Globix Corporation, a provider of application, media and infrastructure
management services. From May 1997 to August 1999, Mr. Reach was the Chief
Financial Officer of IPC Communications, a provider of integrated telecommunications
equipment and services to the financial industry. During his tenure at IPC,
Mr. Reach successfully guided IPC through its leveraged recapitalization
and financially restructured IPC enabling it to invest in strategic
acquisitions and next generation technologies. Prior to IPC, Mr. Reach was
the Chief Financial Officer of Celadon Group, Inc. and Cantel Industries, Inc.
Mr. Reach became a certified public

28

---



accountant in
1980 and received his Bachelor of Science degree in accounting from the
University of Scranton in 1977.

Joseph P.
Ritorto has been a member of our Board since January 2002. Mr. Ritorto is the
co-founder of First Aviation Services, Inc., which is located in Teterboro
Airport, Teterboro, New Jersey and provides a variety of aviation support services.
Mr. Ritorto has been an officer, in various capacities, of First Aviation
Services since 1986. From 1991, until he retired in May 2001, Mr. Ritorto
served as the Senior Executive Vice President and Chief Operating Officer of
Silverstein Properties, Inc. In this capacity, Mr. Ritortos
responsibilities included overseeing operations and directing the lease
administration of Silverstein owned and managed properties.

Robert L. De
Lia, Sr. has been a member of our Board since May 2004. Currently, Mr. De Lia
is vice president of TJs Motorsport, a privately held company dedicated to
supplying quality motor sport products. From 2002 to 2003, Mr. De Lia was
the President and Chief Executive Officer of Airorlite Communications, Inc., a
company that specializes in designing, manufacturing and maintaining wireless
communications equipment used to enhance and extend emergency radio frequency
services and cellular communication for both fixed and mobile applications. In
April 2004, a wholly-owned subsidiary of the Company purchased all of the
issued and outstanding shares of stock of Airorlite Communications, Inc. From
1987 to 1999, Mr. De Lia was the President and Chief Executive Officer of
Fiber Options, Inc. Mr. De Lia graduated from the New York Institute of Technology
in 1969.

David Sands
has served as a director of the Company since 2005. Mr. Sands is a certified
public accountant and a partner of Buchbinder Tunick & Company LLP where he
is the head of the tax department. Mr. Sands is a member of the American
Institute of Certified Public Accountants and the New York State Society of
CPAs. Mr. Sands has also lectured at the New York University Summer
Continuing Education and the Foundation for Accounting Education Programs.
Mr. Sands received a Bachelor of Science from SUNY at Buffalo and a Master
of Science in Taxation from Pace University.

James W. Power
has served as a director of the Company since December 2005. Mr. Power is
Chairman of AXIUM, Inc., a digital video recording company; Chairman of MDI,
Inc, a Nasdaq listed provider of integrated access control and physical
security products for government and commercial organizations; director of RAE
Systems, Inc., a manufacturer of equipment used to detect weapons of mass
destruction, hazardous materials and toxic chemicals; and the principal partner
in J.W. Power & Associates. Mr. Power previously served as Chairman of
the Board of InfoGraphic Systems Corp.; President and Chief Executive Officer
of Martec\SAIC; President and Chief Executive Officer of Pinkerton Control
Systems and has held senior executive positions with Cardkey Systems, Inc.,
Nitrol Corporation and TRW Data Systems. Previously, he has served as a
director of National Semiconductor, ICS Corporation, and Citicorp Custom Credit
and Citicorp Credit Services.

John P. Hopkins was appointed Chief Financial Officer in
August 2006. Prior to joining the Company, Mr. Hopkins was Chief Financial
Officer for Measurement Specialties from July 2002 to August 2006, was Vice
President, Finance from April 2001 to July 2002, and was Vice President and
Controller from January 1999 to March, 2001, with Cambrex Corporation, a
provider of scientific products and services to the life sciences industry.
From 1988 to 1998, he held various

29

---



senior financial positions with ARCO
Chemical Company, a manufacturer and marketer of specialty chemicals and
chemical intermediates. Mr. Hopkins is a Certified Public Accountant and was an
Audit Manager for Coopers & Lybrand prior to joining ARCO Chemical. Mr.
Hopkins holds a B.S. in Accounting from West Chester University, and an M.B.A.
from Villanova University.

Brian J. Smith
was appointed Corporate Controller in April 2007. Prior to joining the Company,
Mr. Smith was VP-General Manager NetVersant of New York, a provider of voice and
data system infrastructure from 2002. From 1991 to 2002 Mr. Smith held various
senior
financial positions with Insilco Technologies, a manufacturer and distributor
of electronic components. Mr. Smith is a Certified Public Accountant and was
and began his career as an auditor for KPMG Peat Marwick. Mr. Smith holds a
B.S. in Accounting from Fordham University.

(c) Compliance
with Section 16(a) of the Exchange Act

Section 16(a)
of the Exchange Act, requires our directors and officers, and persons who own
more than 10% of our Common Stock, to file with the Securities and Exchange
Commission initial reports of beneficial ownership and reports of changes in
beneficial ownership of our Common Stock and other equity securities. Our
officers, directors and greater than 10% beneficial owners are required by SEC
regulation to furnish us with copies of all Section 16(a) forms they file.

To our
knowledge, for the year ended December 31, 2006, based solely on a review of
the copies of such reports furnished to the Company and representations by
these individuals that no other reports were required during the year ended
December 31, 2006, all Section 16(a) filing requirements applicable to our
directors, officers and greater than 10% beneficial owners have been timely
filed except that Messrs. Power and Hopkins did not timely file a Form 4 and
Form 3, respectively. These forms have since been filed.

(d) Code of Conduct and Ethics

We have a Code of Conduct that
applies to all of our directors, officers and employees, including our
principal executive officer, principal financial officer and principal
accounting officer and a Code of Ethics that applies to our senior financial
officers. You can find our Code of Conduct and Code of Ethics on our website:
www.hbe-inc.com. We will post there any amendments to these Codes, as well as
any waivers that are required to be disclosed by the rules of either the
Securities and Exchange Commission or American Stock Exchange.

30

---



Item 11. Executive Compensation

Summary Compensation Table

The following
table sets forth summary information concerning the annual compensation for the
year ended December 31, 2006 for our principal executive officer (PEO),
principal financial officer (PFO) and our most highly compensated executive
officers other than our PEO and our PFO for the year ended December 31, 2006:

|                                                                                 |  |      |      |             |   |            |  |                        |   |                              |  |            |        |  |  |  |   |       |  |  |  |   |         |  | 
|-------------------------------------------------------------------------------- |  | ---- | ---- | ----------- | - | ---------- |  | ---------------------- | - | ---------------------------- |  | ---------- | ------ |  |  |  | - | ----- |  |  |  | - | ------- |  | 
|Name and Principal Position                                                      |  | Year |      | Salary
 ($) |   | Bonus
 ($) |  | Option
 Awards
 ($)(1) |   | All Other
 compensation
 ($) |  | Total
 ($) |       
|                                                                                 |  |      |      |             |   |            |  |                        |   |                              |  |            |       
|James E Henry, Chairman,
 Chief Executive Officer, Treasurer and Director        |  |      | 2006 |             | $ | 130,680    |  | $                      |  |                              |  |            |       |  |  |  | $ | 3,000 |  |  |  | $ | 133,680 |  | 
|Irvin F. Witcosky,
 President and Director (2)                                   |  |      | 2006 |             | $ | 130,680    |  | $                      |  |                              |  |            |       |  |  |  | $ | 3,000 |  |  |  | $ | 133,680 |  | 
|Brian Reach, Vice
 Chairman, Chief Operating Officer, Secretary and Director (3) |  |      | 2006 |             | $ | 72,000     |  | $                      |  |                              |  | $          | 42,363 |  |  |  | $ | 6,052 |  |  |  | $ | 120,415 |  | 
|John P. Hopkins, Chief
 Financial Officer (4)                                    |  |      | 2006 |             | $ | 70,000     |  | $                      |  |                              |  | $          | 13,283 |  |  |  | $ | 3,000 |  |  |  | $ | 86,283  |  | 
|Phlip A. Timpanaro,
 Corporate Controller (4)                                    |  |      | 2006 |             | $ | 128,672    |  | $                      |  |                              |  | $          | 13,924 |  |  |  | $ | 0     |  |  |  | $ | 142,596 |  | 

(1) Represents the dollar
amount recognized for financial statement reporting purposes with respect to
the year ended December 31, 2006 for the fair value of the option granted to
the named executive officer. The fair value was estimated in accordance with
FASB 123R. For a more detailed discussion on the valuations made and
assumptions used to calculate the fair value of our options refer to Note 10 of
our Annual Report on Form 10-K for the year ended December 31, 2006.

(2) Irvin F. Witcosky was
the Companys President and Chief Operating Officer in prior years. Effective
August 8, 2006, Mr. Witcosky ceased being the Chief Operating Officer.
Effective March 23, 2007, Mr. Witcosky resigned as an officer and director of
the Company.

(3) Effective August 8, 2006, Mr. Reach assumed the position of
Chief Operating Officer. Effective March 23, 2007, Mr. Reach assumed the
additional position of President.

(4) Philip A. Timpanaro was
the Companys Chief Financial Officer. Effective August 8, 2006, Mr. Timpanaro
ceased being the Chief Financial Officer and became the Corporate Controller
and John P. Hopkins became the Chief Financial Officer. Effective April 13, 2007,
Mr. Timpanaro resigned from the Company.

Grants of Plan-Based Awards in 2006.

The following
table contains information related to the grant of stock options under our
existing stock option plans issued by us during 2006 to executive officers
named in the Summary Compensation Table with awards disclosed on a
grant-by-grant basis:

31

---



|                    |  |  |            |  |                                                               |           |                                             |  |                                              |  |  |  |         |         |        |  |         |      |   |  |   |         |  |  | 
|------------------- |  |  | ---------- |  | ------------------------------------------------------------- | --------- | ------------------------------------------- |  | -------------------------------------------- |  |  |  | ------- | ------- | ------ |  | ------- | ---- | - |  | - | ------- |  |  | 
|                    |  |  |            |  | Estimated
 Future payouts Under
 Equity Incentive Plan Awards |           | Exercise
 or
 Base Price of
 Option
 Awards |  | Grant Date
 Fair Value of
 Stock and
 Option | 
|                    |  |  |            |  |                                                               |           |                                            
|                    |  |  |            |  |                                                               |           |                                             | 
|                    |  |  | Grant Date |  |                                                               | Threshold |                                             |  | Target                                       |  |  |  | Maximum |         |        | 
|                    |  |  |            |  |                                                               |           |                                             |  |                                              |  |  |  |         |         |        |  |         |      |   |  |  
|Name                |  |  | (1)        |  |                                                               | (#)       |                                             |  | (#)                                          |  |  |  | (#)     |         | ($/Sh) |  | ($) (2) |     
|                    |  |  |            |  |                                                               |           |                                             |  |                                              |  |  |  |         |         |        |  |         |      |   |  |  
|James E.
 Henry     |  |  |           |  |                                                               |          |                                             |  |                                             |  |  |  |         |        |        |  |         |     |   |  |   |        | 
|Irvin F.
 Witcosky  |  |  |           |  |                                                               |          |                                             |  |                                             |  |  |  |         |        |        |  |         |     |   |  |   |        | 
|Brian Reach         |  |  | 8/8/2006   |  |                                                               |          |                                             |  |                                             |  |  |  |         | 50,000  | (3)    |  |         | 3.71 |   |  | $ | 53,131  | 
|John P.
 Hopkins    |  |  | 8/8/2006   |  |                                                               |          |                                             |  |                                             |  |  |  |         | 150,000 | (4)    |  |         | 3.71 |   |  | $ | 159,393 | 
|Phlip A.
 Timpanaro |  |  |           |  |                                                               |          |                                             |  |                                             |  |  |  |         |        |        |  |         |      |  |  |   |         |  |  | 

(1) Represents
grants under the Companys 2002 Stock Option Plan.

(2) Represents
the dollar amount recognized for financial statement reporting purposes with
respect to the year ended December 31, 2006 for the fair value of the option
granted to the named executive officer. The fair value was estimated in
accordance with FASB 123R. For a more detailed discussion on the valuations
made and assumptions used to calculate the fair value of our options refer to
Note 10 of our Annual Report on Form 10-K for the year ended December 31, 2006.

(3) Represents
grant of 50,000 incentive stock options which vests in five equal installments
of 10,000 on August 8, 2007, 2008, 2009, 2010, and 2011, respectively.

(4) Represents
grant of 150,000 incentive stock options which vests in five equal installments
of 30,000 on May 27, 2006, 2007, 2008, 2009, and 2011, respectively.

32

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Outstanding Equity Awards at December 31,
2006.

The following
table contains information concerning unexercised options held as of December
31, 2006 by the executive officers named in the Summary Compensation Table:

|                    |   |                                                            |     |        |                                                              |     |  |                                                                                                    |   |                            |      |                          |  |          |           | 
|------------------- | - | ---------------------------------------------------------- | --- | ------ | ------------------------------------------------------------ | --- |  | -------------------------------------------------------------------------------------------------- | - | -------------------------- | ---- | ------------------------ |  | -------- | --------- | 
|                    |   | Option
 Awards                                             |    
|                    |   |                                                            |    
|Name                |   | Number of
 Securities
 Underlying
 Options
 Exercisable(#) |     |        | Number of
 Securities
 Underlying
 Options
 Unexercisable(#) |     |  | Equity
 Incentive Plan
 Awards: Number of
 Securities Underlying
 Unexercised
 Unearned Options(#) |   | Option
 Exercise
 Price($) |      | Option
 Expiration
 Date | 
|                    |   |                                                            |     |        |                                                              |     |  |                                                                                                    |   |                            |      |                          | 
|James E. Henry      |   |                                                           |     |        |                                                             |     |  |                                                                                                    |  |                            |      |                         |  |          |          | 
|Irvin F. Witcosky   |   |                                                           |     |        |                                                             |     |  |                                                                                                    |  |                            |      |                         |  |          |          | 
|Brian Reach         |   | 100,000                                                    | (1) |        |                                                             |     |  |                                                                                                    |  |                            |      | 7.10                     |  |          | 5/31/2009 | 
|                    |  |                                                            |     | 50,000 | (2)                                                          |     |  |                                                                                                   |   |                            | 3.71 |                          |  | 8/8/2012 |          
|John P. Hopkins     |   |                                                           |     |        | 150,000                                                      | (3) |  |                                                                                                    |  |                            |      | 3.71                     |  |          | 8/8/2012  | 
|Philip A. Timpanaro |   | 5,000                                                      | (4) |        | 20,000                                                       | (4) |  |                                                                                                    |  |                            |      | 5.65                     |  |          | 5/27/2010 | 

(1) Represents grant of
100,000 incentive stock options which vests equally in 25 monthly installments
of 4,000, with the installment vesting on June 30, 2004.

(2) Represents grant of
50,000 incentive stock options which vests in five equal installments of 10,000
on August 8, 2007, 2008, 2009, 2010, and 2011, respectively.

(3) Represents grant of
150,000 incentive stock options which vests in five equal installments of
30,000 on May 27, 2006, 2007, 2008, 2009, and 2011, respectively.

(4) Represents grant of
25,000 incentive stock options which vests in five equal installments of 5,000
on August 8, 2006, 2007, 2008, 2009, and 2010, respectively.

COMPENSATION OF DIRECTORS

Directors who
are also our employees receive no additional compensation for attendance at
board meetings. Mr. Henry and Mr. Reach are the only members of the Board of
Directors who are also employees. The Companys non-employee directors receive
a quarterly fee of $1,250 and an annual stock option grant to purchase 2,000
shares of the Companys common stock at the closing share price on the day of
the grant and $1,000 for attendance at each Board or Committee meeting. For the
year ended December 31, 2006, all of our outside Directors, that is, Directors
who are not employees or full-time consultants of the Company, each received
compensation as follows:

33

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|                    |  |                                        |  |                         |     |            |  |        |  | 
|------------------- |  | -------------------------------------- |  | ----------------------- | --- | ---------- |  | ------ |  | 
|Name                |  | Fees Earned
 or
 Paid in Cash
 ($) (1) |  | Option
 Awards
 ($) (2) |     | Total
 ($) | 
|                    |  |                                        |  |                         |     |            | 
|Robert De
 Lia, Sr. |  | 10,000                                 |  |                         | 756 | (3)        |  | 10,756 |  | 
|James W.
 Power     |  | 6,750                                  |  |                         | 756 | (4)        |  | 7,506  |  | 
|Joseph P.
 Ritorto  |  | 8,000                                  |  |                         | 756 | (5)        |  | 8,756  |  | 
|David Sands         |  | 10,000                                 |  |                         | 756 | (6)        |  | 10,756 |  | 

(1) Outside
Directors each receive a cash retainer at a rate of $5,000 per annum. The
Company reimburses Directors for out-of-pocket expenses incurred travelling to
Board of Directors meetings.

(2) Represents
the dollar amount recognized for financial statement reporting purposes with
respect to the year ended December 31, 2006 for the fair value of the option
granted to the named executive officer. The fair value was estimated in
accordance with FASB 123R. For a more detailed discussion on the valuations
made and assumptions used to calculate the fair value of our options refer to
Note 10 of our Annual Report on Form 10-K for the year ended December 31, 2006.

(3) At
December 31, 2006, Mr. De Lia, Sr. held options to purchase 6,000 shares of
Common Stock.

(4) At December 31, 2006, Mr. Power held options to purchase
4,000 shares of Common Stock.

(5) At
December 31, 2006, Mr. Ritorto held options to purchase 11,000 shares of Common
Stock.

(6) At
December 31, 2006, Mr. Sands held options to purchase 4,000 shares of Common
Stock.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER
PARTICIPATION

The members of
the Compensation Committee in 2006 were Messrs. De Lia, Power and Ritorto. The
Board made all decisions concerning executive compensation during 2006. No executive
officer of the Corporation served as a member of the Board of Directors of
another entity during 2006. None of the members of the Compensation Committee
has ever been an officer or employee of Henry Bros. Electronics, Inc. or any of
its subsidiaries, and no compensation committee interlocks existed during
fiscal 2006.

COMPENSATION DISCUSSION AND ANALYSIS

Through the
following questions and answers we explain all material elements of our
executive compensation:

What are the
objectives of our executive compensation programs?

Our corporate
goal is to maximize our total return to our shareholders through share price
appreciation. Towards this goal, we seek to compensate our executives at levels
that are competitive

34

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with peer
companies so that we may attract, retain and motivate highly capable
executives. We also design our compensation programs to align our executives
interests with those of our shareholders.

Our 2006
executive compensation, including stock option grants awarded for and in 2006,
reflects our effort to realize these objectives.

