**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

Washington, D.C. 20549

**FORM 10-Q**

(MARK ONE) 
| x      | Quarterly Report Pursuant to Section 13 or 15(d) of Securities Exchange Act of 1934 |
|--------|-------------------------------------------------------------------------------------|
|   |                                                                                |
|   | For the quarterly period ended December 31, 2008                                    |
|   |                                                                                |
| o      | Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934  |
|   |                                                                                |
|   | For the transition period from _________ to __________.                             |
| *Commission file number*814-00631                                                                                                                                                                                                                                                        |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **HOMELAND SECURITY CAPITAL CORPORATION**(Name of small business issuer in its charter)                                                                                                                                                                                                       |
|                                                                                                                                                                                                                                                                                          |   |
| Delaware                        (State or Other Jurisdiction of Incorporation                        or Organization)                         1005 North Glebe Road, Suite 550                        Arlington, VA                        (Address of principal executive offices) | 52-2050585                        (I.R.S. Employer Identification No.)                                                                           22201(Zip code) |
| (703) 528-7073                        (Issuer's Telephone Number, Including Area Code)                                                                                                                                                                                                        |

Indicate by checkmark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YesxNoo

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filero |                                          | Accelerated filero          |
|--------------------------|-----------------------------------------------|-----------------------------|
| Non-accelerated filero   | (Do not check if a smaller reporting company) | Smaller reporting company x |

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YesoNo x

**APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY            PROCEEDINGS DURING THE PRECEDING FIVE YEARS**

Check whether the registrant filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Exchange Act subsequent to the distribution of securities under a plan confirmed by a court.oYesoNo

 

**A****PPLICABLE ONLY TO****CORPORATE****ISSUERS:**

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

There were 45,275,813 shares of the issuer’s common stock, par value $.001 per share, outstanding as of February 13, 2009.

 

 

**PART I**

**FINANCIAL INFORMATION**

**ITEM 1.  FINANCIAL STATEMENTS**

The accompanying interim condensed consolidated financial statements and notes to the consolidated financial statements for the interim period as of December 31, 2008 and for the three and six month periods ended December 31, 2008 and 2007, are unaudited. The accompanying interim unaudited financial statements have been prepared by the Company in            accordance with accounting principles generally accepted in the United States for interim financial statements and pursuant to the requirements for reporting on Form 10-Q. Accordingly, these interim unaudited financial statements do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair            presentation have been included. Operating results for the three and six month periods ended December 31, 2008, are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2009. The condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Form 10-K of the Company as of and for the year ended June 30, 2008. For the three and six months ended December 31,            2007, the Company has separately disclosed the operating, investing and financing portions of the cash flows attributable to its discontinued operations, which in prior periods were reported on a combined basis.

 

 

| HOMELAND SECURITY CAPITAL CORPORATION AND SUBSIDIARIES                                            |   |             |
|---------------------------------------------------------------------------------------------------|--------|------------------|
| Consolidated Balance Sheets                                                                       |   |             |   |   |   |
|                                                                                              |   |             | December 31, 2008 |   |   |
| Assets                                                                                            |   |             | (Unaudited) |   | June 30, 2008 |
|  Cash                                                                                        |   |             | $ 1,579,825  |   | $ 3,182,357  |
|  Accounts receivable - net                                                                   |   |             | 18,205,032  |   | 11,977,737  |
|  Cost in excess of billings on uncompleted contracts                                         |   |             | 5,735,935  |   | 5,659,217  |
|  Other current assets                                                                        |   |             | 235,335  |   | 258,958  |
|       Total current assets                                          |   |             | 25,756,127  |   | 21,078,269  |
| Fixed assets - net                                                                                |   |             | 4,874,329  |   | 5,493,396  |
| Deferred financing costs - net                                                                    |   |             | 594,894  |   | 841,079  |
| Notes receivable - related party                                                                  |   |             | 402,953  |   | 393,360  |
| Notes receivable - other                                                                          |   |             | 90,400  |   | 90,400  |
| Assets held for sale                                                                              |   |             | 415,595  |   | 2,057,197  |
| Other non-current assets                                                                          |   |             | 184,613  |   | 178,670  |
| Intangible assets - net                                                                           |   |             | 429,074  |   | 497,622  |
| Goodwill                                                                                          |   |             | 4,266,702  |   | 4,266,702  |
|       Total assets                                                  |   |             | $ 37,014,687  |   | $ 34,896,695  |
| Liabilities and Stockholders' Equity (Deficit)                                                    |   |             |   |   |   |
| Current liabilities                                                                               |   |             |   |   |   |
|  Accounts payable                                                                            |   |             | $ 7,115,012  |   | $ 6,178,804  |
|  Current portion of long term debt                                                           |   |             | 650,742  |   | 647,576  |
|  Notes payable                                                                               |   |             | 20,162  |   | 23,333  |
|  Notes payable - related party                                                               |   |             | 1,571,507  |   | 1,526,137  |
|  Accrued interest and other liabilities                                                      |   |             | 2,814,361  |   | 3,201,606  |
|  Billings in excess of costs on uncompleted contracts                                        |   |             | 3,450,335  |   | 824,402  |
|  Income taxes payable                                                                        |   |             | 143,000  |   | -  |
|  Deferred revenue                                                                            |   |             | 27,757  |   | 43,164  |
|       Total current liabilities                                     |   |             | 15,792,876  |   | 12,445,022  |
| Senior notes payable - related party, net of $58,090 and $82,127                                  |   |             |   |   |
|   discount at December 31, 2008 and June 30, 2008, respectively                         |   | 13,880,833  |   | 13,856,796  |
| Interest payable - related party                                                                  |   |             | 1,352,092  |   | 493,060  |
| Secured notes payable - related party                                                             |   |             | 250,000  |   | -  |
| Long term debt                                                                                    |   |             | 5,914,656  |   | 5,111,420  |
| Dividends payable                                                                                 |   |             | 1,114,652  |   | 400,833  |
|       Total long term debt                                          |   |             | 22,512,233  |   | 19,862,109  |
| Less: Current portion                                                                             |   |             | (650,742) |   | (647,576) |
|       Long term debt                                                |   |             | 21,861,491  |   | 19,214,533  |
|       Total liabilities                                             |   |             | 37,654,367  |   | 31,659,555  |
| Warrants Payable - Series H                                                                       |   |             | 169,768  |   | 169,768  |
| Stockholders' (Deficit) Equity                                                                    |   |             |   |   |   |
| Preferred stock, $0.01 par value, 10,000,000 shares authorized,                                   |   |             |   |   |
|   1,918,080 shares issued and outstanding                                               |   |             | 12,353,845  |   | 12,346,482  |
| Common stock, $0.001 par value, 2,000,000,000 shares authorized,                                  |   |             |   |   |
|   48,846,244 shares issued and 45,275,813 shares outstanding                            |   | 48,846      |   | 48,846  |
| Additional paid-in capital                                                                        |   |             | 52,733,476  |   | 51,385,199  |
| Additional paid-in capital - warrants                                                             |   |             | 148,652  |   | 148,652  |
| Treasury stock - 3,570,431 shares at cost                                                         |   |             | (250,000) |   | -  |
| Accumulated deficit                                                                               |   |             | (62,412,158) |   | (59,339,836) |
| Accumulated comprehensive loss                                                                    |   |             | (3,432,109) |   | (1,521,971) |
|       Total stockholders' (deficit) equity                          |   |             | (809,448) |   | 3,067,372  |
|       Total liabilities and stockholders' (deficit) equity          |   |             | $ 37,014,687  |   | $ 34,896,695  |
| The accompanying notes are an integral part of these condensed consolidated financial statements. |   |