What are the
principal components of our executive compensation programs?

Overview: Our
executive compensation programs consist of three principal components: (i) a
base salary; (ii) annual bonuses; and (iii) stock option grants. The Companys
policy for compensating our executive officers is intended to provide
significant annual long-term performance incentives. We describe each of these
principal components below.

Relationship of the principal components: We have allocated the three principal
components of our executive compensation programs in a manner that we believe
optimizes each executives contribution to us. We have not established specific
formulae for making the allocation.

Base Salary:We
do not have employment agreements with any of our executives. Base salaries for
executive officers are determined by evaluating a variety of factors, including
the experience of the individual, the competitive marketplace for managerial
talent, the Companys performance, the executives performance, and the
responsibilities of the executive. Although our Compensation Committee annually
reviews salaries of our executive officers, our Compensation Committee does not
automatically adjust base salaries if it concludes that adjustments to other
components of the executives compensation would be more appropriate.

Annual Bonus: Cash
bonus awards are based on a variety of factors, including the individual
performance of the executive and the Companys performance.

Long-Term Incentive Compensation (Stock
Options for Common Shares):
The Compensation Committee believes that stock-based
compensation arrangements are essential in aligning the interests of management
and the stockholders. The Companys 2002 and 2006 Stock Plan provides for the
issuance of stock options to its executive officers and other employees. Stock
options to purchase shares of the Companys common stock are issued at an
exercise price equal to the fair market value of such stock on the date
immediately preceding the date on which the stock option is granted. These
options typically vest over a three to five year period from the date of grant
and are granted to the Companys executive officers and other employees as a reward
for past individual and corporate performance and as an incentive for future
performance. The size of awards is determined by the Committee based on factors
such as the executives position, individual performance and the Companys
performance.

What do we seek to
reward and accomplish through our executive compensation programs?

We believe
that our compensation programs, collectively, enable us to attract, retain and
motivate high quality executives. We provide annual bonus awards primarily to
provide performance incentives to our key employees to meet corporate
performance objectives. Our corporate objectives are measured by sales
increases, operating margins, net income and other items of performance as
determined on an annual basis. We design long-term incentive awards primarily
to motivate and reward key employees over longer periods. Through vesting and
forfeiture provisions that we include in awards of stock options we provide an
additional incentive to executives to act in furtherance of our longer-term
interests. An executive whose employment with us terminates before

35

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equity-based
awards have vested, either because the executive has not performed in
accordance with our expectations or because the executive chooses to leave,
will generally forfeit the unvested portion of the award.

Why have we selected
each principal component of our executive compensation programs?

We have
selected programs that we believe are commonly used by public companies, both
within and outside of our industry, because we believe commonly used programs
are well understood by our shareholders, employees and analysts. Moreover, we
selected each program only after we first confirmed, with the assistance of
outside professional advisors, that the program comports with settled legal and
tax rules.

How do we determine
the amount of each principal component of compensation to our executives?

Our
Compensation Committee exercises judgment and discretion in setting
compensation for our senior executives. The Committee exercises its judgment
and discretion only after it has first evaluated the recommendations of our
Chief Executive Officer and evaluated our corporate performance.

What specific items
of corporate performance do we take into account in setting compensation
policies and making compensation decisions?

Our corporate
performance primarily impacts the annual bonuses and long-term incentive
compensation that we provide our executive officers. We use or weight items of
corporate performance differently in our annual bonus and long-term
compensation awards and some items are more determinative than others.

Goals for
executives in 2006 vary because the areas of responsibility of executives
differ. Goals are generally developed around metrics tied to our growth and
profitability, including increases in revenue and operating profit, decreases
in expenses, completion of developments in accordance with budgets and
timelines, execution of acquisitions in accordance with targets, enhanced
operational efficiencies and development of additional opportunities for our
long-term growth.

How do we determine
when awards are granted, including awards of equity-based compensation?

Historically,
our Compensation Committee has awarded annual bonuses in the quarter following
the year end. The Compensation Committee makes awards of stock options on an ad
hoc basis, but generally quarterly, following review of pertinent financial
information and industry data. In addition, the Compensation Committee conducts
a thorough review of stock option awards and grant procedures annually. The
date on which the Committee has met has varied from year to year, primarily
based on the schedules of Committee members and the timing of compilation of
data requested by the Committee.

Over the past
years our equity-based awards to executives have taken the form of stock
options. The number of stock options subject to an award has been computed by
taking into account the Companys performance, the particular executives
performance, our retention objectives, and other factors.

36

---



What factors do we
consider in decisions to increase or decrease compensation materially?

Historically,
we have generally not decreased the base salaries of our executive officers or
reduced their incentive compensation targets due to individual performance.
When an executives performance falls short of our expectations then we believe
our interests are best served by replacing the executive with an executive who
performs at the level we expect. The factors that we consider in decisions to
increase compensation include the individual performance of the executive,
responsibility of the executive and our corporate performance, as discussed
above.

To what extent does
our Compensation Committee consider compensation or amounts realizable from
prior compensation in setting other elements of compensation?

The primary
focus of our Compensation Committee in setting executive compensation is the
executives current level of compensation, including recent awards of long-term
incentives, taking into account the executives performance and our corporate
performance. The Committee has not adopted a formulaic approach for considering
amounts realized by an executive from prior equity-based awards.

How do accounting
considerations impact our compensation practices?

Accounting
consequences are not a material consideration in designing our compensation
practices. However, we design our equity awards so that its overall cost fell
within a budgeted dollar amount and so that the awards would qualify for classification
as equity awards under FAS 123R. Under FAS 123R the compensation cost
recognized for an award classified as an equity award is fixed for the
particular award and, absent modification, is not revised with subsequent
changes in market prices of our common shares or other assumptions used for
purposes of the valuation.

How do tax
considerations impact our compensation practices?

Prior to
implementation of a compensation program and awards under the program, we
evaluate the federal income tax consequences, both to us and to our executives,
of the program and awards. Before approving a program, our Compensation
Committee receives an explanation from our outside professionals as to the tax
treatment of the program and awards under the program and assurances from our
outside professionals that the tax treatment should be respected by taxing
authorities.

Section 162(m)
of the Internal Revenue Code limits our tax deduction each year for
compensation to each of our Chief Executive Officer and our four other highest
paid executive officers to $1 million unless, in general, the compensation is
paid under a plan that is performance-related, non-discretionary and has been
approved by our shareholders. Generally, Section 162(m) has not had a
significant impact on our compensation programs.

What are our equity
or other security ownership requirements for executives and our policies
regarding hedging the economic risk of share ownership?

We do not
maintain minimum share ownership requirements for our executives. We do not
have a policy
regarding hedging the economic risk of share ownership.

37

---



To what extent do we
benchmark total compensation and material elements of compensation and what are
the benchmarks that we use?

While the
Compensation Committee does not perform formal benchmarks, they do compare the
elements of total compensation to compensation provided by knowledge gained in
the industry.

Do we have a policy
regarding the recovery of awards or payments if corporate performance measures
upon which awards or payments are based are restated or adjusted in a manner
that would reduce the size of an award or payment?

For
non-executive officers, we have a policy that provides for a case-by-case
review to determine if a recovery of an award is necessary if a performance
measure used to calculate the award is subsequently adjusted in a manner that
would have reduced the size of the award. For executive officers, we have a
policy that requires a recovery of an award if a performance measure used to
calculate the award is subsequently adjusted in a manner that would have
reduced the size of the award.

What is the role of
our executive officers in the compensation process?

Our
Compensation Committee meets periodically with our Chief Executive Officer to
address executive compensation, including the rationale for our compensation
programs and the efficacy of the programs in achieving our compensation
objectives. The Compensation Committee also relies on executive management to
evaluate compensation programs to assure that they are designed and implemented
in compliance with laws and regulations, including SEC reporting requirements.
The Compensation Committee relies on the recommendations of our Chief Executive
Officer regarding the performance of individual executives. At meetings in 2006
the Compensation Committee received recommendations from our Chief Executive
Officer regarding salary adjustments and annual bonus and stock option awards
for our executive officers. Our Chief Executive Officer plays a significant
role in determining the annual cash compensation of our executive officers. The
Compensation Committee believes that it is important for it to receive the
input of the Chief Executive Officer on compensation matters since he is
knowledgeable about the activities of our executive officers and the
performance of their duties and responsibilities, as well as their
contributions to the growth of the Company and its business. The Compensation
Committee accepted these recommendations after concluding that the
recommendations comported with the Committees objectives and philosophy and
the Committees evaluation of our performance and industry data.

Compensation Committee Report

Our
Compensation Committee has reviewed and discussed the Compensation Discussion and
Analysis with our management and based on the review and discussion recommended
to the Board that the Compensation Discussion and Analysis be included in this
Annual Report on Form 10-K. The Board accepted the Compensation Committees
recommendation. This report is made by the undersigned members of the
Compensation Committee:

Robert L. De
Lia, Sr. (Chair)James W. Power
Joseph P. Ritorto

38

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Item 12. Security Ownership of Certain
Beneficial Owners and Management and Related Stockholder Matters

a) The following
table provides information with respect to the equity securities that are
authorized for issuance under our compensation plans as of December 31, 2006:

Equity Compensation Plan
Information - For the Year Ended December 31, 2006:

|                                                           |  |                                                                                                   |    |                                                                                     |  |                                                                                                                                                     |  |        
|---------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------- | -- | ----------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------
|Plan category                                              |  | Number of securities to
 be issued upon exercise
 of outstanding options,
 warrants and rights(a) |    | Weighted
 average
 exercise price of
 outstanding
 options, warrants
 and rights(b) |  | Number of securities
 remaining available for
 future issuance under
 equity compensation plans
 (excluding securities
 reflected in column (a))(c) | 
|                                                           |  |                                                                                                   |    |                                                                                     |  |                                                                                                                                                     | 
|Equity compensation plans approved by security holders     |  | 670,600                                                                                           | *  |                                                                                     |  | $ 5.17                                                                                                                                              |  | 282,909
|Equity compensation plans not approved by security holders |  | 199,662                                                                                           | ** |                                                                                     |  | $ 7.58                                                                                                                                              |  |       
|Total                                                      |  | 870,262                                                                                           |    |                                                                                     |  | $ 7.41                                                                                                                                              |  | 282,909

* This amount
includes options issuable pursuant to our 2002 and 2006 Stock Option Plans. The
plans authorizes the issuance of options to purchase up to 230,000 and 250,000
shares of our Common Stock to employees, directors, and consultants of the
Company under the 2002 and 2006 Stock Option Plans, respectively.

Also included
are options issuable pursuant to our Incentive Stock Option Plan. The Board of
Directors and our shareholders approved the adoption of the Incentive Stock
Option Plan on December 23, 1999. Our Incentive Stock Option Plan provides for
the granting of options to purchase a maximum of 500,000 shares of the
Companys common stock.

** This amount
includes a five year option (currently exercisable) granted to the Wall
Street Group (WSG) consisting of 5,996 shares granted November 5, 2002 with
an exercise price of $6.90 per share, issued in connection with an agreement to
provided certain services dated November 1, 2001 and terminated in April 2003. Also
included are warrants to purchase 138,333 and 55,333 shares at $7.60
expiring January 27, 2010, that were granted in connection with the issuance of
553,333 shares of our common stock to certain qualified institutional investors
and the placement agent, respectively, in July 2004.

b)
Security Ownership Of Certain Beneficial Owners And Management And Related
Stockholder Matters

The table that follows sets
forth, as of September 4, 2007 certain information regarding beneficial
ownership of our common stock by each person who is known by us to beneficially
own more than 5% of our common stock. The table also identifies the stock
ownership of each of our directors, each of our officers, and all directors and
officers as a group. Except as otherwise indicated, the stockholders listed in
the table have sole voting and investment powers with respect to the shares

39

---



indicated.
Unless otherwise indicated, the business address for each of the named
individuals is Henry Bros. Electronics, Inc., 17-01 Pollitt Drive, Fair Lawn,
New Jersey 07410.

Shares of
common stock which an individual or group has a right to acquire within 60 days
pursuant to the exercise or conversion of options, warrants or other similar
convertible or derivative securities are deemed to be outstanding for the
purpose of computing the percentage ownership of such individual or group, but
are not deemed to be outstanding for the purpose of computing the percentage
ownership of any other person shown in the table.

The
applicable percentage of ownership is based on 5,916,065 shares outstanding as
of September 4, 2007.

|                                                                                             |  |                                      |  |                                                 |  
|-------------------------------------------------------------------------------------------- |  | ------------------------------------ |  | ----------------------------------------------- | -
|Name address and title of beneficial owner                                                   |  | Number of
 shares
 beneficiallyowned |  | Percentage of
 Common
 Stock
 BeneficiallyOwned |  
|                                                                                             |  |                                      |  |                                                 |  
|James E. Henry, Chairman, Chief Executive Officer, Treasurer and
 Director                   |  | 1,400,000                            |  | 23.7                                            | %
|                                                                                             |  |                                      |  |                                                 |  
|Brian Reach, Vice-Chairman, President, Chief Operating
 Officer, Secretary, and Director (1) |  | 195,000                              |  | 3.3                                             | %
|                                                                                             |  |                                      |  |                                                 |  
|John P. Hopkins, Chief Financial Officer (2)                                                 |  | 30,000                               |  |                                                 | *
|                                                                                             |  |                                      |  |                                                 |  
|Brian J. Smith, Corporate Controller                                                         |  |                                     |  |                                                 | *
|                                                                                             |  |                                      |  |                                                 |  
|Robert De Lia, Sr., Director (3)                                                             |  | 44,000                               |  |                                                 | *
|                                                                                             |  |                                      |  |                                                 |  
|James W. Power, Director (4)                                                                 |  | 4,000                                |  |                                                 | *
|                                                                                             |  |                                      |  |                                                 |  
|Joseph P. Ritorto, Director (5)                                                              |  | 46,000                               |  |                                                 | *
|                                                                                             |  |                                      |  |                                                 |  
|David Sands, Director (6)                                                                    |  | 4,000                                |  |                                                 | *
|                                                                                             |  |                                      |  |                                                 |  
|All executive officers and directors as a group (8 persons)
(7)                              |  | 1,723,000                            |  | 29.1                                            | %
|                                                                                             |  |                                      |  |                                                 |  
|* Less than 1%                                                                               |  |                                      |  |                                                 |  

CERTAIN BENEFICIAL OWNERS

The following table gives
information about each additional shareholder known by us to be a beneficial
owner of more than 5 percent of common stock as of September 4, 2007, based on
information filed with the SEC:

|                        |  |           |  |         |  
|----------------------- |  | --------- |  | ------- | -
|                        |  | Amount of |  | Percent |  
|                        |  |           |  |         |  
|Irvin F. Witcosky (8)   |  | 1,361,800 |  | 23.0    | %
|                        |  |           |  |         |  
|Richard D. Rockwell (9) |  | 528,000   |  | 8.9     | %

---

(1) The amount
shown for Mr. Reach includes a currently exercisable option to purchase 100,000
shares of the Companys Common Stock at a price of $7.10 per share and a
currently exercisable option to purchase 10,000 shares of

40

---



the Companys
Common Stock at a price of $3.71 per share.

(2) The amount
shown for Mr. Hopkins includes a currently exercisable option to purchase
30,000 shares of the Companys Common Stock at a price of $3.71 per share.

(3) The amount
shown for Mr. De Lia, Sr. includes three currently exercisable options to
purchase 2,000 shares each of the Companys Common Stock at a price of $7.19,
$4.90 and $3.33 per share, respectively.

(4) The amount
shown for Mr. Power includes two currently exercisable options to purchase
2,000 shares each of the Companys Common Stock at a price of $6.08 and $3.33
per share, respectively.

(5) The amount
shown for Mr. Ritorto includes currently exercisable options to purchase 5,000
shares at $7.95 and 2,000 shares each of the Companys common stock at $7.19,
$4.90 and $3.33 per share, respectively.

(6) The amount
shown for Mr. Sands includes two currently exercisable options to purchase
2,000 shares each of the Companys Common Stock at a price of $4.90 and $3.33
per share, respectively.

(7) The amount
shown includes currently exercisable options to purchase 165,000 shares of the
Companys common stock.

(8) Mr.
Witcosky resigned as the Companys President and as a Director, effective March
23, 2007. The amount shown for Mr. Witcosky is pursuant to a Schedule 13D/A,
filed on April 5, 2007, by Mr. Witcosky. His current address is 419 E. Penn
St., Long Beach, NY 11561.

(9) The amount
shown for Mr. Rockwell is pursuant to a Schedule 13D/A, filed on March 1, 2007,
by Mr. Rockwell, an individual, reporting an address of 43 River Road, Nutley,
NJ 07110.

Item 13. Certain Relationships and Related
Transactions and Director Independence

a) In 2006,
the Company had revenues of $678,138 associated with an integrated security
systems project with First Aviation Services, Inc. (First Aviation). Joseph
P. Ritorto, a member of our Board of Directors since January 2002, is
co-founder of First Aviation.

b) The Company
considers Messrs. Ritorto, De Lia, Sands and Power to be independent directors
in accordance with Section 121A of the American Stock Exchanges listing
standards.

Item 14. Principal Accountant Fees and
Services

Fees Paid to Our Independent Auditors During
2006 and 2005

Audit Fees

The aggregate
fees billed by Demetrius & Company, L.L.C. for professional services
rendered for the audits of the Companys annual financial statements on Form
10-K in 2006 and the reviews of the financial statements on Form 10-Q for the
fiscal year ended December 31, 2006 were $89,587 and the audit of Form 10-KSB
in 2005 and the reviews of the financial statements on Form 10-QSB for the
fiscal year ended December 31, 2005 were $86,087.

Audit-Related Fees

The aggregate
fees billed for audit-related services by the principal accountant for the year
ended December 31, 2006 were approximately $2,200 and for the year ended
December 31, 2005 were $2,200. Audit related services include due diligence in
connection with acquisitions, consultation on accounting and internal control
matters, audits in connection with proposed or consummated acquisitions and
review of registration statements.

Tax Fees

The aggregate
fees billed for tax compliance, tax advice and tax planning rendered by our
independent auditors for the fiscal year ended December 31, 2006 was $22,500,
and for the year

41

---



ended December
31, 2005 was $21,000. The services comprising these fees include tax consulting
and submitting tax returns.

All Other Fees

The aggregate
fees billed for all other professional services rendered by the Companys
independent auditors for the year ended December 31, 2006 was $12,047 and for
the year ended December 31, 2005 was $375. These fees related to a 401(k) plan
audit in 2006 and work performed on consents on Form S-8 Registrations in 2005.