 
| HOMELAND SECURITY CAPITAL CORPORATION AND SUBSIDIARIES                                                                                |                                 |   |                                 |
|---------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------|--------|--------------------------------------|
| Consolidated Statements of Operations (Unaudited)                                                                                     |                                 |   |                                 |
|                                                                                                                                  | Three Months Ended December 31, 2008 |   | Three Months Ended December 31, 2007 |   | Six Months Ended December 31, 2008 |   | Six Months Ended December 31, 2007 |
| Net contract revenue                                                                                                                  | $ 22,212,461                         |   | $ 3,734,738                     |   | $ 39,879,692  |   | $ 6,343,096  |
| Contract costs                                                                                                                        | 18,480,949                      |   | 3,042,140                       |   | 33,313,889  |   | 4,736,714  |
|       Gross profit on sales                                                                             | 3,731,512                       |   | 692,598                         |   | 6,565,803  |   | 1,606,382  |
| Operating expenses                                                                                                                    |                                 |   |                                 |   |   |   |   |
|   Marketing                                                                                                                 | 54,094                          |   | 8,291                           |   | 123,851  |   | 11,851  |
|   Personnel                                                                                                                 | 1,744,094                       |   | 873,371                         |   | 4,353,851  |   | 1,607,041  |
|   Insurance and facility costs                                                                                              | 226,407                         |   | (63,041)                             |   | 522,022  |   | 137,697  |
|   Travel and transportation                                                                                                 | 109,053                         |   | 78,903                          |   | 272,501  |   | 216,420  |
|   Other operating costs                                                                                                     | 225,428                         |   | 13,040                          |   | 458,051  |   | 44,120  |
|   Depreciation and amortization                                                                                             | 468,978                         |   | 15,492                          |   | 616,508  |   | 34,781  |
|   Amortization of intangible assets                                                                                         | 34,274                          |   | -                               |   | 68,548  |   | -  |
|   Professional services                                                                                                     | 199,080                         |   | 149,661                         |   | 514,263  |   | 278,828  |
|   Administrative costs                                                                                                      | 326,140                         |   | 139,711                         |   | 627,432  |   | 217,568  |
|       Total operating expenses                                                                          | 3,387,548                       |   | 1,215,428                       |   | 7,557,027  |   | 2,548,306  |
| Operating income (loss)                                                                                                               | 343,964                         |   | (522,830)                            |   | (991,224) |   | (941,924) |
|   Other (expense) income                                                                                                    |                                 |   |                                 |   |   |   |   |
|       Interest expense                                                                                  | (504,537)                            |   | (324,444)                            |   | (1,006,189) |   | (631,235) |
|       Amortization of debt discounts                                                                    | (12,019)                             |   | (715,465)                            |   | (24,037) |   | (1,379,325) |
|       Amortization of debt offering

        costs              | (123,092)                            |   | (112,669)                            |   | (246,185) |   | (227,032) |
|       Adjustment of fair value of

        derivative liability | -                               |   | (471,354)                            |   | -  |   | 1,155,903  |
|       Investment income                                                                                 | 6,133                           |   | 6,830                           |   | 14,494  |   | 21,242  |
|       Settlement of debt                                                                                | -                               |   | (105,000)                            |   | -  |   | (45,237) |
|       Other income                                                                                      | 22,500                          |   | 17,000                          |   | 45,000  |   | 17,000  |
|       Total other expense                                                                               | (611,015)                            |   | (1,705,102)                          |   | (1,216,917) |   | (1,088,684) |
| Loss from continuingoperations 

   before income taxexpense                                                      | (267,051)                            |   | (2,227,932)                          |   | (2,208,141) |   | (2,030,608) |
| Income tax expense                                                                                                                    | (143,000)                            |   | -                               |   | (143,000) |   | -  |
| Loss from continuing operations                                                                                                       | (410,051)                            |   | (2,227,932)                          |   | (2,351,141) |   | (2,030,608) |
| Discontinued operations                                                                                                               |                                 |   |                                 |   |   |   |   |
|   Loss from discontinued operations                                                                                         | -                               |   | -                               |   | -  |   | (63,979) |
|   Gain from sale of operating segment                                                                                       | -                               |   | -                               |   | -  |   | 3,657,930  |
|   Income from discontinued

    operations                                                              | -                               |   | -                               |   | -  |   | 3,593,951  |
| Net (loss) income                                                                                                                     | (410,051)                            |   | (2,227,932)                          |   | (2,351,141) |   | 1,563,343  |
|   Less preferred dividends and other     beneficial conversion                                          |                                 |   |                                 |   |   |   |   |
|     features associated with preferred     stock issuance                                     | (356,910)                            |   | -                               |   | (713,818) |   | -  |
| Net (loss) income attributable to

  common stockholders                                                                    | $ (766,961)                          |   | $ (2,227,932)                        |   | $ (3,064,959) |   | $ 1,563,343  |
| (Loss) income per common share -

  basic and diluted                                                                       |                                 |   |                                 |   |   |   |   |
|   Loss from continuing operations                                                                                           | $ (0.02)                             |   | $ (0.05)                             |   | $ (0.06) |   | $ (0.05) |
|   Income from discontinued

    operations                                                              | 0.00                            |   | 0.00                            |   | 0.00 |   | 0.08  |
|       Basic and diluted EPS                                                                             | $ (0.02)                             |   | $ (0.05)                             |   | $ (0.06) |   | $ 0.03  |
|       Weighted average shares

        outstanding -            |                                 |   |                                 |   |   |   |   |
|           Basic                                                                     | 47,506,560                      |   | 44,631,048                      |   | 48,183,683 |   | 43,193,149  |
|           Diluted                                                                   | 47,506,560                      |   | 44,631,048                      |   | 48,183,683 |   | 43,193,149  |
|  

The accompanying notes are an integral part of these condensed consolidated financial statements.                             |                                 |        |
| HOMELAND SECURITY CAPITAL CORPORATION AND SUBSIDIARIES                                                          |                                        |   |
|-----------------------------------------------------------------------------------------------------------------|---------------------------------------------|--------|
| Consolidated Statements of Cash Flows (Unaudited)                                                               |                                        |   |   |
|                                                                                                            | Six Months