Pre-Approval of Audit and Permissible Non-Audit Services

The Audit
Committee approved 100% of the fees paid to the principal accountant for
audit-related, tax and other fees. The Audit Committee pre-approves all
non-audit services to be performed by the auditor. The percentage of hours
expended on the principal accountants engagement to audit the Companys
financial statements for the most recent year that were attributed to work
performed by persons other than the principal accountants full-time, permanent
employees was 0%.

Part IV

Item 15. Exhibits, Financial Statement
Schedules

(a) The
following consolidated financial statements and schedules are filed at the end
of this report, beginning on page F-l. Other schedules are omitted because they
are not required or are not applicable or the required information is shown in
the consolidated financial statements or notes thereto.

(b) See
Exhibit Index following this Annual Report on Form 10-K.

|                                                                                                      |             |      
|----------------------------------------------------------------------------------------------------- | ----------- | -----
|DOCUMENT                                                                                              |             | PAGES
|                                                                                                      |             |      
|                                                                                                      |            
|Report of Independent Registered Public Accounting Firm                                               | F-1        
|                                                                                                      |            
|Consolidated Balance
 Sheets as of December 31, 2006 and 2005                                         | F-2        
|                                                                                                      |            
|Consolidated Statements of
 Operations for the Years Ended December 31, 2006, 2005 and 2004           | F-3        
|                                                                                                      |            
|Consolidated Statements of
 Shareholders Equity for the Years Ended December 31, 2006, 2005 and 2004 | F-4        
|                                                                                                      |            
|Consolidated Statements of
 Cash Flows for the Years Ended December 31, 2006, 2005 and
 2004          | F-5        
|                                                                                                      |            
|Notes to Consolidated
 Financial Statements                                                           | F-6 to F-34
|                                                                                                      |            
|Schedule II -Valuation and
 Qualifying Accounts, for the Years Ended December 31, 2006,
 2005 and     | S-1        

42

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SIGNATURES

Pursuant
to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of
1934 as amended, the Registrant had duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

|      |                  |  |                                  |                                                            | 
|----- | ---------------- |  | -------------------------------- | ---------------------------------------------------------- | 
|Date: | October 17, 2007 |  | HENRY BROTHER ELECTRONICS,
 INC.
|      |                  |  |                                  |                                                           
|      |                  |  |                                  | By: /s/ James E. Henry                                    
|      |                  |  |                                  |                                                            | 
|      |                  |  |                                  | James E. Henry                                            
|      |                  |  |                                  | Chairman, Chief Executive
 Officer, Treasurer and Director

Pursuant to the requirements
of the Securities Exchange Act of 1934 as amended, this report has been signed
below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.

Each person, in so signing
also makes, constitutes, and appoints James E. Henry and Brian Reach, and each
of them acting alone, as his true and lawful attorneys-in-fact, with full power
of substitution, in his name, place, and stead, to execute and cause to be
filed with the SEC any or all amendments to this report.

|      |                  |  |                         |                                                            | 
|----- | ---------------- |  | ----------------------- | ---------------------------------------------------------- | 
|      |                  |  |                         | SIGNATURE                                                 
|      |                  |  |                         |                                                           
|Date: | October 17, 2007 |  | /s/ James E. Henry     
|      |                  |  |                         |                                                            | 
|      |                  |  |                         | James E. Henry                                            
|      |                  |  |                         | Chairman, Chief Executive
 Officer, Treasurer and Director
|      |                  |  |                         |                                                           
|Date: | October 17, 2007 |  | /s/ Brian Reach        
|      |                  |  |                         |                                                            | 
|      |                  |  |                         | Brian Reach                                               
|      |                  |  |                         | Vice Chairman, President,
 Chief Operating Officer,       
|      |                  |  |                         | Secretary and Director                                    
|      |                  |  |                         |                                                           
|Date: | October 17, 2007 |  | /s/ John P. Hopkins    
|      |                  |  |                         |                                                            | 
|      |                  |  |                         | John P. Hopkins                                           
|      |                  |  |                         | Chief Financial Officer                                   
|      |                  |  |                         |                                                           
|Date: | October 17, 2007 |  | /s/ Joseph P. Ritorto  
|      |                  |  |                         |                                                            | 
|      |                  |  |                         | Joseph P. Ritorto                                         
|      |                  |  |                         | Director                                                  
|      |                  |  |                         |                                                           
|Date: | October 17, 2007 |  | /s/ Robert L. DeLia Sr.
|      |                  |  |                         |                                                           
|      |                  |  |                         | Robert L. DeLia Sr.                                       
|      |                  |  |                         | Director                                                  
|      |                  |  |                         |                                                           
|Date: | October 17, 2007 |  | /s/ David Sands        
|      |                  |  |                         |                                                            | 
|      |                  |  |                         | David Sands                                               
|      |                  |  |                         | Director                                                  
|      |                  |  |                         |                                                           
|Date: | October 17, 2007 |  | /s/ James W. Power     
|      |                  |  |                         |                                                            | 
|      |                  |  |                         | James W. Power                                            
|      |                  |  |                         | Director                                                  

---



REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM

To the Board
of Directors and 
Stockholders of Henry Bros. Electronics, Inc. and Subsidiaries

We have
audited the accompanying consolidated balance sheets of Henry Bros.
Electronics, Inc. and Subsidiaries as of December 31, 2006 and 2005, and the related consolidated
statements of operations, changes in stockholders equity and cash flows for
each of the three years in the period ended December 31, 2006. These
consolidated financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted
our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

As discussed
in Note 1 to the consolidated financial statements, the Company adopted the
provisions of Staff Accounting Bulletin No. 108, Considering the Effects of
Prior Year Misstatements when Quantifying Misstatements in Current Year
Financial Statements, as of January 1, 2006.

In our
opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Henry Bros.
Electronics, Inc. and Subsidiaries as of December 31, 2006 and 2005, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2006, in conformity with U.S. generally accepted
accounting principles.

As discussed
in Notes 1 and 18, the Company has corrected the consolidated balance sheet as
of December 31, 2005 and the related consolidated statements of operations,
changes is stockholders equity and cash flows for the years ended December 31,
2005 and 2004.

/s/ Demetrius
& Company, L.L.C.

Wayne, New
Jersey 
October 17, 2007

The accompanying notes are an integral part
of these statements.

F-1

---



HENRY BROS. ELECTRONICS,
INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS

|                                                                                                                                   |  |               |            |                 |   |            |  
|---------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ---------- | --------------- | - | ---------- | -
|                                                                                                                                   |  | December
 31, |           
|                                                                                                                                   |  | 2006          |            | 2005(Corrected) |  
|                                                                                                                                   |  |               |            |                 |  
|ASSETS                                                                                                                             |  |               |            |                 |   |            |  
|CURRENT ASSETS                                                                                                                     |  |               |            |                 |   |            |  
|Cash and cash equivalents                                                                                                          |  | $             | 199,853    |                 | $ | 2,177,686  |  
|Accounts receivable-net of allowance for doubtful
accounts                                                                         |  |               | 13,628,358 |                 |   | 9,934,954  |  
|Inventory                                                                                                                          |  |               | 1,707,933  |                 |   | 1,227,871  |  
|Costs in excess of billings and estimated
profits                                                                                  |  |               | 4,643,469  |                 |   | 3,110,798  |  
|Deferred tax asset                                                                                                                 |  |               | 1,155,620  |                 |   | 726,274    |  
|Retainage receivable                                                                                                               |  |               | 1,390,468  |                 |   | 1,210,014  |  
|Prepaid expenses and income tax receivable                                                                                         |  |               | 454,801    |                 |   | 250,187    |  
|Other assets                                                                                                                       |  |               | 290,079    |                 |   | 327,536    |  
|                                                                                                                                   |  |               |            |                 |   |            |  
|Total current assets                                                                                                               |  |               | 23,470,581 |                 |   | 18,965,320 |  
|                                                                                                                                   |  |               |            |                 |   |            |  
|Property and equipment - net of accumulated depreciation                                                                           |  |               | 2,402,394  |                 |   | 1,123,561  |  
|Goodwill                                                                                                                           |  |               | 3,316,530  |                 |   | 3,453,606  |  
|Intangible assets - net of accumulated amortization                                                                                |  |               | 1,436,414  |                 |   | 1,328,509  |  
|Deferred tax asset                                                                                                                 |  |               | 594,545    |                 |   | 221,887    |  
|Other assets                                                                                                                       |  |               | 151,145    |                 |   | 68,647     |  
|                                                                                                                                   |  |               |            |                 |   |            |  
|TOTAL ASSETS                                                                                                                       |  | $             | 31,371,609 |                 | $ | 25,161,530 |  
|                                                                                                                                   |  |               |            |                 |   |            |  
|LIABILITIES
 & STOCKHOLDERS EQUITY                                                                                                |  |               |            |                 |   |            |  
|CURRENT LIABILITIES                                                                                                                |  |               |            |                 |   |            |  
|Accounts payable                                                                                                                   |  | $             | 5,973,047  |                 | $ | 3,538,392  |  
|Accrued expenses                                                                                                                   |  |               | 4,786,203  |                 |   | 2,229,797  |  
|Accrued taxes                                                                                                                      |  |               | 58,914     |                 |   | 205,365    |  
|Billings in excess of costs and estimated
profits                                                                                  |  |               | 1,167,259  |                 |   | 1,176,813  |  
|Deferred income                                                                                                                    |  |               | 476,775    |                 |   | 570,489    |  
|Current portion of long-term debt                                                                                                  |  |               | 505,028    |                 |   | 296,666    |  
|Deferred tax liability                                                                                                             |  |               | 249,365    |                 |   |           |  
|Other current liabilities                                                                                                          |  |               | 252,881    |                 |   |           |  
|                                                                                                                                   |  |               |            |                 |   |            |  
|Total current liabilities                                                                                                          |  |               | 13,469,472 |                 |   | 8,017,522  |  
|                                                                                                                                   |  |               |            |                 |   |            |  
|Long-term debt, less current portion                                                                                               |  |               | 3,463,236  |                 |   | 727,961    |  
|Deferred tax liability                                                                                                             |  |               | 428,283    |                 |   | 433,081    |  
|                                                                                                                                   |  |               |            |                 |   |            |  
|TOTAL LIABILITIES                                                                                                                  |  |               | 17,360,991 |                 |   | 9,178,564  |  
|                                                                                                                                   |  |               |            |                 |   |            |  
|STOCKHOLDERS EQUITY                                                                                                               |  |               |            |                 |   |            |  
|Preferred stock, $.01 par value; 10,000,000 shares
authorized; no
 shares issued                                                   |  |               |           |                 |   |           |  
|Common stock, $.01 par value; 10,000,000 shares
authorized; 5,916,065
 shares issued and outstanding in 2006 and 5,889,399 in 2005 |  |               | 59,161     |                 |   | 58,894     |  
|Additional paid in capital                                                                                                         |  |               | 17,284,205 |                 |   | 16,956,008 |  
|Deferred compensation                                                                                                              |  |               | (383,552   | )               |   | (342,878   | )
|Accumulated deficit                                                                                                                |  |               | (2,949,196 | )               |   | (689,058   | )
|                                                                                                                                   |  |               |            |                 |   |            |  
|TOTAL EQUITY                                                                                                                       |  |               | 14,010,618 |                 |   | 15,982,966 |  
|                                                                                                                                   |  |               |            |                 |   |            |  
|TOTAL LIABILITIES & STOCKHOLDERS
EQUITY                                                                                           |  | $             | 31,371,609 |                 | $ | 25,161,530 |  
|                                                                                                                                   |  |               |            |                 |   |            |  

The accompanying notes are an integral part
of these statements.

F-2

---



HENRY BROS. ELECTRONICS,
INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS

|                                               |  |                                   |            |                 |   |                 |   |   |            |  
|---------------------------------------------- |  | --------------------------------- | ---------- | --------------- | - | --------------- | - | - | ---------- | -
|                                               |  | For the
 years ended December 31, |           
|                                               |  |                                  
|                                               |  | 2006                              |            | 2005(Corrected) |   | 2004(Corrected) |  
|                                               |  |                                   |            |                 |   |                 |  
|Revenue                                        |  | $                                 | 42,132,852 |                 | $ | 42,156,188      |   | $ | 29,725,718 |  
|Cost of revenue                                |  |                                   | 31,586,736 |                 |   | 31,581,187      |   |   | 22,305,632 |  
|                                               |  |                                   |            |                 |   |                 |   |   |            |  
|Gross profit                                   |  |                                   | 10,546,116 |                 |   | 10,575,001      |   |   | 7,420,086  |  
|                                               |  |                                   |            |                 |   |                 |   |   |            |  
|                                               |  |                                   |            |                 |   |                 |   |   |            |  
|Operating expenses:                            |  |                                   |            |                 |   |                 |   |   |            |  
|Selling, general & administrative expenses     |  |                                   | 11,952,477 |                 |   | 8,422,193       |   |   | 6,943,885  |  
|Goodwill & intangible asset impairment charges |  |                                   | 1,191,000  |                 |   | 44,999          |   |   | 77,000     |  
|                                               |  |                                   |            |                 |   |                 |   |   |            |  
|Operating (loss) profit                        |  |                                   | (2,597,361 | )               |   | 2,107,809       |   |   | 399,201    |  
|                                               |  |                                   |            |                 |   |                 |   |   |            |  
|                                               |  |                                   |            |                 |   |                 |   |   |            |  
|Interest income                                |  |                                   | 19,515     |                 |   | 12,507          |   |   | 12,624     |  
|Other expense                                  |  |                                   | (674       | )               |   | (3,780          | ) |   |           |  
|Interest expense                               |  |                                   | (103,923   | )               |   | (84,985         | ) |   | (94,039    | )
|                                               |  |                                   |            |                 |   |                 |   |   |            |  
|(Loss) income before tax expense               |  |                                   | (2,682,443 | )               |   | 2,031,551       |   |   | 317,786    |  
|                                               |  |                                   |            |                 |   |                 |   |   |            |  
|Tax expense (benefit)                          |  |                                   | (422,305   | )               |   | 893,577         |   |   | 148,147    |  
|                                               |  |                                   |            |                 |   |                 |   |   |            |  
|Net (loss) income after taxes                  |  | $                                 | (2,260,138 | )               | $ | 1,137,974       |   | $ | 169,639    |  
|                                               |  |                                   |            |                 |   |                 |   |   |            |  
|                                               |  |                                   |            |                 |   |                 |   |   |            |  
|BASIC (LOSS) EARNINGS PER COMMON SHARE:        |  |                                   |            |                 |   |                 |   |   |            |  
|Basic (loss) profit per common share           |  | $                                 | (0.39      | )               | $ | 0.20            |   | $ | 0.03       |  
|                                               |  |                                   |            |                 |   |                 |   |   |            |  
|Weighted average common shares                 |  |                                   | 5,749,964  |                 |   | 5,739,398       |   |   | 5,411,964  |  
|                                               |  |                                   |            |                 |   |                 |   |   |            |  
|                                               |  |                                   |            |                 |   |                 |   |   |            |  
|DILUTED (LOSS) EARNINGS PER COMMON SHARE:      |  |                                   |            |                 |   |                 |   |   |            |  
|Diluted (loss) profit per common share:        |  | $                                 | (0.39      | )               | $ | 0.20            |   | $ | 0.03       |  
|                                               |  |                                   |            |                 |   |                 |   |   |            |  
|Weighted average diluted common shares         |  |                                   | 5,749,964  |                 |   | 5,773,097       |   |   | 5,411,964  |  
|                                               |  |                                   |            |                 |   |                 |   |   |            |  

The accompanying notes are an integral part
of these statements.

F-3

---



HENRY BROS. ELECTRONCS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY

|                                                                                    |  |                                                     |                |        |                              |        |                           |                    |   |   |          |   |       |            |   |   |          |   |   |            |   |   |            |  
|----------------------------------------------------------------------------------- |  | --------------------------------------------------- | -------------- | ------ | ---------------------------- | ------ | ------------------------- | ------------------ | - | - | -------- | - | ----- | ---------- | - | - | -------- | - | - | ---------- | - | - | ---------- | -
|                                                                                    |  | Common Stock
 par value $.01
 10,000,000 Authorized |                |        |                              |        |                           |                    |   |   |          |   |      
|                                                                                    |  |                                                     |                |        |                              |        |                           |                    |   |   |          |  
|                                                                                    |  |                                                     | Treasury Stock |        | Additional
 Paid-in
 Capital |        | Deferred
 Comp-
 ensation |                    |   |   |          |  
|                                                                                    |  |                                                     |                |        |                              |        |                           | Retained
 Earnings |   |   |         
|                                                                                    |  | Shares                                              |                | Amount |                              | Shares |                           | Amount             |   |   |          |   | Total |           
|                                                                                    |  |                                                     |                |        |                              |        |                           |                    |   |   |          |   |       |            |   |   |         
|Balance at December 31, 2003 (Corrected)                                            |  | 5,201,431                                           |                | $      | 52,015                       |        |                           | 70,891             |   | $ | (500,000 | ) | $     | 13,512,939 |   |   |         |   | $ | (1,996,671 | ) | $ | 11,068,283 |  
|Shares issued in connection with the acquisition of Airorlite
 Communications, Inc. |  | 37,000                                              |                |        | 370                          |        |                           |                    |   |   |          |   |       | 266,030    |   |   |          |   |   |            |   |   | 266,400    |  
|Shares issued in July 2004 net of expenses                                          |  | 553,333                                             |                |        | 5,533                        |        |                           |                    |   |   |          |   |       | 2,952,524  |   |   |          |   |   |            |   |   | 2,958,057  |  
|Employee stock options exercised                                                    |  | 18,525                                              |                |        | 185                          |        |                           |                    |   |   |          |   |       | 123,108    |   |   |          |   |   |            |   |   | 123,293    |  
|Value of stock option grants                                                        |  |                                                     |                |        |                              |        |                           |                    |   |   |          |   |       | 247,056    |   |   | (247,056 | ) |   |            |   |   |           |  
|Amortization of value assigned to stock option grants                               |  |                                                     |                |        |                              |        |                           |                    |   |   |          |   |       |            |   |   | 68,114   |   |   |            |   |   | 68,114     |  
|Treasury shares cancelled                                                           |  | (70,891                                             | )              |        | (709                         | )      |                           | (70,891            | ) |   | 500,000  |   |       | (499,291   | ) |   |          |   |   |            |   |   |           |  
|Net income for 2004 (Corrected)                                                     |  |                                                     |                |        |                              |        |                           |                    |   |   |          |   |       |            |   |   |          |   |   | 169,639    |   |   | 169,639    |  
|                                                                                    |  |                                                     |                |        |                              |        |                           |                    |   |   |          |   |       |            |   |   |          |   |   |            |   |   |            |  
|Balance at December 31, 2004 (Corrected)                                            |  | 5,739,398                                           |                |        | 57,394                       |        |                           |                   |   |   |         |   |       | 16,602,366 |   |   | (178,942 | ) |   | (1,827,032 | ) |   | 14,653,786 |  
|                                                                                    |  |                                                     |                |        |                              |        |                           |                    |   |   |          |   |       |            |   |   |          |   |   |            |   |   |            |  
|Value of stock option grants                                                        |  |                                                     |                |        |                              |        |                           |                    |   |   |          |   |       | 355,142    |   |   | (355,142 | ) |   |            |   |   |           |  
|Amortization of value assigned to stock option grants                               |  |                                                     |                |        |                              |        |                           |                    |   |   |          |   |       |            |   |   | 191,206  |   |   |            |   |   | 191,206    |  
|Shares issued in connection with the acquisition of Securus,
Inc.                   |  | 150,001                                             |                |        | 1,500                        |        |                           |                    |   |   |          |   |       | (1,500     | ) |   |          |   |   |            |   |   |           |  
|Net income for 2005 (Corrected)                                                     |  |                                                     |                |        |                              |        |                           |                    |   |   |          |   |       |            |   |   |          |   |   | 1,137,974  |   |   | 1,137,974  |  
|                                                                                    |  |                                                     |                |        |                              |        |                           |                    |   |   |          |   |       |            |   |   |          |   |   |            |   |   |            |  
|Balance at December 31, 2005 (Corrected)                                            |  | 5,889,399                                           |                |        | 58,894                       |        |                           |                   |   |   |         |   |       | 16,956,008 |   |   | (342,878 | ) |   | (689,058   | ) |   | 15,982,966 |  
|Employee stock options exercised                                                    |  | 6,666                                               |                |        | 67                           |        |                           |                    |   |   |          |   |       | 30,930     |   |   |          |   |   |            |   |   | 30,997     |  
|Value of stock option grants                                                        |  |                                                     |                |        |                              |        |                           |                    |   |   |          |   |       | 230,267    |   |   | (230,267 | ) |   |            |   |   |           |  
|Shares issued in connection with the acquisition of CIS Security
 Systems           |  | 20,000                                              |                |        | 200                          |        |                           |                    |   |   |          |   |       | 67,000     |   |   |          |   |   |            |   |   | 67,200     |  
|Amortization of value assigned to stock option grants                               |  |                                                     |                |        |                              |        |                           |                    |   |   |          |   |       |            |   |   | 189,593  |   |   |            |   |   | 189,593    |  
|Net loss December 31, 2006                                                          |  |                                                     |                |        |                              |        |                           |                    |   |   |          |   |       |            |   |   |          |   |   | (2,260,138 | ) |   | (2,260,138 | )
|                                                                                    |  |                                                     |                |        |                              |        |                           |                    |   |   |          |   |       |            |   |   |          |   |   |            |   |   |            |  
|Balance at December 31, 2006                                                        |  | 5,916,065                                           |                | $      | 59,161                       |        |                           |                   |   |   |         |   | $     | 17,284,205 |   | $ | (383,552 | ) | $ | (2,949,196 | ) | $ | 14,010,618 |  
|                                                                                    |  |                                                     |                |        |                              |        |                           |                    |   |   |          |   |       |            |   |   |          |   |   |            |   |   |            |  