 Ended

December 31,

2008 |   | Six Months

Ended

December 31,

2007 |
| Cash flows from operating activities:                                                                           |                                        |   |   |
|   Net (loss) income                                                                                   | $ (2,351,141)                               |   | $ 1,563,343  |
|   Adjustments to reconcile net loss to net                                                            |                                        |   |   |
|     cash (used in) operating activities:                                                    |                                        |   |   |
|       Gain on sale of operating segment                                           | -                                      |   | (3,657,930) |
|       Settlement of debt                                                          | -                                      |   | 45,237  |
|       Stock-based compensation expense                                            | 1,348,278                              |   | 170,905  |
|       Depreciation                                                                | 886,497                                |   | 34,781  |
|       Amortization of intangibles                                                 | 68,548                                 |   | -  |
|       Valuation reserve for accounts receivable                                   | (36,152)                                    |   | (57,407) |
|       Amortization of debt discount                                               | 24,037                                 |   | 1,379,324  |
|       Amortization of debt offering costs                                         | 246,185                                |   | 227,032  |
|       Valuation losses for changes in derivative liability                        | -                                      |   | (1,155,903) |
|       Changes in operating assets and liabilities:                                |                                        |   |   |
|         Accounts receivable                                             | (6,191,142)                                 |   | 1,258,385  |
|         Costs in excess of billings on uncompleted contracts            | (76,718)                                    |   | (185,327) |
|         Other assets                                                    | 17,678                                 |   | 44,969  |
|         Accounts payable                                                | 936,206                                |   | (236,975) |
|         Billings in excess of costs on uncompleted contracts            | 2,625,933                              |   | (261,671) |
|         Accrued liabilities                                             | 507,563                                |   | 536,110  |
|         Income taxes payable                                            | 143,000                                |   | -  |
|         Deferred revenue                                                | (15,407)                                    |   | -  |
|           Net cash used in operating activities               | (1,866,635)                                 |   | (295,127) |
| Cash flows from investing activities:                                                                           |                                        |   |   |
|   Purchase of fixed assets                                                                            | (313,321)                                   |   | (14,589) |
|   Investment activity of discontinued operations                                                      | -                                      |   | 687,708  |
|           Net cash (used in) provided by investing activities | (313,321)                                   |   | 673,119  |
| Cash flows from financing activities:                                                                           |                                        |   |   |
|   Net borrowings on line of credit                                                                    | 1,178,065                              |   | -  |
|   Proceeds from notes payable                                                                         | -                                      |   | 34,149  |
|   Payments on term debt                                                                               | (332,107)                                   |   | (474,402) |
|   Cost of convertible debentures                                                                      | -                                      |   | 92,486  |
|   Financing activities of discontinued operations                                                     | -                                      |   | (674,121) |
|           Net cash provided by (used in) financing activities | 845,958                                |   | (1,021,888) |
| Effect of exchange rate changes on cash and cash equivalents                                                    | (268,534)                                   |   | -  |
| Net decrease in cash                                                                                            | (1,602,532)                                 |   | (643,896) |
| Cash, beginning of period                                                                                       | 3,182,357                              |   | 701,417  |
| Cash, end of period                                                                                             | $ 1,579,825                            |   | $ 57,521  |
| The accompanying notes are an integral part of these condensed consolidated financial statements.               |

 
| HOMELAND SECURITY CAPITAL CORPORATION AND SUBSIDIARIESConsolidated Statements of Changes in Stockholders' Equity (Deficit) |
|----------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                       |   |   |   |   |   | Additional

Paid-In

Capital -

Warrants |   |   |   | Total

Stockholders'

Equity

(Deficit) |
|                                                                                                                       |   |   |   |   | Additional

Paid-In

Capital |   |                              
Accumulated

Deficit | Accumulated

Comprehensive

Loss |
|                                                                                                                       | Preferred | Common Stock | Treasury

Stock |
|                                                                                                                       | Stock | Shares                            Issued |   | Amount |
| Balance, June 30, 2008                                                                                                     | $ 12,346,482 | 48,846,244 |   | $ 48,846 | $ 51,385,199 | $ 148,652 | $                  - | $ (59,339,836) | $ (1,521,971) | $ 3,067,372  |
| Following

  Transactions

  Unaudited:                                                                |   |   |   |   |   |   |   |   |   |   |
| Amortization of Series

  H  warrants                                                                  | 7,363 |   |   |   |   |   |   | (7,363) |   | -  |
| Purchase of treasury

  stock                                                                                    |   |   |   |   |   |   | (250,000) |   |   | (250,000) |
| Dividends on Series H

  and Series I                                                                            |   |   |   |   |   |   |   | (713,818) |   | (713,818) |
| Value of vested stock

  options                                                                                 |   |   |   |   | 1,348,277 |   |   |   |   | 1,348,277  |
| Reduction in value of

  assets held for sale                                                                    |   |   |   |   |   |   |   |   | (1,641,602) | (1,641,602) |
| Currency translation                                                                                                       |   |   |   |   |   |   |   |   | (268,536) | (268,536) |
| Net loss                                                                                                                   |   |   |   |   |   |   |   | (2,351,141) |   | (2,351,141) |
| Net comprehensive

  loss                                                                                        |   |   |   |   |   |   |   |   |   | (4,261,279) |
| Balance, December 31,

  2008                                                                                    | $ 12,353,845 | 48,846,244 |   | $ 48,846 | $ 52,733,476 | $ 148,652 | $ (250,000) | $ (62,412,158) | $ (3,432,109) | $ (809,448) |
|                                                                                                                       |   |   |   |   |   |   |   |   |   |   |
| The accompanying notes are an integral part of these consolidated financial statements.                                    |  |  |

 

 

**HOMELAND SECURITY CAPITAL CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**(UNAUDITED)            December 31, 2008

**1. Presentation of Unaudited Interim Financial Statements.**

The accompanying unaudited condensed consolidated financial statements of Homeland Security Capital Corporation (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and pursuant to the rules and regulations of the            Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six months endedDecember 31, 2008 are not necessarily indicative of the results that may be expected            for the fiscal year ended June 30, 2009.

The condensed consolidated financial statements include the accounts of Homeland Security Capital Corporation and its wholly-owned subsidiary, Safety & Ecology Holdings Corporation (“Safety”), and its majority owned subsidiaries Nexus Technologies Group, Inc., and Polimatrix, Inc. All intercompany balances and transactions have been            eliminated.

The balance sheet at June 30, 2008 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements. For further information, please refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report            on Form 10-K for the transition period ended June 30, 2008.

Homeland Security Capital Corporation (together with any subsidiaries shall be referred to as the “Company,” “we,” “us” and “our”) is an international provider of specialized technology-based radiological, nuclear, environmental, disaster relief and security solutions to government and commercial customers.            The Company is focused on creating long-term value by taking controlling interest in and developing its subsidiary companies through superior operations, financial support and management. We operate businesses that provide homeland security products and services solutions, growing organically and by acquisitions. The Company is targeting companies that are generating revenues but face challenges in scaling their businesses to capitalize on homeland security opportunities.

On February 7, 2006, the Company organized Nexus Technologies Group, Inc. (“Nexus”) as a new subsidiary and purchased $3,400,000 of Nexus’ convertible preferred stock. Simultaneously with its formation, Nexus acquired 100% of the outstanding common stock of Corporate Security Solutions, Inc. (“CSS”), which was organized in            2001 and provides integrated security systems for the corporate and governmental security markets, through engineering, design and installation of open-ended technologically advanced applications. At December 31, 2008 the Company owns approximately 93% of Nexus.

On August 21, 2006, the Company organized Security Holding Corp. (“SHC”) and purchased $3,000,000 of SHC’s convertible preferred stock. Simultaneously with its formation SHC acquired 100% of the outstanding stock of Security Holdings Enterprises, Inc. (“SHEI”). SHEI owned 100% of the outstanding equity of three subsidiaries.            SHEI merged with SHC, with SHC remaining as the surviving corporate entity. As further described in Note 6, the Company has sold its ownership interest in SHC and discontinued operations with respect to RFID, access control and security software.