The accompanying notes are an integral part
of these statements.

F-4

---



HENRY BROS. ELECTRONICS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                                   |  | For the years
          ended December 31,
|------------------------------------------------------------------ |  | ------------------------------------------
|                                                                   |  | 2006                                      
|                                                                   |  |                                           
|                                                                   |  |                                           
|Cash flows from operating
        activities:                      |  |                                           
|Net
        (loss) income                                          |  | $                                         
|Adjustments
        to reconcile net (loss) income from operations |  |                                           
|to
        net cash provided by (used in) operating activities:    |  |                                           
|Depreciation
        and amortization                              |  |                                           
|Bad
        debt expense                                           |  |                                           
|Provision
        for obsolete inventory                           |  |                                           
|Impairment
        charges                                         |  |                                           
|Stock
        option expense                                       |  |                                           
|Deferred
        income taxes                                      |  |                                           
|Changes
        in operating assets and liabilities:               |  |                                           
|Accounts
        receivable                                        |  |                                           
|Inventories                                                        |  |                                           
|Costs
        in excess of billings and estimated profits          |  |                                           
|Retainage
        receivable                                       |  |                                           
|Other
        assets                                               |  |                                           
|Prepaid
        expenses and income tax receivable                 |  |                                           
|Accounts
        payable                                           |  |                                           
|Accrued
        expenses                                           |  |                                           
|Billings
        in excess of cost and estimated profits           |  |                                           
|Deferred
        income                                            |  |                                           
|Other
        liabilities                                          |  |                                           
|                                                                   |  |                                           
|Net
        cash provided by (used in) operating activities        |  |                                           
|                                                                   |  |                                           
|Cash flows from investing
        activities:                      |  |                                           
|Purchase
        of businesses, net of cash acquired               |  |                                           
|Purchase
        of property and equipment                         |  |                                           
|                                                                   |  |                                           
|Net cash used in investing
        activities                      |  |                                           
|                                                                   |  |                                           
|Cash flows from financing
        activities:                      |  |                                           
|Proceeds
        from issuance of common stock - net of fees       |  |                                           
|Net
        proceeds and (payments) from revolving bank lines      |  |                                           
|Proceeds
        from bank loans                                   |  |                                           
|Payments
        of bank loans                                     |  |                                           
|Net
        repayments of other debt                               |  |                                           
|Capitalized
        lease payments                                 |  |                                           
|Payment
        of loan payable to owner of acquired company       |  |                                           
|                                                                   |  |                                           
|Net
        Cash provided by (used in) financing activities        |  |                                           
|                                                                   |  |                                           
|Increase
        (decrease) in cash and cash equivalents           |  |                                           
|Cash
        and cash equivalents - beginning of period            |  |                                           
|                                                                   |  |                                           
|Cash
        and cash equivalents - end of period                  |  | $                                         
|                                                                   |  |                                           
|Supplemental disclosure of
        cash flow information:          |  |                                           
|Amount paid for the period
        for:                            |  |                                           
|Interest                                                           |  | $                                         
|Taxes                                                              |  | $                                         
|Non-cash investing and financing
        activities:               |  |                                           
|Equipment
        financed                                         |  | $                                         
|Issuance
        of stock to acquire businesses                    |  | $                                         
|Value
        of stock options issued to employees                 |  | $                                         

The accompanying notes are an integral part
of these statements.

F-5

---



HENRY BROS. ELECTRONICS, INC. AND SUBSIDIARIESNotes to the Consolidated Financial Statements

NATURE OF OPERATIONS

Henry Bros.
Electronics, Inc., (the Company) and its subsidiaries, are divided into two
business segments  Security System Integration (Integration) and Specialty
Products and Services (Specialty). The Integration segment provides cradle
to grave services for a wide variety of security, communications and control
systems. The Company specializes in turn-key systems that integrate many
different technologies. Systems are customized to meet the specific needs of
its customers. Through the Specialty Products and Services segment we provide
emergency preparedness programs, mobile digital recording solutions and
specialized radio frequency communication equipment and integration. Each of
the Companys segments markets nationwide with an emphasis in the Arizona,
California, Colorado, Maryland, New Jersey, New York, Texas and Virginia
metropolitan areas. Customers are primarily medium and large businesses and
governmental agencies. The Company derives a majority of its revenues from
project installations and to a smaller extent, maintenance service revenue.

The table
below shows revenue percentage by geographic location for each of the years
ended December 31:

|                             |  |      |   |      |     |      |  |     |   | 
|---------------------------- |  | ---- | - | ---- | --- | ---- |  | --- | - | 
|                             |  | 2006 |   | 2005 |     | 2004 | 
|                             |  |      |   |      |     |      | 
|New
 Jersey/New York         |  | 44   | % |      | 53  | %    |  | 35  | % | 
|California                   |  | 27   | % |      | 23  | %    |  | 33  | % | 
|Texas                        |  | 3    | % |      | 8   | %    |  | 13  | % | 
|Arizona                      |  | 7    | % |      | 6   | %    |  | 7   | % | 
|Colorado
 (1)                |  | 11   | % |      | 2   | %    |  |    |   | 
|CIS
 - Virginia/Maryland (2) |  | 4    | % |      |    |      |  |    |   | 
|                             |  |      |   |      |     |      |  |     |   | 
|Integration segment          |  | 96   | % |      | 92  | %    |  | 88  | % | 
|Specialty segment            |  | 7    | % |      | 9   | %    |  | 13  | % | 
|Inter-segment                |  | -3   | % |      | -1  | %    |  | -1  | % | 
|                             |  |      |   |      |     |      |  |     |   | 
|Total revenue                |  | 100  | % |      | 100 | %    |  | 100 | % | 
|                             |  |      |   |      |     |      |  |     |   | 

(1)
Acquired October 10, 2005
(2) Acquired October 2, 2006

F-6

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

|   |                                           
|-- | ------------------------------------------
|1. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a)Principles
of Consolidation

The
consolidated financial statements include the accounts of the Company and its
subsidiaries. Acquisitions are recorded as of the purchase date, and are included in the consolidated financial statements from the date of acquisition. All material intercompany transactions have been eliminated in
consolidation.

(b)
Reclassifications

The
presentation of certain prior year information has been reclassified to conform
to the current year presentation. The Retainage Receivable has been broken out
separately on the balance sheets. In 2005, this amount was included in Other
Assets.

(c) Revenue
Recognition

Revenue from a
project in either the Integration or Specialty segments are recognized on the
percentage of completion method, whereby revenue and the related gross profit
are determined based upon the actual costs incurred to date for the project to
the total estimated project costs at completion. Project costs generally
include all material and shipping costs, the Companys direct labor,
subcontractor costs and an allocation of indirect costs related to the direct
labor. Changes in the project scope, site conditions, staff performance and
delays or problems with the equipment used on the project can result in increased
costs that may not be billable or accepted by the customer and results in a
loss or lower profit from what was originally anticipated at the time of the
proposal.

Estimates for
the costs to complete the project are periodically updated by management during
the performance of the project. Provision for changes in estimated costs and
losses, if any, on uncompleted projects are made in the period in which such
losses are determined. In general, we determine
a project to be substantially completed after:

| |    |                                                                                                      
| | -- | -----------------------------------------------------------------------------------------------------
| | 1. | The scope of work is
 completed which includes installing the equipment as required in the
 contract.
| |    |                                                                                                      
| | 2. | System is functional and
 has been tested.                                                           
| |    |                                                                                                      
| | 3. | Training has been
 provided.                                                                         

The majority
of the Companys projects are completed within a year. Revenue from product
sales are recognized when title and risk of loss passes to the customer.

Service
contracts, which are generally separate and distinct agreements from project
agreements, are billed either monthly or quarterly on the last day of the month
covered by the contract. Accordingly, revenues from service contracts are
recognized ratably over the length of the

F-7

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

agreement. In 2006,
2005 and 2004, the Company did not bundle any significant service contracts
with our systems installation work.

The
Diversified Security Solutions, Inc. division provides emergency planning
services to commercial real estate owners and managers. In general, project
labor is the predominant cost associated with the completion of these projects. The Company utilizes labor as the output
measure in order to recognize revenue and believes this to be an accurate
matching of costs and revenue.

(d) Use of Estimates

The
preparation of financial statements, in conformity with generally accepted
accounting principles in the United States, requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities, at the
date of the financial statements and the reported amount of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.

Revenue and
costs relating to security integration systems projects and service agreements
are particularly affected by managements estimates. The contract sale price
and estimated costs are based upon the facts and circumstances known at the
time of the proposal. Estimates for the costs to complete the contract are
periodically updated during the performance of the contract. Unpredictable
events can occur during the performance of the contract that can increase the
costs and reduce the estimated gross profit. Change orders to record additional
costs may not be approved or can become subject to long negotiations with the
customer and can result in concessions by the Company. Considerable judgments
are made during the performance of the contract that affects the Companys
revenue recognition and cost accruals that may have a significant impact on the
results of operations reported by the Company.

(e) Cash Equivalents

The Company
considers highly liquid instruments with original maturity of three months or
less to be cash equivalents.

(f)
Trade Receivables

Trade
receivables are stated at net realizable value. This value includes an
appropriate allowance for estimated uncollectible accounts. The allowance is
evaluated on a regular basis by management and is based upon historical
experience with the customer, the aging of the past due amounts and the
relationship with and economic status of our customers. The evaluation is based
upon estimates taking into account the facts and circumstances at the time of
the evaluation. Actual uncollectible accounts could exceed the Companys
estimates and changes to its estimates will be accounted for in the period of
change. Account balances are charged against the allowance after all means of
collection have been exhausted and the potential for recovery is considered remote.
Our trade receivables are not collateralized.

F-8

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

(g) Inventories

Inventories
are stated at the lower of cost or market value. Cost has been determined using
the first-in, first-out method. Inventory quantities on-hand are regularly
reviewed, and where necessary, reserves for excess and obsolete inventories are
recorded.

(h) Property and
Equipment

Property and
equipment are recorded at cost, net of accumulated depreciation. Depreciation
is computed on a straight-line basis over estimated useful lives of five to
seven years. Leasehold improvements are amortized over the shorter of related
lease term or the estimated useful lives. Upon retirement or sale, the costs of
the assets disposed of and the related accumulated depreciation are removed
from the accounts and any resulting gain or loss is included in the
determination of income. Repairs and maintenance costs are expensed as
incurred. Annually, the Company routinely reviews its property and equipment
for impairment, and accordingly, will write-down those assets to their
estimated fair value. There was no impaired property and equipment in 2006 and 2005.

(i) Intangible
Assets

The Companys
intangible assets include goodwill and other intangibles that consist of the
fair value of acquired customer lists, service contracts acquired, trade names,
and covenants not to compete. Goodwill represents the excess of purchase price
over fair value of net assets acquired at the date of acquisition.

Effective
January 1, 2002, the company adopted the provisions of Statement of Financial
and Accounting Standards (SFAS) 142 Goodwill and Other Intangible Assets. In
accordance with that statement, goodwill and intangible assets with indefinite
lives are not amortized, but are tested at least annually for impairment. Prior
to January 1, 2002, the company had not recorded goodwill or other intangible
assets of indefinite lives. Intangible assets with estimable useful lives,
consisting primarily of acquired customer lists, service contracts and
covenants not to compete, are amortized on a straight-line basis over their
estimated useful lives of three to fifteen years and are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset or asset group may not be recoverable. If the
intangible assets remaining useful life is changed, the intangible asset will
be amortized over the remaining useful life. If the asset being amortized is
determined to have an indefinite useful life, the asset will be tested for
impairment. The impairment test will consist of measuring its fair value with
its carrying amount. If the carrying amount of the intangible assets exceeds
its fair value, an impairment loss is recognized for an amount equal to the
excess and the adjusted carrying amount is recognized as its new accounting
basis. The company recorded an impairment charge of approximately $0, $45,000
and $77,000 for the write down of customer lists and service contract rights
for the years ended December 31, 2006, 2005 and 2004, respectively.

F-9

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

(j)
Goodwill

The Companys
goodwill impairment test is based on a two part procedure consistent with the
requirements of SFAS 142. The first test consists of determining the fair value
of the reporting unit and comparing it to the carrying value of the reporting
unit. If the carrying value of the reporting unit exceeds the fair value of the
reporting unit, a second test is performed. In step two, the implied fair value
of the goodwill (which is the excess of the fair value of the reporting unit
over the fair value of the net assets) is compared to the carrying value of the
goodwill. An impairment loss is recognized for any excess value of goodwill
over the implied value. The Company determines the reporting unit by analyzing
geographic region, as management evaluates the Companys performance in this
manner. We identified five separate and distinct operating units for the
testing requirements of SFAS 142. In 2005 and 2004, no charges to operations
resulted from managements goodwill impairment evaluation. However, based upon
our 2006 evaluation, the Company took a charge to operations of $1.2
million (or $.21 per diluted share) associated with goodwill impairment
associated with our California banking vertical market.

(k) Concentrations
of Credit Risk

Financial
instruments that potentially subject the Company to concentrations of credit
risk consist primarily of cash, cash equivalents and accounts receivable. At
various times, the Company had cash balances at certain financial institutions
in excess of federally insured limits. However, the Company does not believe
that it is subject to unusual credit risk beyond the normal credit risk
associated with commercial banking relationships.

Credit risk is
generally diversified due to the large number of customers that make up the
Companys customer base and their geographic dispersion resulting from three
acquisitions in 2002. The Company performs an ongoing credit evaluation of its
customers. In 2006 billings to one customer represented 9.7% of the Companys
consolidated revenue or 10.1% of revenue from the Integration segment. Revenues
from local government agencies were 22.6%, 39% and 20% of total revenue for the
years ended December 31, 2006, 2005 and 2004, respectively.

There are a
few vendors from whom we obtain devices and software for specific access
control, imaging, remote transmission, smart key and mobile applications. The
loss of any one of these companies as suppliers could have a materially adverse
impact on our business, financial condition and results of operations if we are
unable to develop or acquire new technologies from other sources. We believe
there are alternative vendors to source such products.

Timely vendor
deliveries of equipment meeting our quality control standards from all
suppliers are also important to our business because each installed system
requires the integration of a variety of elements to be fully functional. The
failure to deliver any component when required, in operating condition, can
delay the project, triggering contract penalties, delay in progress payments
and may result in cancellation of the project.

F-10

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

(l)
Income Taxes

Deferred taxes
are provided on the asset and liability method whereby assets and liabilities
are recognized for taxable temporary differences. Temporary differences are the
differences between the amounts reported for financial statement purposes and
corresponding amounts for tax purposes. Deferred tax assets are reduced by a
valuation allowance when, in the opinion of management, it is more likely than
not that some portion or all of the deferred tax assets will not be realized.
Deferred tax assets and liabilities are adjusted for the effects of changes in
tax laws and rates on the date of enactment.

(m)
Fair Value of Financial Instruments

The carrying
amounts of the Companys financial instruments, which include cash equivalents,
accounts receivable, accounts payable, accrued expenses, short and long-term
debt, approximate their fair values as of December 31, 2006.

(n) Advertising Costs

The Company
expenses advertising cost when the advertisement occurs. Total advertising
expenses amounted to approximately $67,542, $40,346 and $44,466 for the years
ended December 31, 2006, 2005 and 2004, respectively.

(o) Stock Based
Compensation

In December 2004, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 123(R) (FAS-123(R)), Share-Based
Payment,which is a revision of Statement of Financial Accounting
Standards No. 123 (FAS-123), Accounting for
Stock-Based Compensation.