On September 15, 2006, the Company formed Polimatrix, Inc. (“PMX”), and on September 18, 2006 entered into a U.S.-based joint venture with Polimaster, Inc., an Arlington, Virginia company involved in the field of nuclear and radiological detection and isotope identification. PMX uses technology licensed from Polimaster, Inc. in the development            of hand-held, networked detection devices intended to be sold to governmental and commercial customers. At December 31, 2008, the Company owns 51% of PMX.

On March 13, 2008, in conjunction with its primary business plan, the Company, entered into an Agreement and Plan of Merger and Stock Purchase Agreement (the “Merger Agreement”) with Safety & Ecology Holdings Corporation (“Safety”) and certain persons named therein. Pursuant to the Merger Agreement, the Company purchased            10,550,000 shares of Safety’s Series A Convertible Preferred Stock (the “Preferred Shares”) for an aggregate purchase price of $10,550,000. As

 

 

            further described in Note 8, the Company effectively acquired 100% of Safety as of March 1, 2008, subject to future management equity incentive programs, and at December 31, 2008 owned 100% of the outstanding capital stock of Safety.

The Company owns a majority of the outstanding capital stock of its subsidiaries, controls each of the subsidiary boards of directors and provides extensive advisory services to the subsidiaries. Accordingly, the Company believes it exercises sufficient control over the operations and financial results of each company and consolidates the results of            operations, eliminating minority interests when such minority interests have a basis in the consolidated entity.

**2. Summary of Significant Accounting Policies**

Foreign Operations – Safety & Ecology, Ltd. (“SECL”), a United Kingdom corporation, which is wholly owned by Safety has total assets before intercompany eliminations of $2,751,084, total liabilities of $2,367,979 and a net loss of $164,196 as of December 31, 2008, which are included in the Company’s consolidated financial            statements with intercompany eliminations to liabilities of $2,596,045 and expenses of $44,517.

The financial statements of SECL are translated using exchange rates in effect at period-end for assets and liabilities and average exchange rates during the period for results of operations. The related translation adjustments are reported as a separate component of shareholders’ equity.

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

Fair Value of Financial Instruments - The carrying amount of items included in working capital approximates fair value because of the short maturity of those instruments. The carrying value of the Company's debt approximates fair value because it bears interest at rates that are similar to current borrowing rates for loans of comparable terms, maturity            and credit risk that are available to the Company.

Revenue Recognition – Revenues are derived primarily from services performed under time and materials and fixed fee contracts. Revenues and costs derived from fixed price contracts are recognized using the percentage of completion (efforts expended) method.

Contract costs include all direct labor, materials, and other non-labor costs and those indirect costs related to contract support, such as depreciation, fringe benefits, overhead labor, supplies, tools, repairs and equipment rental. General and administrative costs are charged to expense as incurred. Provisions for estimated losses on uncompleted            contracts are made in the period in which such losses are determined. Changes in job performance, job conditions and estimated profitability, including those arising from contract penalty provisions, and final contract settlements may result in revisions to costs and income and are recognized in the period in which the revisions are determined. Because of inherent uncertainties in estimating costs, it is at least reasonably possible the estimates used may change within the near            term.

The asset, “costs in excess of billings on uncompleted contracts” represents revenues recognized in excess of billed amounts. The liability, “billings in excess of costs on uncompleted contracts,” represents billings in excess of revenues recognized.

Cash and Cash Equivalents - The Company considers all investments with a maturity of three months or less when purchased to be cash equivalents. Cash consists of cash on hand and deposits in banks. On October 3, 2008 the Federal Deposit Insurance Corporation (“FDIC”) temporarily increased deposit guarantees from $100,000 to $250,000. The            Company has approximately $728,964 atrisk for funds held in excess of the FDIC guarantee at December 31, 2008.

Recognition of Losses on Receivables- Trade accounts receivable are recorded at their estimated net realizable values using the allowance method. The Company generally does not require collateral from customers. Management periodically reviews accounts for collectability, including accounts determined to be            delinquent based on contractual terms. An allowance for doubtful accounts is maintained at the level management deems necessary to reflect anticipated credit losses. When accounts are determined to be uncollectible, they are charged off against the allowance for bad debts. At December 31, 2008, the Company has a consolidated bad debt allowance of $309,846.

 

 

Property and Equipment - Fixed assets are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the underlying assets, generally five years. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful lives of the assets or the term of the lease.            Routine repair and maintenance costs are expensed as incurred. Costs of major additions, replacements and improvements are capitalized. Gains and losses from disposals are included in income. The Company periodically evaluates the carrying value by considering the future cash flows generated by the assets. Management believes that the carrying value reflected in the consolidated financial statements is fairly stated based on these criteria.

Debt Offering Costs - Debt offering costs are related to private placements and are amortized on a straight-line basis over the term of the related debt, most of which is in the form of senior secured notes. Amortization expense amounted to $123,092 and $112,669 for the three months ended December 31, 2008 and December 31, 2007, respectively, and $246,185            and $227,032 for the six months ended December 31, 2008 and December 31, 2007, respectively.

Investments in Assets Held for Sale – The Company accounts for investments in marketable securities and other investments in accordance with the provisions of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. SFAS No. 115 addresses the accounting and reporting for investment equity securities with readily determinable            fair values and for all investments in debt securities. As of December 31, 2008 and June 30, 2008, all marketable securities were classified as assets held for sale. Under this classification, securities are carried at fair value (period end market closing prices) with unrealized gains and losses excluded from earnings and reported in a separate component of shareholder’s equity until the gains or losses are realized or a provision for impairment is recognized.

The table below reflects the assets held for sale as of December 31, 2008 and June 30, 2008
|              |       |   | Gross Unrealized |        |   |
|-------------------|------------|--------|------------------|-------------|--------|
|              | Cost       |   | Gain             | Loss        |   | Estimated                         Fair Value |
| December 31, 2008 | $3,581,047 |   | -                | $ 3,165,452 |   | $415,595 |
| June 30, 2008     | $3,581,047 |   | -                | $ 1,523,850 |   | $2,057,197 |

Investment Valuation - The value of investments that have no ready market are recorded at cost. Periodically management makes an assessment as to impairment of the Company’s investment and accordingly adjusts the investment to record other than a temporary change in value.

Income Taxes - Deferred income taxes are provided using the liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards 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 bases. 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 the changes in tax laws and rates on the date of enactment.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in            the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon            settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the statement of income.

Valuation of Options and Warrants - The valuation of options and warrants granted to unrelated parties for services are measured the earlier of: (1) the date at which a commitment for performance by the counterparty to earn the equity instrument is reached, or (2) the date the counterparty's performance is complete. Pursuant to the requirements of EITF            96-18, the options and warrants will continue to be revalued in situations where they are granted prior to the completion of the performance.

 

 

Employee Benefit Plans - Safety has a 401(k) profit sharing plan covering substantially all its employees. Employees are allowed to make pre-tax contributions to the plan, through salary reductions, up to the legal limits as described under the Internal Revenue Code. Any company match is discretionary. Safety contributed $70,530 and $154,308 to this plan            during the three and six months endedDecember 31, 2008, respectively.

SECL, a wholly owned subsidiary of Safety, has a group stakeholder pension scheme for the benefit of its employees. The plan covers substantially all SECL employees and provides for SECL to contribute at least three percent of the eligible employee’s compensation to the plan. SECL contributed $967 and $2,415 to their plan during the three and six            months endedDecember 31, 2008, respectively.

HSCC and Nexus both have salary deferral plans available to all their employees which allows each company to make a discretionary match to their plan. Employees are allowed to make pre-tax contributions to the plans, through salary reduction, up to the legal limits as described under the Internal Revenue Code. Neither HSCC nor Nexus made contributions to            their plans for the three and six month periods endingDecember 31, 2008.

PMX does not have a plan covering its employees.

Net Earnings (Loss) Per Share -The Company computes basic earnings (loss) per share in accordance with SFAS 128, “Earnings Per Share”by dividing net income (loss), adjusted for preferred stock dividends and other beneficial conversion features associated with the            preferred stock issuance, by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is computed by dividing net income by diluted weighted average shares outstanding. Potentially dilutive shares include the assumed exercise of stock options and warrants, the assumed conversion of preferred stock and the assumed vesting of stock option grants (using the treasury stock method), if dilutive.

Reclassifications – Certain amounts in the prior period have been reclassified to conform with current period classifications.

**3. Fixed Assets, net**

Cost and related accumulated depreciation of the fixed assets are as follows:
|                                   |   | December 31,                        2008 |   |                          
June 30,                        2008 |
|----------------------------------------|--------|------------------------------------------|--------|---------------------------------------------------------------------|
| Office equipment             | $      | 361,830                                  |   | $                                                                   | 367,942 |
| Operating equipment                    |   | 3,397,243                                |   |                                                                | 3,139,423 |
| Computer equipment                     |   | 1,845,878                                |   |                                                                | 1,781,828 |
| Vehicles                               |   | 799,837                                  |   |                                                                | 886,360 |
| Accumulated depreciation     |   | (1,530,459                               | )      |  (682,157)                                                     |
| June 30,                               |   |                                     |   | $                                                                   | 5,493,396 |
| December 31,                           | $      | 4,874,329                                |   |                                                                |   |

Depreciation expense was $448,453 and $15,492 for the three months ended December 31, 2008 and December 31, 2007, respectively, and $886,497 and $34,781 for the six months ended December 31, 2008 and December 31, 2007, respectively.

**4. Intangible Assets, net**

The components of intangible assets consist of the following at December 31, 2008 and June 30, 2008:
|                                         |   | December 31, 2008 |      |   | June 30, 2008 |
|----------------------------------------------|--------|-------------------|-----------|--------|---------------|
| Depreciable intangibles:                     |   |              |      |   |          |
| Non-compete agreements                       |   |         | $92,665   |   |          |   | $92,665 |
| Contracts                                    |   |              | 445,823   |   |          |   | 445,823 |
|                                         |   |              | 538,488   |   |          |   | 538,488 |
| Less accumulated amortization                |   |              | (114,414) |   |          |   | (45,866) |
|                                         |   |              | 424,074   |   |          |   | 492,622 |
| Non-depreciable intangibles                  |   |              |      |   |          |
| Trademarks                                   |   |              | 5,000     |   |          |   | 5,000 |
| Total intangible assets, net of amortization |   |              | $429,074  |   |          |   | $497,622 |

 

 

Amortization expense for intangibles was $34,274 for the three months ended December 31, 2008 and $68,548 for the six months ended December 31, 2008.

**5. Goodwill**

Goodwill is calculated as the difference between the cost of acquisition and the fair value of the net assets acquired of any business that is acquired.  The Company follows the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets,” and performs impairment tests of the intangible assets at least annually and impairment            losses are recognized if the carrying value of the intangible exceeds its fair value. For the three and six months endedDecember 31, 2008 and the period ended June 30, 2008, the Company did not incur any charges for impairment.

**6. Discontinued Operations**

On July 3, 2007, the Company entered into an agreement to sell the SHC business to Vuance Ltd. (“Vuance”). Pursuant to the terms of the Purchase Agreement, dated July 3, 2007, by and among the Company, as majority shareholder of SHC, the other shareholders of SHC (the “Minority Shareholders”) and SuperCom, Inc., a Delaware            corporation and wholly owned subsidiary of Vuance (“SuperCom”), SuperCom agreed to acquire all of the issued and outstanding capital stock of SHC for a purchase price of $5.1 million, payable in Vuance ordinary (common) shares. All required conditions were met and the sale was closed on August 29, 2007.

On August 29, 2007, 692,660 ordinary (common) shares of Vuance were issued to the Company at a price of $5.17 per share. Vuance also repaid all obligations of SHC to the Company under a certain note in the amount of approximately $400,000. The Company agreed to certain lock-up periods during which it will not sell or otherwise dispose of the Vuance            ordinary (common) shares.

Management has recognized the SHC activity as discontinued operations for the six months endedDecember 31, 2007.  The following table reflects selected elements of SHC’s results for the six months endedDecember 31, 2007 (there were no discontinued operations for the            three months ended December 31, 2007):
|   |                                  | Six Months Ended                        December 31, 2007              |   |   |
|--------|---------------------------------------|-----------------------------------------------------------------------------|--------|--------|
|   |                                  |                                                                        |   |   |
|   | Revenue                               | $            865,737 |   |   |
|   | Gross Margin                          | 405,143                                                                     |   |   |
|   | Operating Expenses                    | 467,143                                                                     |   |   |
|   | Other Expense                         | 1,979                                                                       |   |   |
|   | Net Loss from Discontinued Operations | (63,979)                                                                    |   |   |
|   | Gain on Sale of Operating Segment     | 3,657,930                                                                   |   |   |
|   |                                  |                                                                        |   |   |
|   | Net Assets                            | 1,861,572                                                                   |   |   |
|   | Net Liabilities                       | 1,938,456                                                                   |   |   |

For the six months ended December 31, 2007, the Company has separately disclosed the operating, investing and financing portions of the cash flows attributable to its discontinued operations, which in prior periods were reported on a combined basis.

**7.   Minority Interest in Secure America Acquisition Corporation**

The Company has indirectly acquired a minority equity interest in Secure America Acquisition Corporation (“SAAC”). SAAC is a blank check company formed for the purpose of acquiring one or more operating businesses in the homeland security industry. On June 1, 2007, the Company loaned $500,000 to Secure America Acquisition Holdings, LLC (“SAAH”), the principal initial stockholder of SAAC, pursuant to a promissory note (the            “SAAH Note”). The SAAH Note has a maturity date of May 31, 2011 and bears interest at a rate of 5% per annum. All principal and accrued interest on the SAAH Note is due upon maturity. The obligations of SAAH under the SAAH Note have been guaranteed by our Chief Executive Officer and Chairman. As consideration for the issuance of the SAAH Note, the Company received 250,000 membership interests in SAAH. On October 22, 2007, the Company purchased 75,000 Class C            membership interests in SAAH, through an investment in SAAH in the amount of $150,000. Also, on October 22, 2007, the Company loaned SAAH $65,000. The unsecured loan was for working capital purposes, was evidenced by a note and was due before October 22, 2008 with no prepayment penalties. The loan was repaid on October 29, 2007 in its entirety. Through its membership interests in SAAH, the Company is deemed to beneficially own 2.6% of the outstanding capital stock of            SAAC at December

 

 

31, 2008 and is entitled to receive 325,000 shares of common stock in SAAC if and when SAAC completes an acquisition or business combination which it has 24 months to consummate. At December 31, 2008, the balance of the SAAH Note due to the Company was $402,953.

In addition to the Company’s ownership in SAAH, our Chief Executive Officer and Chairman beneficially owns 1,178,733 membership interests in SAAH or approximately 50.71%, our Chief Financial Officer owns 82,500 membership interests or 3.50%, and two of our directors collectively own 125,000 membership interests in SAAH or 4.24%.