FAS-123(R)
eliminates accounting for share-based compensation transactions using the
intrinsic value method prescribed in Accounting Principles Board Opinion No. 25
(APB-25), Accounting for Stock Issued to
Employees,and requires instead that such transactions be accounted
for using a fair-value-based method. The Company has elected to adopt the
provisions of FAS-123(R) effective January 1, 2006, under the modified
prospective transition method, in which compensation cost was recognized
beginning with the effective date (a) based on the requirements of FAS-123R for
all share-based payments granted after the effective date and (b) based on the
requirements of FAS-123R for all awards granted to employees prior to the
effective date of FAS-123R that remain unvested on the effective date.

As permitted
under FAS-123, the Company elected to follow Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued
to Employees, and related interpretations in accounting for
stock-based awards to employees through December 31, 2005. Accordingly,
compensation cost for stock options and nonvested stock grants was measured as
the excess, if any, of the market price of the Companys common stock at the
date of grant over the exercise price.

F-11

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIESNotes to the Consolidated Financial
Statements (continued)

With the
adoption of FAS-123(R), the Company elected to amortize stock-based
compensation for awards granted on or after the adoption of FAS-123R on January
1, 2006, on a straight-line basis over the requisite service (vesting) period
for the entire award. For awards granted prior to January 1, 2006, compensation
costs are amortized in a manner consistent with Financial Accounting Standards
Board Interpretation No. 28 (FIN-28), Accounting
for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.
This is the same manner applied in the pro forma disclosures under FAS-123.
Accordingly, the fair value of all options granted on and after January 1, 2003
is to be charged against income over the vesting period. The company charged
$189,593, $191,106 and $68,114 to operations for the years ended December 31,
2006, 2005 and 2004, respectively, for the fair value of those options granted
subsequent to January 1, 2003. Those issued prior to adoption are accounted for
under the intrinsic value method in accordance with APB No. 25. The Company
adopted the perspective method as permitted by SFAS No. 148 on January 1, 2003.

(p) Warranty

The Company
offers warranties on all products, including parts and labor that ranges from
one to three years, depending upon the product. For products made by others,
the Company passes along the manufacturers warranty to the end user. The
Company charges operations with warranty expenses as incurred. For the years
ended December 31, 2006, 2005 and 2004, warranty expense was approximately
$34,490, $49,231 and $152,500, respectively.

(q) Net (Loss)
Income Per Share

The
computation of basic (loss) earnings per share is based upon the weighted
average number of shares of common stock outstanding during the period. The
computation of diluted (loss) earnings per share includes the dilutive effects
of common stock equivalents of options and warrants. Potentially dilutive
securities are not included in earnings per share for the year ended December
31, 2006 as their inclusion would be antidilutive.

The following securities
were not included in the computation of diluted net earnings per share as their
effect would have been anti-dilutive:

|                                                                                   |  |               |         |      |  |      | 
|---------------------------------------------------------------------------------- |  | ------------- | ------- | ---- |  | ---- | 
|                                                                                   |  | December
 31, |        
|                                                                                   |  |               |        
|                                                                                   |  | 2006          |         | 2005 |  | 2004 | 
|                                                                                   |  |               |         |      |  |      | 
|Options to purchase common
 stock                                                  |  |               | 1,149   |      |  |     | 
|Shares issued in
 connection with the acquisition of Securus Inc., held in
 escrow |  |               | 150,001 |      |  |     | 

F-12

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIESNotes to the Consolidated Financial
Statements (continued)

(r) Segment
Information

FASB issued
Statement of Financial Accounting Standards No. 131, Disclosure about Segments of an Enterprise and Related
Information (Statement 131), that establish standards for the
reporting by public business enterprises of financial and descriptive
information about reportable operating segments in annual financial statements
and interim financial reports issued to shareholders. The Company has
identified two operating segments in which it operates; Security Systems
Integration (Integration) and Specialty Products and services (Specialty).
The Integration segment provides design, installation and support services for
a wide variety of security, communications and control systems. The Company
specializes in turn-key systems that integrate many different technologies.
Systems are customized to meet the specific needs of its customers. The
Specialty Products and Services segment (Specialty) includes the Companys
digital mobile recording business, its emergency preparedness planning programs
business, and its wireless business specializes in designing, manufacturing and
maintaining wireless communications equipment used to enhance and extend
emergency radio frequency services and cellular communication for both fixed
and mobile applications.

Each of the
Companys segments market nationwide with an emphasis in the Arizona,
California, Colorado, Maryland, New Jersey, New York, Texas and Virginia
metropolitan areas. Customers are primarily medium and large businesses and
governmental agencies. The Company derives a majority of its revenues from
project installations and to a smaller extent, maintenance service revenue.

(s) Recently Adopted
Accounting Pronouncements

In May 2005,
the FASB issued SFAS No. 154, Accounting
Changes and Error Corrections. This new standard replaces APB
Opinion No. 20, Accounting Changes,
and SFAS No. 3, Reporting Accounting Changes
in Interim Financial Statements, and represents another step in the
FASBs goal to converge its standards with those issued by the IASB. Among
other changes, SFAS No. 154 requires that a voluntary change in accounting
principle be applied retrospectively with all prior period financial statements
presented on the new accounting principle, unless it is impracticable to do so.
SFAS No. 154 also provides that (1) a change in method of depreciating or
amortizing a long-lived non-financial asset be accounted for as a change in
estimate (prospectively) that was effected by a change in accounting principle,
and (2) correction of errors in previously issued financial statements should
be termed a restatement. The new standard is effective for accounting changes
and correction of errors made in fiscal years beginning after December 15,
2005. Early adoption of this standard is permitted for accounting changes and
correction of errors made in fiscal years beginning after June 1, 2005. The
adoption of SFAS No. 154 did not have a material effect on the Companys
financial position or results of operations. On September 13, 2006, the
Securities Exchange Commission (SEC) staff issued Staff Accounting Bulletin
(SAB) Topic No. 108, Financial Statements  Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements (SAB 108). SAB 108 addresses how a registrant should evaluate
whether an error

F-13

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

in its
financial statements is material. The SEC staff concludes in SAB 108 that
materiality should be evaluated using both the rollover and iron curtain
methods. Registrants are required to comply with the guidance in SAB 108 in
financial statements for fiscal years ending after November 15, 2006. After
analyzing the materiality of the impact arising from these deficiencies in
accordance with the provisions of SAB 108 (See Notes 6, 9, 18 and 19),
management concluded that the financial statements for the years ended December
31, 2005 and 2004, included as part of this Annual Report on Form 10-K, and the
Selected Financial Data, included as Item 6 of this Annual Report on Form 10-K,
should be corrected to reflect the proper accounting related to income taxes.
The impact resulting from these corrections for income tax accounting that had
an income statement impact was to increase (decrease) tax expense by$(29,696),
$(125,618), $111,080, and $99,776, for the years ended December 31, 2005, 2004,
2003 and 2002, respectively, with a corresponding increase or decrease to net
tax liabilities. The impact resulting from these corrections for income tax
accounting that only had a balance sheet impact was to increase net deferred tax
liabilities by $549,262, $580,032, $533,648, and $533,648 for the years ended
December 31, 2005, 2004, 2003 and 2002, respectively, with a corresponding net
increase to goodwill. Unadjusted differences were not material to 2006 or
individually to the prior years.

(t) Recently Issued
Accounting Pronouncements

In September
2006, the FASB issued No. 157, Fair Value
Measurements. This new standard provides guidance for using fair
value to measure assets and liabilities. The FASB believes the standard also 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.
Statement 157 applies whenever other standards require (or permit) assets or
liabilities to be measured at fair value but does not expand the use of fair
value in any new circumstances.

Under
Statement 157, 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. In this
standard, the FASB 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, Statement 157 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.

The provisions
of Statement 157 are effective for financial statements issued for fiscal years
beginning after November 15, 2007, and interim periods within those fiscal
years. Earlier application is encouraged, provided that the reporting entity
has not yet issued financial statements for that fiscal year, including any
financial statements for an interim period within that fiscal year. The Company
is currently quantifying the impact of SFAS No. 157.

F-14

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

On July 13,
2006, Financial Accounting Standards Board Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes
- An
Interpretation of FASB Statement No. 109, was issued. FIN 48
clarifies the accounting for uncertainty in income tax recognized in an
enterprises financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes (SFAS No.
109). FIN 48 also prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in
a tax return. The new FASB standard also provides guidance on de-recognition,
classification, interest and penalties, accounting in interim periods,
disclosure, and transition.

The evaluation
of a tax position in accordance with FIN 48 is a two-step process. The first
step is a recognition process whereby the enterprise determines whether it is
more likely than not that a tax position will be sustained upon examination,
including resolution of any related appeals or litigation processes, based on
the technical merits of the position. In evaluating whether a tax position has
met the more-likely-than-not recognition threshold, the enterprise should presume
that the position will be examined by the appropriate taxing authority that has
full knowledge of all relevant information. The second step is a measurement
process whereby a tax position that meets the more-likely-than-not recognition
threshold is calculated to determine the amount of benefit to recognize in the
financial statements. The tax position is measured at the largest amount of
benefit that is greater than 50% likely of being realized upon ultimate
settlement. The provisions of FIN 48 are effective for fiscal years beginning
after December 15, 2006. Earlier application is permitted as long as the
enterprise has not yet issued financial statements, including interim financial
statements, in the period of adoption. The provisions of FIN 48 are to be
applied to all tax positions upon initial adoption of this standard. Only tax
positions that meet the more-likely-than-not recognition threshold at the
effective date may be recognized or continue to be recognized upon adoption of
FIN 48. The cumulative effect of applying the provisions of FIN 48 should be
reported as an adjustment to the opening balance of retained earnings of the
year adopted (or other appropriate components of equity or net assets in the
statement of financial position) for that fiscal year. The Company is currently
quantifying the impact of FIN 48.

In February
2007, FASB issued FAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities Including an Amendment of FASB Statement No. 115 (FAS
159). FAS 159 permits entities to choose to measure many financial instruments
and certain other items at fair value. FAS 159 is effective for fiscal years
beginning after November 15, 2007. The Company is currently evaluating the
impact of adopting FAS 159 on its financial statements.

The FASB is
currently working on amendments to the existing accounting standards governing
asset transfers and fair value measurements in business combinations and
impairment tests, among other issues. Upon completion of these standards, the
Company will need to reevaluate its accounting and disclosures. Due to the
ongoing deliberations of the standard setters, the Company is unable to
accurately determine the effect of future amendments or proposals at this time.

F-15

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

|   |                    
|-- | -------------------
|2. | ACCOUNTS RECEIVABLE

Accounts
receivable consisted of the following:

|                                           |  |               |            |      |   |            | 
|------------------------------------------ |  | ------------- | ---------- | ---- | - | ---------- | 
|                                           |  | December
 31, |           
|                                           |  |               |           
|                                           |  | 2006          |            | 2005 |  
|                                           |  |               |            |      |  
|                                          
|Completed
 contracts, including retentions |  | $             | 7,002,134  |      | $ | 3,189,288  | 
|Contracts in
 progess:                     |  |               |            |      |   |            | 
|Current                                    |  |               | 7,150,234  |      |   | 6,894,444  | 
|Retentions                                 |  |               | 459,781    |      |   | 662,611    | 
|                                           |  |               |            |      |   |            | 
|                                          
|                                           |  |               | 14,612,149 |      |   | 10,746,343 | 
|Less:
 Allowance for doubtful accounts     |  |               | 983,791    |      |   | 811,389    | 
|                                           |  |               |            |      |   |            | 
|                                           |  | $             | 13,628,358 |      | $ | 9,934,954  | 
|                                           |  |               |            |      |   |            | 

At December 31, 2006
and 2005, one customer represented 9.7% and 12.5% of the net accounts
receivable, respectively.

F-16

---



HENRY BROS. ELECTRONICS, INC. AND SUBSIDIARIES
  Notes to the Consolidated Financial Statements (continued)

|   |                                            
|-- | -------------------------------------------
|3. | COSTS AND BILLINGS ON UNCOMPLETED CONTRACTS

Costs and billing on uncompleted contracts consisted of the following:

|                                       |  |               |            |      |   |            | 
|-------------------------------------- |  | ------------- | ---------- | ---- | - | ---------- | 
|                                       |  | December
 31, |           
|                                       |  |               |           
|                                       |  | 2006          |            | 2005 |  
|                                       |  |               |            |      |  
|                                      
|Cost incurred on uncompleted contracts |  | $             | 38,769,725 |      | $ | 32,014,993 | 
|Billings on uncompleted contracts      |  |               | 35,293,515 |      |   | 30,081,008 | 
|                                       |  |               |            |      |   |            | 
|                                       |  | $             | 3,476,210  |      | $ | 1,933,985  | 
|                                       |  |               |            |      |   |            | 

Included in accompanying
Balance Sheets under the following captions:

|                                                  |  |               |           |      |   |           | 
|------------------------------------------------- |  | ------------- | --------- | ---- | - | --------- | 
|                                                  |  | December
 31, |          
|                                                  |  |               |          
|                                                  |  | 2006          |           | 2005 |  
|                                                  |  |               |           |      |  
|                                                 
|Costs in excess of billings and estimated profits |  | $             | 4,643,469 |      | $ | 3,110,798 | 
|Billing in excess of costs and estimated profits  |  |               | 1,167,259 |      |   | 1,176,813 | 
|                                                  |  |               |           |      |   |           | 
|                                                  |  | $             | 3,476,210 |      | $ | 1,933,985 | 
|                                                  |  |               |           |      |   |           | 

Backlog

At December 31, 2006, the dollar amount of backlog believed to
    be firm was $27,802,404. Backlog from acquisitions completed during fiscal
    2005 that were not included as part of the December 31, 2005 backlog accounted
    for $680,065 of this backlog. At December 31, 2005, our backlog was $16,002,144.
    At June 30, 2007, the dollar amount of backlog believed to be firm was approximately
    $32,300,000.

F-17

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

|   |            
|-- | -----------
|4. | INVENTORIES

Inventories
consisted of the following:

|                           |  |              |           |      |   |           | 
|-------------------------- |  | ------------ | --------- | ---- | - | --------- | 
|                           |  | December 31, |          
|                           |  |              |          
|                           |  | 2006         |           | 2005 |  
|                           |  |              |           |      |  
|                           |  |              |           |      |  
|Component
 parts           |  | $            | 434,282   |      | $ | 144,028   | 
|Finished
 goods            |  |              | 1,689,190 |      |   | 1,115,382 | 
|                           |  |              |           |      |   |           | 
|                           |  |              | 2,123,472 |      |   | 1,259,410 | 
|Less:
 Valuation allowance |  |              | 415,539   |      |   | 31,539    | 
|                           |  |              |           |      |   |           | 
|Net
 inventory             |  | $            | 1,707,933 |      | $ | 1,227,871 | 
|                           |  |              |           |      |   |           | 

|   |                       
|-- | ----------------------
|5. | PROPERTY AND EQUIPMENT

Property and
equipment consisted of the following:

|                                |  |              |            |      |   |            |  
|------------------------------- |  | ------------ | ---------- | ---- | - | ---------- | -
|                                |  | December 31, |           
|                                |  |              |           
|                                |  | 2006         |            | 2005 |  
|                                |  |              |            |      |  
|                                |  |              |            |      |  
|Office
 equipment               |  | $            | 432,519    |      | $ | 250,768    |  
|Demo and
 testing equipment     |  |              | 133,448    |      |   | 104,501    |  
|Automotive
 equipment           |  |              | 1,582,834  |      |   | 1,394,477  |  
|Computer
 equipment             |  |              | 1,239,364  |      |   | 960,134    |  
|Machinery
 and equipment        |  |              | 372,565    |      |   | 182,082    |  
|Leasehold
 improvements         |  |              | 500,325    |      |   | 56,171     |  
|                                |  |              |            |      |   |            |  
|                                |  |              |            |      |   |            |  
|                                |  |              | 4,261,055  |      |   | 2,948,133  |  
|                                |  |              |            |      |   |            |  
|Less:
 Accumulated depreciation |  |              | (1,858,661 | )    |   | (1,824,572 | )
|                                |  |              |            |      |   |            |  
|                                |  |              |            |      |   |            |  
|                                |  | $            | 2,402,394  |      | $ | 1,123,561  |  
|                                |  |              |            |      |   |            |  

Depreciation
Expense was $515,972, $488,899 and $340,268 for the years ended December 31,
2006, 2005 and 2004, respectively.

F-18

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

Equipment
under capital leases included in Property and Equipment are as follows:

|                                |  |              |         |      |   |         | 
|------------------------------- |  | ------------ | ------- | ---- | - | ------- | 
|                                |  | December 31, |        
|                                |  |              |        
|                                |  | 2006         |         | 2005 |  
|                                |  |              |         |      |  
|                                |  |              |         |      |   |         | 
|Automotive
 equipment           |  | $            | 511,992 |      | $ | 309,128 | 
|Less:
 Accumulated depreciation |  |              | 137,475 |      |   | 99,306  | 
|                                |  |              |         |      |   |         | 
|                                |  | $            | 374,517 |      | $ | 209,822 | 
|                                |  |              |         |      |   |         | 

|   |         
|-- | --------
|6. | GOODWILL

Goodwill
consisted of the following:

|                                        |  |              |           |                 |   |           | 
|--------------------------------------- |  | ------------ | --------- | --------------- | - | --------- | 
|                                        |  | December 31, |          
|                                        |  |              |          
|                                        |  | 2006         |           | 2005(Corrected) |  
|                                        |  |              |           |                 |  
|                                        |  |              |           |                 |   |           | 
|National
 Safe of California, Inc.      |  | $            | 483,753   |                 | $ | 1,674,753 | 
|Photo Scan
 Systems, Inc.               |  |              | 472,475   |                 |   | 472,475   | 
|Henry Bros.
 Electronics, LLC (Arizona) |  |              | 317,114   |                 |   | 317,114   | 
|Airolite
 Communications, Inc.          |  |              | 250,034   |                 |   | 250,034   | 
|Securus,
 Inc.                          |  |              | 971,210   |                 |   | 739,230   | 
|CIS Security
 Systems Corp.             |  |              | 783,650   |                 |   |          | 
|Southwest Securityscan, Inc.            |  |              | 38,294    |                 |   |          | 
|                                        |  |              |           |                 |   |           | 
|                                        |  | $            | 3,316,530 |                 | $ | 3,453,606 | 
|                                        |  |              |           |                 |   |           | 

Based upon the
Companys 2006 goodwill evaluation under the requirements of FAS 142, the
Company took a charge to operations of $1.2 million (or $.21 per diluted share)
associated with goodwill impairment associated with our California banking
vertical market (National Safe of California).

In addition,
there were certain adjustments made to goodwill resulting from a correction of
accounting for deferred income taxes related to prior year stock acquisitions.
See Notes 1, 9 and 18. The net effect was to increase overall goodwill by
$549,262 for the years ended December 31, 2006 and 2005, with a corresponding
increase to net deferred tax liabilities to correct for the effect on prior
years acquisitions. There was no income statement impact resulting from this
adjustment.