The Company has also entered into an agreement (the “SAAC Agreement”) with SAAC whereby the Company is to receive a monthly fee of up to $7,500 for providing SAAC with office space and certain office and administrative services. The SAAC Agreement became effective on October 23, 2007, the effective date of the Registration Statement as filed            with the Securities and Exchange Commission (the “SAAC IPO”). Certain employees of the Company will perform required services pursuant to the SAAC Agreement.

Notwithstanding the completion of the SAAC IPO, the Company does not value at market prices the shares of common stock in SAAC it is entitled to receive as a result of its membership interests in SAAH. Management believes some uncertainty to the successful completion of an acquisition or business combination exists and therefore values its loan to SAAH at            the principal amount plus accrued interest and its investment in SAAH at the original investment amount. The Company measures impairment of these amounts on a monthly basis and adjusts the amounts accordingly.

**8. Investment in Safety & Ecology Holdings Corporation**

On March 13, 2008, the Company entered into a Merger Agreement with Safety. Previously, Safety and the Company agreed, for the purposes of the transaction, to transfer effective control of Safety to the Company as of March 1, 2008. From the period of March 1, 2008 until the purchase consideration was exchanged, the Company recorded $59,736 for interest            imputed during the period. The accompanying financial statements include the results of Safety from July 1, 2008 throughDecember 31, 2008.

Pursuant to the Merger Agreement, the Company purchased 10,550,000 shares of Safety Series A Convertible Preferred Stock (the “Safety Preferred Shares”) and 20 shares of Safety common stock for an aggregate purchase price of $10,550,020. Each Safety Preferred Share will accrue dividends cumulatively at the rate of eight percent (8%) per annum            and is convertible into one (1) share of the Safety common stock at any time by the Company, subject to adjustment for stock dividends, stock splits, and similar events. Each Safety Preferred Share will be entitled to one vote as if converted into Safety common stock. The holders of the outstanding Safety Preferred Shares vote as a class on certain matters and will have the right to designate a majority of the board of directors of Safety. Each Safety Preferred Share will have a            liquidation preference of $1.00 per share plus any accrued and unpaid dividends.

As stipulated in the Merger Agreement, a new subsidiary was merged with and into Safety (the "Merger"), with Safety surviving the Merger. In exchange for all of the issued and outstanding Safety common stock, the shareholders of Safety (the “Shareholders”) initially received: (1) an aggregate of 550,000 shares of Company’s Series I            Convertible Preferred Stock (the “Series I Stock”) with an initial stated and liquidation value of $3,300,000, (2) warrants (the “Warrants”) to purchase up to 22,000,000 shares of the Company’s common stock, par value $0.001 per share (the “Common Stock”), (3) unsecured promissory notes (the “Notes”) of Safety in an aggregate principal amount of $2,000,000, and (4) $3,900,000 in cash, (collectively, the “Merger            Consideration”). Pursuant to the Merger Agreement, the Merger Consideration received by the Shareholders may be: (1) reduced based on Safety’s stockholders’ equity (as determined at closing) and (2) reduced or increased based on Safety’s working capital (as determined at closing). In addition, in the future, the Shareholders may receive up to an aggregate of $6,000,000 of the Common Stock if certain performance criteria are achieved by Safety in 2008 and            2009. The Series I Stock and Warrants will be held in escrow for twelve months to offset any indemnification claims or purchase price adjustments pursuant to the Merger Agreement. As of March 27, 2008, Safety secured an extension of their pending Radcon contract and qualified to release $1,800,000, in stated value, of the Series I Stock (and related Warrants) from escrow.

On December 31, 2008, pursuant to the Merger Agreement, (1) 300,000 shares of Series I Stock and (2) Warrants to purchase 12,000,000 shares of Common Stock, were released from escrow to the former stockholders of Safety.

 

 

Also pursuant to the Merger Agreement, (1) $6,650,000 in existing indebtedness of Safety was repaid, (2) $2,000,000 in Safety preferred stock was redeemed, and (3) approximately $2,400,000 of existing indebtedness of Safety was permitted to remain outstanding.

The Company amended its Certificate of Incorporation to designate 550,000 shares of its authorized preferred stock as Series I Convertible Preferred Stock. Each share of Series I Stock accrues a dividend of 12% per annum. The Series I Stock rankspari passuwith the Company’s            Series H Convertible Preferred Stock (See Notes 9 and 15) and is senior to all other series of the Company’s preferred stock and the Common Stock. The holder of the Series I Stock may convert the accrued dividends into the Common Stock at a conversion price of $0.06 per share or receive a cash payment upon liquidation or sale of the Company. Each share of Series I Stock is convertible into 200 shares of Common Stock (effectively a conversion price of $0.038 per            share at the date issued) and has a liquidation preference of $6.00 per share.

The Warrants have an exercise price equal to $0.03, which may be adjusted under the terms of the Warrants, and have a term of five years from the date of issuance of March 14, 2008. The Notes accrue interest at a rate of 6% per annum and are subordinate to the existing indebtedness of Safety. Immediately following the Merger, the Company controlled            100% of the voting power of Safety.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition, rounded to the nearest thousand, as recorded by the Company at June 30, 2008 andDecember 31, 2008. The Company is still in the process of finalizing third party valuations of certain            intangible assets; therefore the allocation of the purchase price is preliminary and subject to refinement.
|        |                                 |         | June 30, 2008                        and                        December 31, 2008 |   |
|--------|--------------------------------------|--------------|-----------------------------------------------------------------------------------|--------|
|   | Current assets                       | $            | 8,724,000                                                                         |   |
|   | Property, plant and equipment        |         | 5,273,000                                                                         |   |
|   | Other assets                         |         | 29,000                                                                            |   |
|   | Goodwill and other intangible assets |         | 5,785,000                                                                         |   |
|   |                                 |         |                                                                              |   |
|   | Total assets acquired                |         | 29,811,000                                                                        |   |
|   |                                 |         |                                                                              |   |
|   | Current liabilities                  |         | 13,501,000                                                                        |   |
|   | Long term debt                       |         | 1,885,000                                                                         |   |
|   | Other liabilities                    |         | 1,203,000                                                                         |   |
|   | Total liabilities assumed            |         | 16,589,000                                                                        |   |
|   |                                 |         |                                                                              |   |
|   | Net assets acquired                  | $            | 13,222,000                                                                        |   |
|   |                                 |    |                                                                              |   |

At June 30, 2008 andDecember 31, 2008, goodwill and other intangible assets includes: $93,000 assigned to non-compete agreements (1 year useful life), $446,000 assigned to contracts (10 year useful life), $5,000 assigned to trademarks (indefinite life) and $5,241,000 assigned to goodwill.

As mentioned above, the Company is still in the process of finalizing third party valuations for certain intangible assets. The changes from March 31, 2008 to December 31, 2008 in how purchase price was allocated to the acquisition of Safety, reflect further refinements in valuation for certain intangible assets, changes in estimated useful lives of            certain intangible assets, adjustments to estimates originally made by management and changes in the calculation of purchase price, specifically the valuation of warrants, by recalculating their value using new volatility measurements and expected life.

**9. Securities Purchase Agreement with YA Global Investments, L.P. (“YA”)**

On March 13, 2008, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with YA, which resulted in the following transactions being consummated on March 14, 2008:

Pursuant to the Purchase Agreement, the Company has authorized the designation of its Series H Convertible Preferred Stock, par value $.01 per share (the "Series H Stock"), consisting of 10,000 shares of Series H Stock, which are

 

 

 

convertible into shares of the Common Stock, in accordance with the terms of the Certificate of Designation of the Series H Stock of the Company (the "Series H Certificate of Designation").

Pursuant to the Purchase Agreement, the Company sold to YA (1) $6,310,000 of senior secured notes (the “New Notes”) for a purchase price of $6,310,000, (2) 6,190 Shares of Series H Stock (the “New Preferred Shares”) for a purchase price of $6,190,000, and (3) a warrant (the “YA Warrant”) to be initially exercisable to            acquire 83,333,333 shares of Company’s common stock (the “Warrant Shares”).

The Company used $10,550,020 of the proceeds from the Purchase Agreement to acquire Safety. The remaining cash proceeds and other consideration were used to restructure the debentures, related discounts and derivative liabilities as follows:

(1) a Securities Purchase Agreement, dated as of February 6, 2006 (the “February 2006 Purchase Agreement”), pursuant to which, among other things, YA purchased from the Company an aggregate original principal amount of $4,000,000 of senior secured convertible debentures (the “February 2006 Debentures”), which had an outstanding            principal balance at March 17, 2008 of $3,810,000, plus accrued and unpaid interest thereon.

(2) a Securities Purchase Agreement, dated as of August 21, 2006 (the “August 2006 Purchase Agreement”), pursuant to which, among other things, YA purchased from the Company an aggregate original principal amount of $4,000,000 of senior secured convertible debentures (the “August 2007 Debentures”), which had an outstanding            principal balance at March 17, 2008 of $4,000,000, plus accrued and unpaid interest thereon.

(3) a Securities Purchase Agreement, dated as of June 1, 2007 (the “June 2007 Purchase Agreement”), pursuant to which, among other things, YA purchased from the Company an aggregate original principal amount of $2,750,000 of senior secured convertible debentures (the “June 2007 Debentures”), which had an outstanding principal            balance at March 17, 2008 of $2,750,000, plus accrued and unpaid interest thereon.

In addition, pursuant to the Purchase Agreement, YA exchanged (1) its February 2006 Debentures (but not accrued and unpaid interest thereon) in the amount of $3,810,000 for 3,810 Shares of Series H Stock (the “Exchanged Preferred Shares” and collectively along with the New Preferred Shares, the “Preferred Shares”); and (2) its            August 2006 Debentures and its June 2007 Debentures (but not accrued and unpaid interest thereon) for an aggregate original principal amount of $6,750,000 of senior secured notes (the “Exchanged Notes” and collectively along with the New Notes, the “Notes”).

Each share of Series H Stock accrues a dividend of 12% per annum. The holder of the shares of Series H Stock (a “Series H Holder”) may convert the accrued dividends into Common Stock at a conversion price of $0.06 per share or receive a cash payment on liquidation or sale of the Company. The Series H Stock will rankpari passuwith the Series I Stock and senior to all other series of the Company’s preferred stock and the Common Stock. Each share of Series H Stock is convertible into 33,334 shares of Common Stock (effectively a conversion price of $0.03 per share) and has a liquidation preference of $1,000 per share. Each share of Series H Stock may be voted on an as-converted basis with the Common Stock but in no            instance will the voting power of a Series H Holder with respect to its Series H Stock (when aggregated with all other Common Stock beneficially owned by the Series H Holder) be permitted to exceed 9.99% of the shares permitted to vote at a meeting of the Company’s stockholders. In addition, Series H Holders are restricted from conversions of the Series H Stock that will result in it beneficially owning more than 9.99% of the Common Stock following such conversion, which is            subject to waiver by the Series H Holder. The number of shares issuable upon the conversion of our Series H Stock will increase if our Safety subsidiary has EBITDA of less than $4,000,000 for either the 2008 calendar year or the 2009 calendar year. The amount of the adjustment will be based on the amount of the shortfall from such targets (see Series H Certificate of Designation).

The Notes accrue interest at a rate of 13% per annum and have a maturity date of March 13, 2010. The obligations of the Company pursuant to the Purchase Agreement and the Notes have been guaranteed by Celerity Systems, Inc. (“Celerity”), Nexus and Homeland Security Advisory Services, Inc. (“HSAS”) pursuant to a Guaranty. The            Notes are secured by the assets of the Company, Celerity and HSAS.

In connection with the Purchase Agreement, the Company issued to YA a warrant to purchase up to 83,333,333 shares of Common Stock (the “YA Warrant”). The YA Warrant has an exercise price equal to $0.03, which may be adjusted under the terms of the YA Warrant, and has a term of five years from the date of issuance on March 17, 2008. In            addition, the holder of the YA Warrant is restricted from exercises of the YA Warrant that will result in it beneficially owning more than 9.99% of the outstanding Common Stock following such exercise.  If the Company fails to file a registration statement, or if filed, fails to maintain the registration statements effectiveness covering the underlying shares pursuant to the YA Warrant,

 

 

 

the Company will be required to settle the intrinsic value of the YA Warrant in cash. As a result of this feature in the Purchase Agreement, the Company has recorded the value of the YA Warrant outside of permanent equity.

In connection with the transactions pursuant to the Purchase Agreement, an affiliate of YA received a monitoring fee of $800,000 in the aggregate for its monitoring and managing the YA investment in the Company was payable ratably on June 30, 2008 and September 30, 2008. In addition, such affiliate received $50,000 for its structuring of the transaction            and its due diligence costs.

On March 17, 2008, the accrued but unpaid interest on the February 2006 Debentures, the August 2006 Debentures and the June 2007 Debentures amounted to $878,923. Pursuant to the Purchase Agreement, the Company exchanged a non-interest bearing note (the “Conversion Note”) for the entire amount of the unpaid interest. The Conversion Note is due            March 13, 2010.

The Company’s Senior Secured Notes Payable and Conversion Note Payable consist of the following:
|        |                                              |   | December 31, 2008 |            | June 30, 2008 |   |
|--------|---------------------------------------------------|--------|-------------------|-----------------|---------------|--------|
|   | Senior Secured Notes Payable (the New Notes)      |   | $                 |  6,310,000 |          | $      | 6,310,000 |   |
|   | Senior Secured Notes Payable (the Exchange Notes) |   |              | 6,750,000       |          |   | 6,750,000 |   |
|   | Debenture interest conversion note                |   |              | 878,923         |          |   | 878,923 |   |
|   | Less debt discount                                |   |              | (58,090)        |          |   |  (82,127) |   |
|   |                                              |   | $                 | 13,880,833      |          | $      | 13,856,796 |   |
|   |                                              |   |              |            |          |   |   |   |

In connection with EITF 98-5 and EITF 00-27, the Company reduced the carrying value of the Series H Stock for the fair value of the YA Warrant in the amount of $169,768. The Series H Stock was further reduced by $2,740,540 for the beneficial conversion feature of the security. Since the Series H Stock was convertible and the YA Warrant exercisable at            the time of issuance, the Series H Stock was increased to stated value through a charge to retained earnings.

The Company also entered into a Registration Rights Agreement with YA pursuant to which the Company is obligated, upon request of YA (or its successors and assigns), to file a registration statement covering the resale of shares of Common Stock issuable upon the conversion of the Series H Stock and exercise of the YA Warrant.