F-19

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

|   |                  
|-- | -----------------
|7. | INTANGIBLE ASSETS

Intangible
assets consist of the following:

|                                |  |                          |          |                 |   |                           |   |             |          |                                 |   |             |   |                    |           |   |   |         |  |   |           |  
|------------------------------- |  | ------------------------ | -------- | --------------- | - | ------------------------- | - | ----------- | -------- | ------------------------------- | - | ----------- | - | ------------------ | --------- | - | - | ------- |  | - | --------- | -
|                                |  | Amortizable
 Intangibles |          |                 |   |                           |  
|                                |  |                          |          |                 |   |                           |  
|                                |  | Acquired
 Customer
 List |          | Service
 Rights |   | Covenant
 Not to
 Compete |   | Trade
 Name |          | Total
 Amortizable
 Intangibles |   | Trade
 Name |   | Total
 Intangibles |          
|                                |  |                          |          |                 |   |                           |   |             |          |                                 |   |             |   |                    |          
|Gross carrying value:           |  |                          |          |                 |   |                           |   |             |          |                                 |   |             |   |                    |           |   |   |         |  |   |           |  
|                                |  |                          |          |                 |   |                           |   |             |          |                                 |   |             |   |                    |           |   |   |         |  |   |           |  
|December 31, 2004               |  | $                        | 426,248  |                 | $ | 473,208                   |   | $           | 287,773  |                                 | $ |            |   | $                  | 1,187,229 |   | $ | 315,114 |  | $ | 1,502,343 |  
|Additions (deletions)           |  |                          | 260,000  |                 |   |                          |   |             |         |                                 |   | 80,000      |   |                    | 340,000   |   |   |        |  |   | 340,000   |  
|Impairment charge               |  |                          | (17,742  | )               |   | (36,559                   | ) |             |         |                                 |   |            |   |                    | (54,301   | ) |   |        |  |   | (54,301   | )
|                                |  |                          |          |                 |   |                           |   |             |          |                                 |   |             |   |                    |           |   |   |         |  |   |           |  
|December 31, 2005               |  | $                        | 668,506  |                 | $ | 436,649                   |   | $           | 287,773  |                                 | $ | 80,000      |   | $                  | 1,472,928 |   | $ | 315,114 |  | $ | 1,788,042 |  
|                                |  |                          |          |                 |   |                           |   |             |          |                                 |   |             |   |                    |           |   |   |         |  |   |           |  
|Additions (deletions)           |  |                          | 291,492  |                 |   |                          |   |             |         |                                 |   |            |   |                    | 291,492   |   |   |        |  |   | 291,492   |  
|Impairment charge               |  |                          |         |                 |   |                          |   |             |         |                                 |   |            |   |                    |          |   |   |        |  |   |          |  
|                                |  |                          |          |                 |   |                           |   |             |          |                                 |   |             |   |                    |           |   |   |         |  |   |           |  
|December 31, 2006               |  |                          | 959,998  |                 |   | 436,649                   |   |             | 287,773  |                                 |   | 80,000      |   |                    | 1,764,420 |   |   | 315,114 |  |   | 2,079,534 |  
|                                |  |                          |          |                 |   |                           |   |             |          |                                 |   |             |   |                    |           |   |   |         |  |   |           |  
|                                |  |                          |          |                 |   |                           |   |             |          |                                 |   |             |   |                    |           |   |   |         |  |   |           |  
|Accumulated amortization:       |  |                          |          |                 |   |                           |   |             |          |                                 |   |             |   |                    |           |   |   |         |  |   |           |  
|December 31, 2004               |  |                          | (71,040  | )               |   | (100,527                  | ) |             | (138,924 | )                               |   |            |   |                    | (310,491  | ) |   |        |  |   | (310,491  | )
|2005 Amortization               |  |                          | (38,879  | )               |   | (54,829                   | ) |             | (60,636  | )                               |   | (4,000      | ) |                    | (158,344  | ) |   |        |  |   | (158,344  | )
|Impairment charge               |  |                          | 4,651    |                 |   | 4,651                     |   |             |          |                                 |   |             |   |                    | 9,302     |   |   |        |  |   | 9,302     |  
|                                |  |                          |          |                 |   |                           |   |             |          |                                 |   |             |   |                    |           |   |   |         |  |   |           |  
|December 31, 2005               |  |                          | (105,268 | )               |   | (150,705                  | ) |             | (199,560 | )                               |   | (4,000      | ) |                    | (459,533  | ) |   |        |  |   | (459,533  | )
|                                |  |                          |          |                 |   |                           |   |             |          |                                 |   |             |   |                    |           |   |   |         |  |   |           |  
|2006 Amortization               |  |                          | (67,583  | )               |   | (37,759                   | ) |             | (62,245  | )                               |   | (16,000     | ) |                    | (183,587  | ) |   |        |  |   | (183,587  | )
|Impairment charge               |  |                          |         |                 |   |                          |   |             |         |                                 |   |            |   |                    |          |   |   |        |  |   |          |  
|                                |  |                          |          |                 |   |                           |   |             |          |                                 |   |             |   |                    |           |   |   |         |  |   |           |  
|December 31, 2006               |  |                          | (172,851 | )               |   | (188,464                  | ) |             | (261,805 | )                               |   | (20,000     | ) |                    | (643,120  | ) |   |        |  |   | (643,120  | )
|                                |  |                          |          |                 |   |                           |   |             |          |                                 |   |             |   |                    |           |   |   |         |  |   |           |  
|Net Carrying Value              |  | $                        | 787,147  |                 | $ | 248,185                   |   | $           | 25,968   |                                 | $ | 60,000      |   | $                  | 1,121,300 |   | $ | 315,114 |  | $ | 1,436,414 |  
|                                |  |                          |          |                 |   |                           |   |             |          |                                 |   |             |   |                    |           |   |   |         |  |   |           |  
|                                |  |                          |          |                 |   |                           |   |             |          |                                 |   |             |   |                    |           |   |   |         |  |   |           |  
|Weighted average life in
 years |  |                          | 11       |                 |   | 6                         |   |             | 3        |                                 |   | 5           |   |                    | 6         |   |   |         |  |   |           |  

Amortization expense was
$183,587, $158,344 and $150,588 for the years ended December 31, 2006, 2005 and
2004, respectively.

Future amortization expense
for the next five years is as follows:

|            |  |   |         | 
|----------- |  | - | ------- | 
|December 31 |  |   |         | 
|            |  |   |         | 
|            |  |   |         | 
|2007        |  | $ | 175,884 | 
|2008        |  |   | 149,916 | 
|2009        |  |   | 149,916 | 
|2010        |  |   | 149,916 | 
|2011        |  |   | 133,916 | 

F-20

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

|   |               
|-- | --------------
|8. | LONG-TERM DEBT

On June 30,
2005, the Company entered into a loan agreement (the Loan Agreement) with TD
Banknorth, N.A. (TD Banknorth, formerly known as Hudson United Bank) pursuant to which TD Banknorth
extended a $4 million two-year credit facility (the Revolving Loan), to the
Company and refinanced $1 million of existing indebtedness to TD Banknorth into
a five year term loan (the Term Loan).

Advances under
the Revolving Loan may be used to finance working capital and acquisitions.
Interest is paid monthly in arrears at TD Banknorths prime rate (8.25% at
December 31, 2006) through May 1, 2008, when all amounts outstanding under the
Revolving loan is due. The Revolving Loan was originally due May 1, 2007;
however, in December 2006 TD Banknorth provided the Company a one year
extension.

The Term Loan
provides for the payment of sixty equal monthly installments of principal and
interest in the amount of $19,729.65 commencing July 30, 2005 and continuing
thru June 30, 2010. Interest under the Term Loan is 6.75%.

The Company is required to maintain
certain financial and reporting covenants and is restricted from paying dividends
    under the terms of the Loan Agreement. The Company was not in compliance
    with certain of these bank covenants at December 31, 2006. TD Banknorth provided
    the Company with a waiver associated with the bank covenants in default on
    October 11, 2007. As a condition of the waiver, the Company agreed to grant
TD Banknorth a first security interest on its accounts receivable.

F-21

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

Long-term debt
included of the following balances:

|                                                                                                    |  |              |           |      |   |           |  
|--------------------------------------------------------------------------------------------------- |  | ------------ | --------- | ---- | - | --------- | -
|                                                                                                    |  | December 31, |          
|                                                                                                    |  |              |          
|                                                                                                    |  | 2006         |           | 2005 |  
|                                                                                                    |  |              |           |      |  
|Term loan at 6.75% interest payable in
 monthly installments of $19,730 thru June 30, 2010          |  | $            | 531,122   |      | $ | 724,829   |  
|                                                                                                    |  |              |           |      |   |           |  
|Revolving line at the prime rate of
 interest, payable in monthly installments thru May 1, 2008     |  |              | 2,847,897 |      |   |          |  
|                                                                                                    |  |              |           |      |   |           |  
|Corporate insurance financed at 8.49% in
 monthly installments thru October 1, 2007                 |  |              | 162,397   |      |   |          |  
|                                                                                                    |  |              |           |      |   |           |  
|Capitilzed lease obligations due in monthly
 installments, with interest ranging from 6.4% to 11.7% |  |              | 399,731   |      |   | 246,215   |  
|                                                                                                    |  |              |           |      |   |           |  
|Other miscellaneous debt                                                                            |  |              | 27,117    |      |   | 53,583    |  
|                                                                                                    |  |              |           |      |   |           |  
|                                                                                                    |  |              | 3,968,264 |      |   | 1,024,627 |  
|Less: Current Portion                                                                               |  |              | (505,028  | )    |   | (296,666  | )
|                                                                                                    |  |              |           |      |   |           |  
|                                                                                                    |  | $            | 3,463,236 |      | $ | 727,961   |  
|                                                                                                    |  |              |           |      |   |           |  

The weighted
average prime interest rate for the years ended December 31, 2006 and 2005 were
7.9% and 6.4%, respectively.

F-22

---



HENRY BROS.

ELECTRONICS, INC. AND
SUBSIDIARIES 
Notes to the Consolidated Financial Statements (continued)

|   |             
|-- | ------------
|9. | INCOME TAXES

The tax
provision consists of the following:

|         |  |                            |          |      |   |         |  |   |         | 
|-------- |  | -------------------------- | -------- | ---- | - | ------- |  | - | ------- | 
|         |  | Years
  Ended December 31, |         
|         |  |                            |         
|         |  | 2006                       |          | 2005 |   | 2004    | 
|         |  |                            |          |      |   |         | 
|        
|Federal  |  |                            |          |      |   |         |  |   |         | 
|Current  |  | $                          | (130,790 | )    | $ | 112,790 |  | $ |        | 
|Deferred |  |                            | (318,002 | )    |   | 594,579 |  |   | 48,677  | 
|         |  |                            |          |      |   |         |  |   |         | 
|         |  |                            | (448,792 | )    |   | 707,369 |  |   | 48,677  | 
|         |  |                            |          |      |   |         |  |   |         | 
|State    |  |                            |          |      |   |         |  |   |         | 
|Current  |  |                            | 94,492   |      |   | 95,945  |  |   | 95,811  | 
|Deferred |  |                            | (68,005  | )    |   | 90,263  |  |   | 3,659   | 
|         |  |                            |          |      |   |         |  |   |         | 
|         |  |                            | 26,487   |      |   | 186,208 |  |   | 99,470  | 
|         |  |                            |          |      |   |         |  |   |         | 
|         |  | $                          | (422,305 | )    | $ | 893,577 |  | $ | 148,147 | 
|         |  |                            |          |      |   |         |  |   |         | 

The components
of the deferred tax asset (liability) are as follows:

|                                  |  |                |           |      |   |          |  
|--------------------------------- |  | -------------- | --------- | ---- | - | -------- | -
|                                  |  | December
  31, |          
|                                  |  |                |          
|                                  |  | 2006           |           | 2005 |  
|                                  |  |                |           |      |  
|Deferred
  tax asset:             |  |                |           |      |   |          |  
|Allowance for doubtful

accounts  |  | $              | 398,548   |      | $ | 328,553  |  
|Accrued absences                  |  |                | 280,475   |      |   | 92,351   |  
|Accrued warranty                  |  |                | 125,554   |      |   | 162,677  |  
|Depreciation                      |  |                | 13,871    |      |   |         |  
|Inventory                         |  |                | 137,748   |      |   | 2,693    |  
|Stock compensation                |  |                | 54,267    |      |   | 43,520   |  
|Unearned maintenance              |  |                | 213,296   |      |   | 140,000  |  
|Net operating loss carry

forward |  |                | 526,406   |      |   | 178,367  |  
|                                  |  |                |           |      |   |          |  
|Total deferred tax asset          |  | $              | 1,750,165 |      | $ | 948,161  |  
|                                  |  |                |           |      |   |          |  
|                                  |  |                |           |      |   |          |  
|Short-term                        |  | $              | 1,155,620 |      | $ | 726,274  |  
|                                  |  |                |           |      |   |          |  
|Long-term                         |  | $              | 594,545   |      | $ | 221,887  |  
|                                  |  |                |           |      |   |          |  
|                                  |  |                |           |      |   |          |  
|Deferred
  tax liability:         |  |                |           |      |   |          |  
|Deferred Revenue                  |  |                | (249,365  | )    |   |         |  
|Depreciation                      |  |                |          |      |   | (27,382  | )
|Intangible Assets                 |  |                | (428,283  | )    |   | (405,699 | )
|                                  |  |                |           |      |   |          |  
|Total deferred tax
  liability    |  | $              | (677,648  | )    | $ | (433,081 | )
|                                  |  |                |           |      |   |          |  
|                                  |  |                |           |      |   |          |  
|Short-term                        |  | $              | (249,365  | )    | $ |         |  
|                                  |  |                |           |      |   |          |  
|Long-term                         |  | $              | (428,283  | )    | $ | (433,081 | )
|                                  |  |                |           |      |   |          |  
|                                  |  |                |           |      |   |          |  
|Net
  deferred tax                |  | $              | 1,072,516 |      | $ | 515,080  |  
|                                  |  |                |           |      |   |          |  

F-23

---



HENRY BROS.

ELECTRONICS, INC. AND
SUBSIDIARIES 
Notes to the Consolidated Financial Statements (continued)

During the year ended

December 31, 2006, the Company
generated a net operating loss carryforward of which approximately $126,000 is
available for carryforward through 2026. Additionally, there is approximately
$1,146,000 of acquired NOLs which are subject to various expiration dates. The
acquired NOLs are also subject to limitations in their use based on the value
of the acquired company at the date of the change of ownership.

There were
certain adjustments made to goodwill resulting from a correction of accounting
for deferred income taxes related to prior year stock acquisitions. See Notes
1, 6 and 18. The net effect was to increase overall goodwill by $549,262 for
the years ended December 31, 2006 and 2005, with a corresponding increase to net
deferred tax liabilities to correct for the effect on prior years acquisitions.
There was no income statement impact resulting from this adjustment.

The provision
for income taxes reported for the years ended December 31, differs from that
computed using the United States statutory tax rate of 34% due to the
following:

|                                                     |  |                            |          |      |   |         |  |   |         |  
|---------------------------------------------------- |  | -------------------------- | -------- | ---- | - | ------- |  | - | ------- | -
|                                                     |  | Years
  Ended December 31, |         
|                                                     |  |                            |         
|                                                     |  | 2006                       |          | 2005 |   | 2004    | 
|                                                     |  |                            |          |      |   |         | 
|                                                     |  |                            |          |      |   |         |  |   |         |  
|Provision (benefit) for
  taxes using statutory rate |  | $                          | (918,977 | )    |   | 690,727 |  |   | 108,047 |  
|State taxes, net of
  federal tax benefit            |  |                            | 17,481   |      |   | 122,897 |  |   | 65,650  |  
|Permanent differences:                               |  |                            |          |      |   |         |  |   |         |  
|Goodwill impairment                                  |  |                            | 404,940  |      |   |         |  |   |         |  
|Qualified stock based

compensation                  |  |                            | 58,501   |      |   | 40,081  |  |   | 11,062  |  
|Other                                                |  |                            | 15,750   |      |   | 39,872  |  |   | (36,612 | )
|                                                     |  |                            |          |      |   |         |  |   |         |  
|Provision (benefit) for income

taxes                |  | $                          | (422,305 | )    | $ | 893,577 |  | $ | 148,147 |  
|                                                     |  |                            |          |      |   |         |  |   |         |  

|    |                            
|--- | ---------------------------
|10. | INCENTIVE STOCK OPTION PLAN

The Company
has a Stock Option Plan (the 1999 Plan), for the benefit of employees of the
Company, under which options to purchase up to a maximum of 500,000 shares of
its common stock may be issued. The maximum term of any option is ten years,
and the option price per share may not be less than the fair market value of
the Companys shares at the date the option is granted. However, options
granted to persons owning more than 10% of the voting shares will have a term
not to exceed five years, and the option price will not be less than 110% of
fair market value. Options granted to an optionee will usually vest 33 1/3%
annually, beginning on the first anniversary of the option grant, subject to
the discretion of the Compensation Committee of the Board of Directors. The
1999 Plan will terminate on December 23, 2009 or on such earlier date as the
Board of Directors may determine. Any option outstanding at the termination
date will remain outstanding until it expires or is exercised in full, which
ever occurs first.

F-24

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

On May 10,
2002, the Board of Directors approved the 2002 Incentive Stock Option Plan (the
2002 Plan), which the shareholders subsequently approved on October 28, 2002.
On August 2, 2006, the Board of Directors approved the 2006 Stock Option Plan
(the 2006 Plan), which the shareholders subsequently approved on November 1,
2006.

The 2002 and
2006 Plans (collectively the Plans) allow the granting of incentive stock
options or non-qualified stock options to the Companys employees, directors
and consultants, up to a maximum of 230,000 and 250,000 shares of its common
stock for the 2002 and 2006 Plans, respectively. All stock options granted
under the Plans will be exercisable at such time or times and in such
installments, if any, as our Compensation Committee or the Board may determine
and expire no more than ten years from the date of grant. The 2002 Plan will
terminate on May 9, 2012 and the 2006 Plan will terminate on August 2, 2016, or
such earlier date as the Board of Directors may determine. Any option
outstanding at the termination date will remain outstanding until it expires or
is exercised in full, whichever occurs first. The exercise price of the stock
option will be at fair market value. Vesting is at the discretion of the
Compensation Committee. The Plans allows for immediate vesting if there is a
change of control. As of December 31, 2006, in total, 282,909 options are
available for future grant under the 1999, 2002 and 2006 Plans. The company
charged $189,593, $191,106 and $68,114 to operations for the years ended
December 31, 2006, 2005 and 2004, respectively, for the fair value of those
options granted subsequent to January 1, 2003.

A summary of
stock option activity under the 1999, 2002, and 2006 Plans follows:

|                   |  |                       |         |                  |  |             |  |             |      |  |   |      | 
|------------------ |  | --------------------- | ------- | ---------------- |  | ----------- |  | ----------- | ---- |  | - | ---- | 
|                   |  | Number of Outstanding |         | Weighted Average | 
|                   |  |                       |         |                  | 
|                   |  | Outstanding           |         | Exercisable      |  | Outstanding |  | Exercisable |     
|                   |  |                       |         |                  |  |             |  |             |     
|December 31,
 2005 |  |                       | 471,375 |                  |  | 240,375     |  |             | 5.95 |  | $ | 6.70 | 
|Granted at market  |  |                       | 256,000 |                  |  |             |  |             | 3.90 |  |   |      | 
|Exercised          |  |                       | (6,666  | )                |  |             |  |             | 4.65 |  |   |      | 
|Forfeited          |  |                       | (50,109 | )                |  |             |  |             | 5.65 |  |   |      | 
|                   |  |                       |         |                  |  |             |  |             |      |  |   |      | 
|December 31,
 2006 |  |                       | 670,600 |                  |  | 290,435     |  | $           | 5.17 |  | $ | 6.37 | 
|                   |  |                       |         |                  |  |             |  |             |      |  |   |      | 

The aggregate
fair value of options outstanding at December 31, 2006, was $ 872,830 and had a
weighted-average remaining contractual life of 4.1 years. Of these options
outstanding, 176,333 were exercisable and 280,125 were expected to vest, and
had an aggregate fair value of $759,589 with a weighted-average remaining
contractual life of 4.0 years. The following table provides information related
to options exercised during the years ended December 31, 2006, 2005, and 2004:

F-25

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

|                               |  |      |        |      |   |      |  |   |         | 
|------------------------------ |  | ---- | ------ | ---- | - | ---- |  | - | ------- | 
|                               |  | 2006 |        | 2005 |   | 2004 | 
|                               |  |      |        |      |   |      | 
|Total
 intrinsic value         |  | $    | 39,596 |      | $ |     |  | $ | 160,254 | 
|Cash
 received upon exercise   |  |      | 30,997 |      |   |     |  |   | 123,294 | 
|Related tax
 benefits realized |  |      | 2,924  |      |   |     |  |   | 17,223  | 

Deferred
compensation cost 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 years ended December 31:

|                                        |  |      |      |      |   |      |   |   |      |  
|--------------------------------------- |  | ---- | ---- | ---- | - | ---- | - | - | ---- | -
|                                        |  | 2006 |      | 2005 |   | 2004 |  
|                                        |  |      |      |      |   |      |  
|Expected
 Life (years)                  |  |      | 3    |      |   | 3    |   |   | 3    |  
|Expected
 volatility                    |  |      | 36.8 | %    |   | 33.0 | % |   | 20.7 | %
|Risk-free
 interest rates               |  |      | 4.2  | %    |   | 3.9  | % |   | 3.3  | %
|Dividend
 Yield                         |  |      |     |      |   |     |   |   |     |  
|Weighted-average
 grant-date fair value |  | $    | 1.44 |      | $ | 1.78 |   | $ | 2.03 |  

|    |                     
|--- | --------------------
|11. | STOCKHOLDERS EQUITY

In connection
with the acquisition of all the capital stock of CIS Security Systems Corp.
(CIS) on October 2, 2006, the Company issued an aggregate of 20,000 shares of
its common stock, valued at $67,200. The issuance of the shares of restricted
stock in connection with the aforementioned acquisition was made in reliance
upon the exemption provided in section 4(2) of the Securities Act of 1933, as
amended. In addition, the selling shareholder may earn an additional 80,000
additional shares of the Companys common stock if CIS achieves certain
performance targets through December, 2011.

In connection
with the acquisition of Securus, Inc. on October 10, 2005, the Company issued
an aggregate of 150,001 shares of its common stock, all of which are being held
in escrow pursuant to the stock purchase escrow agreement between the Company
and the selling shareholders of Securus, Inc. The issuance of the shares of
restricted stock, in connection with the aforementioned acquisition, was made
in reliance upon the exemption provided in section 4(2) of the Securities Act
of 1933, as amended.

ACI
Acquisition Corporation, a wholly-owned subsidiary of the Company, purchased
all of the issued and outstanding stock of Airorlite Communications, Inc
(Airorlite) effective April 1, 2004. The purchase consisted of $200,000 in
cash and 37,000 shares of the Companys common stock, valued at $266,400. ACI
Acquisition Corporation was subsequently renamed Airorlite Communications, Inc.
These shares were issued in reliance on the exemption provided by section 4(2)
of the Securities Act of 1933, as amended, regarding transactions not involving
a public offering.

F-26

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

On July 28,
2004, the Company completed a $3,319,998 private placement of its common stock
to certain qualified institutional investors. Under the terms of the agreement,
the Company sold an aggregate of 553,333 shares of common stock for $6.00 per
share. The Company also has granted the investors a warrant to acquire 138,333
shares of common stock at an exercise price of $7.60 per share, exercisable for
a period commencing six months after the date of issuance through the fifth
anniversary of the issuance. In addition, the Placement Agent received a
commission of 8% of the proceeds plus expenses and was issued a warrant to
acquire 55,333 shares of common stock with the same terms as those issued to
the institutional investors. After expenses, the net proceeds of the
transaction were $2,958,058. The Company filed a registration statement with
the SEC covering the resale of the shares sold under this private placement and
the shares issuable upon the exercise of the warrants on August 29, 2004, which
statement was declared effective on September 7, 2004.

On December
31, 2003, the Board of Directors authorized the issuance of 52,550 shares of
restricted stock to employees. These shares were valued at $294,280 and the
Company included this expense in the Consolidated Statements of Operations for
2003. On November 5, 2004, the Companys shareholders approved the issuance of
these shares. These shares were restricted from resale for a one year period
and were issued on January 3, 2005.

On November 1,
2001, the Company entered into an agreement with The Wall Street Group, Inc.
(WSG) to provide financial public relations services to the Company (the
Agreement). Under the Agreement, WSG was paid a monthly fee and reimbursed
out-of-pocket expenses, and earned options for the purchase of the Companys
common stock. The Agreement also provided WSG with the right to have the shares
issued under the Agreement, registered for sale under the Securities Act of
1933. Throughout the term of the Agreement until its termination on April 6,
2003, Wall Street Group earned options for the purchase of up to 45,996 shares
of the Companys common stock having an average exercise price of $6.99 per
share. 40,000 of these options expired in November 2006 and the remaining 5,999
expire in November 2007. The options were not granted as part of the Companys
1999 Plan or 2002 Plan.

Holders of
common stock are entitled to one vote for each share held on all matters
submitted for a vote of stockholders and do not have cumulative voting rights.
Apart from preferences that may be applicable to any shares of preferred stock
outstanding at the time, holders of our common stock are entitled to receive
dividends ratably, if any, as may be declared from time to time by our board of
directors out of funds legally available. Upon the liquidation, dissolution or
winding up of the Company, the holders of common stock are entitled to receive
ratably the net assets available after the payment of all liabilities and
liquidation preferences on any outstanding preferred stock. Holders of common
stock have no preemptive, subscription, redemption or conversion rights, and
there are no redemption or sinking fund provisions applicable to the common
stock.

F-27

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

Treasury Stock
- On November 5, 2004, a resolution of the Board of Directors provided for the
return of shares held in treasury to unissued shares.

Preferred Stock
 Our board of directors is authorized, without stockholder approval, to issue
up to 2,000,000 shares of preferred stock in one or more series and to fix the
rights, preferences, privileges and restrictions of these shares, including
dividend rights, conversion rights, voting rights, terms of redemption and
liquidation preferences, and to fix the number of shares constituting any
series and the designations of these series. These shares may have rights
senior to our common stock. The issuance of preferred stock may have the effect
of delaying or preventing a change in control. The issuance of preferred stock
could decrease the amount of earnings and assets available for distribution to
the holders of our common stock or could aversely affect the rights and powers,
including voting rights, of the holders of our common stock. At present, we
have no plans to issue preferred stock in the foreseeable future.

Warrants
- In connection with the Companys private placement of its common stock to
certain qualified institutional investors in July 2004 (as noted above), such
investors were issued warrants to acquire 138,333 shares of common stock at an
exercise price of $7.60 per share, exercisable for a period commencing six
months after the date of issuance through the fifth anniversary of the issuance.
In addition, the Placement Agent was issued warrants to acquire 55,333 shares
of common stock with the same terms as those issued to the institutional
investors. These warrants will expire January 27, 2010.

A total of 897,475 common shares are reserved for exercise of employee stock options and
warrants as of December 31, 2006.

|    |            
|--- | -----------
|12. | COMMITMENTS

Leases
- The Company leases its office and warehouse facilities under operating leases
that expire through 2016. Future minimum rental payments, under non-cancelable
leases as of December 31, 2006, are as follows:

|           |  |   |           |  | 
|---------- |  | - | --------- |  | 
|2007       |  | $ | 656,503   |  | 
|2008       |  |   | 640,775   |  | 
|2009       |  |   | 622,512   |  | 
|2010       |  |   | 590,390   |  | 
|2011       |  |   | 408,491   |  | 
|Thereafter |  |   | 1,037,406 |  | 
|           |  |   |           |  | 
|           |  |   |           |  | 
|Total      |  | $ | 3,956,077 |  | 
|           |  |   |           |  | 

Rent expense
under operating leases were approximately $663,000, $421,000 and $381,000 for
the years ended December 31, 2006, 2005 and 2004, respectively.

Obligations Under Capital Leases:

Future minimum lease payments for assets under capital leases
    at December 31, 2006

|                                                      |  |   |         |         | 
|----------------------------------------------------- |  | - | ------- | ------- | 
|Years
          ending December 31, :                 |  |   |         |        
|2007                                                  |  |   | $       | 161,009 | 
|2008                                                  |  |   |         | 157,386 | 
|2009                                                  |  |   |         | 99,379  | 
|2010                                                  |  |   |         | 46,090  | 
|2011                                                  |  |   |         |        | 
|                                                      |  |   |         |         | 
|Total                                                 |  |   |         | 463,864 | 
|Less:
          Amount representing interest          |  |   | (64,133 | )      
|                                                      |  |   |         |        
|Present
          value of net minimum lease payments |  | $ | 399,731 |        
|                                                      |  |   |         |        

Aggregate maturities of all outstanding debt for each of the
    years ended

|                                      |  |   |           |           | 
|------------------------------------- |  | - | --------- | --------- | 
|Years ending
          December 31, : |  |   |           |          
|2007                                  |  |   | $         | 505,028   | 
|2008                                  |  |   |           | 3,221,169 | 
|2009                                  |  |   |           | 198,126   | 
|2010                                  |  |   |           | 43,941    | 
|2011                                  |  |   |           |          | 
|Thereafter                            |  |   |          |          
|                                      |  |   |           |          
|                                      |  | $ | 3,968,264 |          
|                                      |  |   |           |          

F-28

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

|    |                      
|--- | ---------------------
|13. | EMPLOYEE BENEFIT PLAN

As of January
1, 2003, the Company sponsored a 401-K plan, including discretionary profit
sharing (the 401-K Plan). The Company may match up to three percent of
qualifying employees compensation when contributed to the 401-K Plan. As of
September 1, 2003, the Company decided to discontinue matching employee
contributions to the 401-K Plan but may resume discretionary matches in the
future. The Companys contributions to the employees accounts vest equally
over three years and the employee contribution to their own account vests
immediately. There were no Company matching contributions to the 401-K plan
during 2006, 2005 or 2004.

|    |                           
|--- | --------------------------
|14. | RELATED PARTY TRANSACTIONS

In 2006, the
Company had revenues of $678,138 associated with an integrated security systems
project with First Aviation Services, Inc. (First Aviation). Joseph P.
Ritorto, a member of our Board of Directors since January 2002, is co-founder
of First Aviation.

|    |                       
|--- | ----------------------
|15. | CONTINGENT LIABILITIES

From time to
time, the Company is subject to various claims with respect to matters arising
out of the normal course of business. In managements opinion, none of these
claims is likely to have a material affect on the Companys consolidated
financial statements.

|    |             
|--- | ------------
|16. | SEGMENT DATA

Selected
information by business segment is presented in the following tables for the
years ended December 31:

|                                 |  |                                 |            |      |   |            |   |   |            |  
|-------------------------------- |  | ------------------------------- | ---------- | ---- | - | ---------- | - | - | ---------- | -
|                                 |  | For the year ended December 31, |           
|                                 |  |                                 |           
|                                 |  | 2006                            |            | 2005 |   | 2004       |  
|                                 |  |                                 |            |      |   |            |  
|Revenue                          |  |                                 |            |      |   |            |   |   |            |  
|Total
 Integration               |  | $                               | 40,606,101 |      | $ | 38,848,317 |   | $ | 26,231,565 |  
|Specialty
 Products and Services |  |                                 | 2,766,024  |      |   | 3,890,952  |   |   | 3,757,817  |  
|Inter-segment                    |  |                                 | (1,239,273 | )    |   | (583,081   | ) |   | (263,664   | )
|                                 |  |                                 |            |      |   |            |   |   |            |  
|Total Revenue                    |  | $                               | 42,132,852 |      | $ | 42,156,188 |   | $ | 29,725,718 |  
|                                 |  |                                 |            |      |   |            |   |   |            |  
|                                 |  |                                 |            |      |   |            |   |   |            |  
|Operating
 (Loss) Profit         |  |                                 |            |      |   |            |   |   |            |  
|Total
 Integration               |  | $                               | 144,229    |      | $ | 2,928,282  |   | $ | 683,653    |  
|Specialty
 Products and Services |  |                                 | (751,919   | )    |   | 574,920    |   |   | 1,106,801  |  
|Corporate                        |  |                                 | (1,989,671 | )    |   | (1,395,393 | ) |   | (1,391,253 | )
|                                 |  |                                 |            |      |   |            |   |   |            |  
|Total Operating (Loss) Profit    |  | $                               | (2,597,361 | )    | $ | 2,107,809  |   | $ | 399,201    |  
|                                 |  |                                 |            |      |   |            |   |   |            |  

F-29

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES 
Notes to the Consolidated Financial Statements (continued)

Selected
balance sheet information by business segment is presented in the following
table as of December 31:

| |                                  |  |               |            |                 |   |            | 
| | -------------------------------- |  | ------------- | ---------- | --------------- | - | ---------- | 
| |                                  |  | December
 31, |           
| |                                  |  | 2006          |            | 2005(Corrected) |  
| |                                  |  |               |            |                 |  
| | Total Assets                     |  |               |            |                 |   |            | 
| | Total
 Integration               |  | $             | 28,209,608 |                 | $ | 19,483,806 | 
| | Specialty
 Products and Services |  |               | 2,146,308  |                 |   | 2,816,577  | 
| | Corporate                        |  |               | 1,015,693  |                 |   | 2,861,147  | 
| |                                  |  |               |            |                 |   |            | 
| | Total Assets                     |  | $             | 31,371,609 |                 | $ | 25,161,530 | 
| |                                  |  |               |            |                 |   |            | 

|    |             
|--- | ------------
|17. | ACQUISITIONS

On October 10,
2005 we acquired Securus, Inc. (Securus) a privately held company established
in 1969 having offices in Denver and Colorado Springs, Colorado. Securus
designs, installs and maintains physical electronic security systems for
government and commercial enterprises. Securus will be included as part of our
Integration business segment.

Under the
terms of the Stock Purchase Agreement with the Securus shareholders, pursuant
to which we acquired all of the issued and outstanding stock of Securus, we
paid an aggregate purchase price of $1,110,000 comprised of $770,000 cash to
the selling shareholders, the assumption and subsequent repayment of $240,000
of Securus bank debt and incurred approximately $100,000 in transactions costs.
We also issued and placed into escrow 150,001 shares of our common stock which
may be earned out through December 31, 2010 based upon the aggregate value of
the earnings before interest and tax (EBIT) to $2,960,000. In addition, the
selling shareholders may earn an additional amount of up to $200,000 based upon
one third of the aggregate EBIT earned in excess of $2,960,000 thru December
31, 2010.

The purchase
price was allocated to the assets acquired and liabilities assumed based upon
the estimated fair market values as follows:

F-30

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES 
Notes to the Consolidated Financial Statements (continued)

|                                |  |   |           |  
|------------------------------- |  | - | --------- | -
|Cash and
 cash equilivalents    |  | $ | 31,009    |  
|Accounts
 receivable - net      |  |   | 645,016   |  
|Inventory                       |  |   | 95,859    |  
|Cost in
 excess of billings     |  |   | 135,130   |  
|Other assets                    |  |   | 80,443    |  
|                                |  |   |           |  
|Total current assets            |  |   | 987,457   |  
|Property and
 equipment - net   |  |   | 24,368    |  
|Amortizable
 intangible assets: |  |   |           |  
|Customer relationship           |  |   | 260,000   |  
|Trademark
    and trade name    |  |   | 80,000    |  
|Deferred tax
 asset             |  |   | 306,770   |  
|Other assets                    |  |   | 31,110    |  
|                                |  |   |           |  
|Total assets                    |  |   | 1,689,705 |  
|Accounts
 Payables              |  |   | (513,391  | )
|Other
 current liabilities      |  |   | (952,119  | )
|Deferred tax
 liability         |  |   | (136,000  | )
|                                |  |   |           |  
|Net assets acquired             |  | $ | 88,195    |  
|                                |  |   |           |  

The excess
purchase price of $971,210 was assigned to goodwill.

Selected
unaudited pro forma consolidated statements of income data for each of the
years ended December 31, 2005 and 2004 assuming that Securus was included in
our results from the beginning of 2004 is as follows:

| |                                  |  |      |            |      |   |            |  
| | -------------------------------- |  | ---- | ---------- | ---- | - | ---------- | -
| |                                  |  | 2005 |            | 2004 |  
| |                                  |  |      |            |      |  
| | Revenue                          |  | $    | 45,888,287 |      | $ | 34,721,320 |  
| | Net income                       |  | $    | 1,187,156  |      | $ | (217,517   | )
| |                                  |  |      |            |      |   |            |  
| | Earnings per
 share:             |  |      |            |      |   |            |  
| | Basic                            |  | $    | 0.21       |      | $ | (0.04      | )
| | Diluted                          |  | $    | 0.20       |      | $ | (0.04      | )
| |                                  |  |      |            |      |   |            |  
| | Weighted
 average common shares: |  |      |            |      |   |            |  
| | Basic                            |  |      | 5,739,398  |      |   | 5,411,964  |  
| | Diluted                          |  |      | 5,889,399  |      |   | 5,561,965  |  

The pro forma
information is for illustrative purposes only, and does not necessarily
indicate what the operating results of the combined companies would be had the
acquisition actually occurred at the beginning of 2004, nor does it necessarily
indicate the companys future operating results.

F-31

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES 
Notes to the Consolidated Financial Statements (continued)

On October 2,
2006, the Company consummated the acquisition of all the capital stock of CIS
Security Systems Corp. (CIS), a privately-held security systems integrator
with offices in Baltimore, Maryland and Newington, Virginia, for an aggregate
purchase price of $1,545,973 ($850,000 in cash to the selling shareholder, the
assumption and subsequent repayment of CIS debt in the amount of $603,364, the
issuance of 20,000 shares of the Companys $0.01 par value common stock valued
at $67,200 and $25,409 in transaction costs). In addition, the selling
shareholder may earn an additional amount up to $250,000 in cash and 80,000
additional shares of the Companys common stock if CIS achieves certain
performance targets through December, 2011.

Established in
1987, CIS provides design, engineering and installation services for integrated
electronic security systems for both commercial and government clients in the
Washington-Baltimore metropolitan area. CIS also provides design-build services
for large-scale security systems for malls, shopping centers and stadiums
throughout the country.

The purchase
price was allocated to the assets acquired and liabilities assumed based upon
the estimated fair market values as follows:

|                                |  |   |           |  
|------------------------------- |  | - | --------- | -
|Cash and
 cash equilivalents    |  | $ | 15,721    |  
|Accounts
 receivable - net      |  |   | 794,503   |  
|Inventory                       |  |   | 62,522    |  
|Cost in
 excess of billings     |  |   | 47,810    |  
|Other assets                    |  |   | 14,901    |  
|                                |  |   |           |  
|Total current assets            |  |   | 935,457   |  
|Property and
 equipment - net   |  |   | 74,722    |  
|Amortizable
 intangible assets: |  |   |           |  
|Customer relationship           |  |   | 235,000   |  
|Deferred tax
 asset             |  |   | 265,739   |  
|Other assets                    |  |   | 8,330     |  
|                                |  |   |           |  
|Total assets                    |  |   | 1,519,248 |  
|Accounts
 Payables              |  |   | (504,620  | )
|Other
 current liabilities      |  |   | (158,305  | )
|Deferred tax
 liability         |  |   | (94,000   | )
|                                |  |   |           |  
|Net assets acquired             |  | $ | 762,323   |  
|                                |  |   |           |  

The excess
purchase price of $783,650 was assigned to goodwill.

Pro forma
information is not required for either the CIS or SSI acquisition.

On October 2,
2006, the Company acquired certain assets of Southwest Securityscan, Inc.
(SSI), a privately-held company headquartered in Duncanville, Texas. In
exchange for certain

F-32

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES 
Notes to the Consolidated Financial Statements (continued)

inventory,
furniture, equipment, vehicles, customer lists, customer monitoring contracts
and relationships, the Company paid outstanding SSI indebtedness of $88,014 on
behalf of SSI and $6,773 in cash to SSI. Established in 1974, SSI provides
installation, service and monitoring of access, surveillance and alarm systems.

|    |                      
|--- | ---------------------
|18. | CORRECTION OF ERRORS:

After
analyzing the materiality of the impact arising from the weaknesses in internal
control identified in Item 9A in accordance with the provisions of SAB 108 (See
Notes 1, 6, 9 and 19), management concluded that the financial statements for
the years ended December 31, 2005 and 2004 and the Quarterly Financial
Information included as part of this Annual Report on Form 10-K, and the
Selected Financial Data included as Item 6 of this Annual Report on Form 10-K
should be corrected to reflect the proper accounting related to income taxes.
The impact resulting from these corrections for income tax accounting that had
an income statement impact was to increase (decrease) tax expense by $(29,696),
$(125,618), $111,080, and $99,776, for the years ended December 31, 2005, 2004,
2003 and 2002, respectively, with a corresponding increase or decrease to net
tax liabilities. The impact resulting from these corrections for income tax
accounting that only had a balance sheet impact was to increase net deferred
tax liabilities by $549,262, $580,032, $533,648, and $533,648 for the years
ended December 31, 2005, 2004, 2003 and 2002, respectively, with a
corresponding net increase to goodwill. Unadjusted differences were not
material to 2006 or individually to the prior years.

In addition,
as a result the weaknesses identified in the Companys intercompany clearing
and cash accounts (See Item 9A) certain of these adjustments affected prior
quarters in 2006 and those corrections have been made in Note 19 and will be
reflected in subsequent quarterly filings on the Companys Quarterly Reports on
Form 10-Q.

F-33

---



HENRY BROS. ELECTRONICS, INC. AND
SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)

|    |                                             
|--- | --------------------------------------------
|19. | QUARTERLY
FINANCIAL INFORMATION (UNAUDITED):

Presented below is a schedule
of selected quarterly operating results:

|                                       |  | First Quarter            |           | Second Quarter          |   | Third Quarter            |   | Fourth Quarter              |  
|-------------------------------------- |  | ------------------------ | --------- | ----------------------- | - | ------------------------ | - | --------------------------- | -
|                                       |  | Ended March
          31 |           | Ended June
          30 |   | Ended Sept.
          30 |   | Ended Dec.
          31 (1) |  
|                                       |  |                          |           |                         |   |                          |   |                             |  
|                                      
|Year Ended December 31,
          2006 |  |                          |           |                         |   |                          |   |                             |  
|                                      
|As Reported                            |  |                          |           |                         |   |                          |   |                             |  
|Revenue                                |  | $                        | 9,155,078 |                         | $ | 10,030,118               |   |                             | $
|Gross profit                           |  |                          | 2,995,705 |                         |   | 2,564,036                |   |                             |  
|Net (loss)
        income              |  |                          | 225,687   |                         |   | 30,001                   |   |                             |  
|                                      
|(Loss) earnings per share              |  |                          |           |                         |   |                          |   |                             |  
|Basic                                  |  | $                        | 0.04      |                         | $ | 0.01                     |   |                             | $
|Diluted                                |  |                          | 0.04      |                         |   | 0.01                     |   |                             |  
|                                      
|As Restated                            |  |                          |           |                         |   |                          |   |                             |  
|Revenue                                |  | $                        | 9,144,828 |                         | $ | 10,139,969               |   |                             | $
|Gross profit                           |  |                          | 2,938,175 |                         |   | 2,212,794                |   |                             |  
|Net (loss)
        income              |  |                          | 101,687   |                         |   | (393,999                 | ) |                             |  
|                                      
|(Loss) earnings per share              |  |                          |           |                         |   |                          |   |                             |  
|Basic                                  |  | $                        | 0.02      |                         | $ | (0.07                    | ) |                             | $
|Diluted                                |  |                          | 0.02      |                         |   | (0.07                    | ) |                             |  
|                                      
|Year Ended December 31,
          2005 |  |                          |           |                         |   |                          |   |                             |  
|                                      
|As Reported                            |  |                          |           |                         |   |                          |   |                             |  
|Revenue                                |  | $                        | 8,613,074 |                         | $ | 10,198,826               |   |                             | $
|Gross profit                           |  |                          | 2,183,781 |                         |   | 2,894,149                |   |                             |  
|Net income                             |  |                          | 62,297    |                         |   | 305,972                  |   |                             |  
|                                      
|Earnings per share                     |  |                          |           |                         |   |                          |   |                             |  
|Basic                                  |  | $                        | 0.01      |                         | $ | 0.05                     |   |                             | $
|Diluted                                |  |                          | 0.01      |                         |   | 0.05                     |   |                             |  
|                                      
|As Restated                            |  |                          |           |                         |   |                          |   |                             |  
|Revenue                                |  | $                        | 8,613,074 |                         | $ | 10,198,826               |   |                             | $
|Gross profit                           |  |                          | 2,183,781 |                         |   | 2,894,149                |   |                             |  
|Net income                             |  |                          | 63,971    |                         |   | 314,193                  |   |                             |  
|                                      
|Earnings per share                     |  |                          |           |                         |   |                          |   |                             |  
|Basic                                  |  | $                        | 0.01      |                         | $ | 0.05                     |   |                             | $
|Diluted                                |  |                          | 0.01      |                         |   | 0.05                     |   |                             |  

(1) Fourth quarter 2006 not previously reported.

Earnings per share are computed independently for each of the quarters presented, on the basis described in Note 1. The sum of the quarters may not be equal to the full year earnings per share amount.

F-34

---



SCHEDULE II

VALUATION AND QUALIFYING ACCOUNTSYEARS ENDED DECEMBER 31, 2006, 2005, AND 2004

|                                |  |                                  |         |                                  |   |                                        |  |                       |        |                            |   |        |  |   |         | 
|------------------------------- |  | -------------------------------- | ------- | -------------------------------- | - | -------------------------------------- |  | --------------------- | ------ | -------------------------- | - | ------ |  | - | ------- | 
|Col. A                          |  | Col. B                           |         | Col. C                           |   | Col. D                                 |  | Col. E                |       
|                                |  |                                  |         |                                  |   |                                        |  |                       |       
|                                |  |                                  |         | Additions                        |   |                                        |  |                       |       
|                                |  |                                  |         |                                  |   |                                        |  |                       |       
|Description                     |  | Balance at
 Beginning
 of Period |         | Charged
 to Costs
 and
 Expenses |   | Charged
 to Other
 Accounts-
 Describe |  | Deductions-
 Describe |        | Balance at
 End of
 Period |  
|                                |  |                                  |         |                                  |   |                                        |  |                       |        |                            |  
|Year ended December 31, 2006    |  |                                  |         |                                  |   |                                        |  |                       |        |                            |   |        |  |   |         | 
|Deducted from asset
 accounts:  |  |                                  |         |                                  |   |                                        |  |                       |        |                            |   |        |  |   |         | 
|Allowance for doubtful accounts |  | $                                | 811,389 |                                  | $ | 206,894                                |  | $                     |       |                            | $ | 34,492 |  | $ | 983,791 | 
|Inventory allowance             |  |                                  | 31,539  |                                  |   | 384,000                                |  |                       |       |                            |   |       |  |   | 415,539 | 
|Valuation allowance             |  |                                  |         |                                  |   |                                        |  |                       |        |                            |   |        |  |   |         | 
|Warranty reserve                |  |                                  | 393,405 |                                  |   | 34,490                                 |  |                       |       |                            |   | 35,588 |  |   | 392,307 | 
|Year ended December 31, 2005    |  |                                  |         |                                  |   |                                        |  |                       |        |                            |   |        |  |   |         | 
|Deducted from asset
 accounts:  |  |                                  |         |                                  |   |                                        |  |                       |        |                            |   |        |  |   |         | 
|Allowance for doubtful accounts |  |                                  | 357,500 |                                  |   | 421,239                                |  |                       | 32,650 |                            |   |       |  |   | 811,389 | 
|Inventory allowance             |  |                                  | 50,000  |                                  |   | 55,000                                 |  |                       |       |                            |   | 73,461 |  |   | 31,539  | 
|Valuation allowance             |  |                                  |         |                                  |   |                                        |  |                       |        |                            |   |        |  |   |         | 
|Warranty reserve                |  |                                  | 351,451 |                                  |   | 43,950                                 |  |                       |       |                            |   | 1,996  |  |   | 393,405 | 
|Year ended December 31, 2004    |  |                                  |         |                                  |   |                                        |  |                       |        |                            |   |        |  |   |         | 
|Deducted from asset
 accounts:  |  |                                  |         |                                  |   |                                        |  |                       |        |                            |   |        |  |   |         | 
|Allowance for doubtful accounts |  |                                  | 135,000 |                                  |   | 240,714                                |  |                       |       |                            |   | 18,214 |  |   | 357,500 | 
|Inventory allowance             |  |                                  |        |                                  |   | 50,000                                 |  |                       |       |                            |   |       |  |   | 50,000  | 
|Valuation allowance             |  |                                  |         |                                  |   |                                        |  |                       |        |                            |   |        |  |   |         | 
|Warranty reserve                |  |                                  | 170,892 |                                  |   | 152,500                                |  |                       | 28,059 |                            |   |       |  |   | 351,451 | 

S-1

---



EXHIBIT INDEX

The following
exhibits are filed herewith as part of this Report on Form 10-K:

|                 |         |                           |                                                                            |                    |      | 
|---------------- | ------- | ------------------------- | -------------------------------------------------------------------------- | ------------------ | ---- | 
|Exhibit
  Number |         | Description
  of Document |                                                                            | Method
  of Filing
|                 |         |                           |                                                                            |                    |     
|                 | 3.1    |                           | Certificate
  of Incorporation of the Company                              |                    | (1)  | 
|                
|                 | 3.2    |                           | By-laws of
  the Company                                                   |                    | (1)  | 
|                
|                 | 3.3    |                           | Certificate
  of Amendment of the Certificate of Incorporation of the      |                    |      | 
|                 |         |                           | Company,
  filed on July 5, 2001                                           |                    | (2)  | 
|                
|                 | 3.4    |                           | Certificate
  of Amendment of the Certificate of Incorporation of the      |                    |      | 
|                 |         |                           | Company,
  filed on August 28, 2001                                        |                    | (2)  | 
|                
|                 | 3.5    |                           | Certificate
  of Amendment of the Certificate of Incorporation of the      |                    |      | 
|                 |         |                           | Company,
  filed on August 9, 2005                                         |                    | (3)  | 
|                
|                 | 3.6    |                           | Amended and
  Restated By-laws of the Company, filed on August 9, 2005     |                    | (3)  | 
|                
|                 | 4.1    |                           | Specimen
  Common Stock Certificate of the Company                         |                    | (4)  | 
|                
|                 | 10.1   |                           | 2002 Stock
  Option Plan                                                   |                    | (5)  | 
|                
|                 | 10.5   |                           | 1999
  Incentive Stock Option Plan and form of Stock Option Agreement      |                    | (1)  | 
|                
|                 | 10.8   |                           | Office Lease
  between the Company and Eagle-DFW, Inc                      |                    | (6)  | 
|                
|                 | 10.11  |                           | Agreement
  between the Company and Administaff, Inc                       |                    | (7)  | 
|                
|                 | 10.12  |                           | Loan
  Agreement between the Company and Hudson United Bank                |                    | (8)  | 
|                
|                 | 10.13  |                           | Stock
  Purchase Agreement between the Company and Securus, Inc            |                    | (9)  | 
|                
|                 | 10.14  |                           | Office Lease
  between the Company and C.K. Bergen Holdings, LLC           |                    | (10) | 
|                
|                 | 10.15  |                           | Stock
  Purchase Agreement between the Company and CIS Security            |                    |      | 
|                 |         |                           | Systems,
  Corporation                                                     |                    | (11) | 
|                
|                 | 10.16  |                           | 2006 Stock
  Option Plan                                                   |                    | (12) | 
|                
|                 | 14.1   |                           | Code of
  Ethics                                                           |                    | (13) | 
|                
|                 | 14.2   |                           | Nominating
  Committee Charter                                             |                    | (14) | 
|                
|                 | 14.3   |                           | Audit Committee
  Charter                                                  |                    | (14) | 
|                
|                 | 21.1   |                           | List of
  Subsidiaries                                                     |                    | (*)  | 
|                
|                 | 23     |                           | Consent of
  Demetrius & Company, LLC                                      |                    | (*)  | 
|                
|                 | 24     |                           | Power of
  Attorney (included on signature page (hereto)                   |                    | (*)  | 
|                
|                 | 31.1   |                           | Certification
  of Chief Executive Officer pursuant to Rule 13a- 14 (a) or |                    |      | 
|                 |         |                           | Rule
  15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley  |                    |      | 
|                 |         |                           | Act of 2002                                                                |                    | (*)  | 
|                
|                 | 31.2   |                           | Certification
  of Chief Operating Officer pursuant to Rule 13a- 14 (a) or |                    |      | 
|                 |         |                           | Rule
  15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley  |                    |      | 
|                 |         |                           | Act of 2002                                                                |                    | (*)  | 
|                
|                 | 31.3   |                           | Certification
  of Chief Financial Officer pursuant to Rule 13a- 14(a) or  |                    |      | 
|                 |         |                           | Rule
  15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley  |                    |      | 
|                 |         |                           | Act of 2002                                                                |                    | (*)  | 
|                
|                 | 32     |                           | Section 1350
  Compliance                                                  |                    | (*)  | 
|                
|                 | 99     |                           | Audit
  Committee Report                                                   |                    | (*)  | 

---



(1)
Incorporated by reference to the Registration Statement on Form SB-2 File No.
333-94477,  filed with the Securities
and Exchange Commission on January 12, 2002 (The Registration  Statement).

(2)
Incorporated by reference to Amendment No. 4 to the Registration Statement
filed with the  Securities and Exchange
Commission on September 25, 2001.

(3)
Incorporated by reference to the Companys Current Report on Form 8-K, filed
with the  Securities and Exchange
Commission on August 9, 2005.

(4)
Incorporated by reference to Amendment No. 6 to the Registration Statement
filed with the  Securities and Exchange
Commission on November 13, 2001.

(5)
Incorporated by reference to the Companys Definitive Proxy on Form 14A, filed
with the  Securities and Exchange
Commission on September 27, 2002.

(6)
Incorporated by reference to Post-Effective Amendment No. 1 to the
Registration  Statement filed on
February 8, 2001.

(7)
Incorporated by reference to the Companys Annual Report on 10-KSB for the
Company  for the Year Ended December 31,
2004 filed with the Securities and Exchange Commission on  March 28, 2005.

(8)
Incorporated by reference to the Companys Current Report on Form 8-K, filed
with the  Securities and Exchange
Commission on July 7, 2005.

(9)
Incorporated by reference to the Companys Current Report on Form 8-K, filed
with the  Securities and Exchange
Commission on October 14, 2005.

(10)
Incorporated by reference to the Companys Current Report on Form 8-K, filed
with the  Securities and Exchange
Commission on June 2, 2006.

(11)
Incorporated by reference to the Companys Current Report on Form 8-K, filed
with the  Securities and Exchange
Commission on October 5, 2006.

(12)
Incorporated by reference to the Companys Definitive Proxy on Form 14A, filed
with the  Securities and Exchange
Commission on September 22, 2006.

(13)
Incorporated by reference to the Companys Annual Report on 10-KSB for the
Company for  the Year Ended December 31,
2003 filed with the Securities and Exchange Commission on April  1, 2004.

(14)
Incorporated by reference to the Companys Definitive Proxy on Form 14A, filed
with the  Securities and Exchange
Commission on July 5, 2005.

|                    | 
|------------------- | 
|(*) Filed herewith.

---