The Company amended its Certificate of Incorporation to designate 10,000 shares of its authorized preferred stock as Series H Stock.

**10. Common Stock Purchase Agreement with YA Global Investments, L.P. (“YA”)**

On November 26, 2008, the Company entered into a Common Stock Purchase Agreement with YA, where the Company purchased from YA 2,043,494 shares of its Common Stock, par value $0.001 per share, for a purchase price of $178,655. The transaction was funded with a note issued to YA for the total purchase price and bears interest at 13% with principal and            accrued interest due March 24, 2010 (the “YA Note 1”). The Company has accounted for the purchase of the common shares as treasury stock on the balance sheet at cost.

On November 28, 2008, the Company entered into another Common Stock Purchase Agreement with YA, where the Company purchased from YA 1,526,937 shares of its Common Stock, par value $0.001 per share, for a purchase price of $71,345. The transaction was funded with a note issued to YA for the total purchase price and bears interest at 13% with principal and            accrued interest due March 24, 2010 (‘YA Note 2” and together with YA Note 1, the “YA Notes”). The Company has accounted for the purchase of the common shares as treasury stock on the balance sheet at cost.

The YA Notes are secured by the Common Stock purchased from YA (the “Purchased Common Stock”) in these transactions. The Purchased Common Stock will be held in escrow until all obligations pursuant to the YA Notes have been paid in full.

The Company recorded the Purchased Common Stock as treasury stock and excludes these shares from the total shares outstanding at December 31, 2008.

The Company’s Secured Notes Payable for the repurchase of Common Stock consist of the following:

 

 
|   | Secured Notes Payable (November 26, 2008 Agreement) | $      | 178,655 |   |
|--------|-----------------------------------------------------|--------|---------|--------|
|   | Secured Notes Payable (November 28, 2008 Agreement) |   | 71,345  |   |
|   |                                                | $      | 250,000 |   |
|   |                                                |   |    |   |

**11. Income Taxes**

The Company and certain of its subsidiaries file income tax returns in the U.S. and in various state jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-US income tax examinations by tax authorities for years before 2003.

The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. As a result of the implementation of Interpretation 48, the Company recognized no increase in the liability for unrecognized tax benefits.

There are no amounts included in the balance atDecember 31, 2008 for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of the shorter            deductibility period would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period.

It is the Company’s policy to recognize any interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expenses. During the six months endedDecember 31, 2008, the Company recognized no interest or penalties.

The tax effects of temporary differences giving rise to the Company's deferred tax assets (liabilities) atDecember 31, 2008 and June 30, 2008areasfollows:
|   |                                                       |   | **December 31,                        2008** |        | **June 30,                        2008** |   |
|--------|------------------------------------------------------------|--------|----------------------------------------------|-------------|------------------------------------------|--------|
|   | Current:                                                   |   |                                         |        |                                     |   |   |   |
|   | Related party accruals                                     |   | $                                            | 517,716     |                                     | $      | 188,793 |   |
|   | Allowance for doubtful accounts                            |   |                                         | 118,359     |                                     |   | 132,101 |   |
|   | Accrued and prepaid expenses                               |   |                                         | 115,166     |                                     |   | 104,035 |   |
|   | Accumulated option expense                                 |   |                                         | 796,119     |                                     |   | -- |   |
|   | Other                                                      |   |                                         | 41,104      |                                     |   | 48,281 |   |
|   |                                                       |   |                                         |        |                                     |   |   |   |
|   | Valuation allowance for net current deferred tax assets    |   |                                         | (1,588,464) |                                     |   | (473,210) |   |
|   |                                                       |   |                                         |        |                                     |   |   |   |
|   | Total net current deferred tax asset                       |   | $                                            | —     |                                     | $      | — |   |
|   |                                                       |   |                                         |        |                                     |   |   |   |
|   | Noncurrent:                                                |   |                                         |        |                                     |   |   |   |
|   | Net operating loss and research credit carryforwards       |   |                                         | 5,348,878   |                                     |   | 4,382,868 |   |
|   | Depreciation and amortization expenses                     |   |                                         | (426,618)   |                                     |   | (688,800) |   |
|   | Amortization of intangible assets                          |   |                                         | (162,394)   |                                     |   | (188,670) |   |
|   | Valuation allowance for net noncurrent deferred tax assets |   |                                         | (4,759,866) |                                     |   | (3,505,398) |   |
|   |                                                       |   |                                         |        |                                     |   |   |   |
|   | Total net noncurrent deferred tax asset                    |   | $                                            | —     |                                     | $      | — |   |
|   |                                                       |   |                                         |        |                                     |   |   |   |

As a result of significant historical pretax losses, management cannot conclude that it is more likely than not that the deferred tax asset will be realized. Accordingly, a full valuation allowance has been established against the total net deferred tax asset. During the six month period endedDecember 31, 2008, the            Company increased its valuation allowance by $2,369,722 primarily due to unusable net operating losses.

The Company's income tax benefit differs from that obtained by using the federal statutory rate of 39% as a result of the following:

 

 
|   |                                                                                    | **December 31,                        2008** |      |   | **June 30,                        2008** |   |
|--------|-----------------------------------------------------------------------------------------|----------------------------------------------|-----------|--------|------------------------------------------|--------|
|   |                                                                                    |                                         |      |   |                                     |   |   |   |
|   | Computed "expected" tax (benefit)                                                       | $                                            | (845,497) |   |                                     | $      | (14,482) |   |
|   |                                                                                    |                                         |      |   |                                     |   |   |   |
|   | Keyman insurance                                                                        |                                         | —   |   |                                     |   | 22,084 |   |
|   | Amortization debt discount costs                                                        |                                         |      |   |                                     |   |   |   |
|   | and valuation of derivative liability                                                   |                                         | —   |   |                                     |   | 505,895 |   |
|   | Meals and entertainment                                                                 |                                         | 9,296     |   |                                     |   | 5,990 |   |
|   | Political contributions                                                                 |                                         | 1,149     |   |                                     |   | 6,126 |   |
|   | Gain on debt conversion                                                                 |                                         | —   |   |                                     |   | (1,293,435) |   |
|   | Penalties                                                                               |                                         | 4,395     |   |                                     |   | — |   |
|   | Potential future tax benefit of net operating loss not recognized in the current period |                                         | 687,657   |   |                                     |   | 767,822 |   |
|   |                                                                                    |                                         |      |   |                                     |   |   |   |
|   |                                                                                    | $                                            | 143,000   |   |                                     | $      | — |   |
|   |                                                                                    |                                         |      |   |                                     |   |   |   |

At December 31, 2008, the Company had an available net operating loss carryforward of approximately $15,732,000. These amounts are available to reduce the Company’s future taxable income and expire in the years 2011 through 2027. The majority of the expirations take place after 2014.

**12. Long-Term Debt**

The Company’s long-term debt is as follows:
|   |                                                                                                                                                                                                                                |   | **December 31,                        2008** |      |   | **June 30,                        2008** |   |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------|-----------|--------|------------------------------------------|--------|
|   |                                                                                                                                                                                                                                |   |                                         |      |   |                                     |   |   |   |
|   | Safety Promissory Note payable due in monthly installments of $38,296 including interest at 5.22% until March 2012, when the unpaid balance is due, collateralized by equipment with an original cost of $1,993,212                 |   | $                                            | 1,610,180 |   |                                     | $      | 1,794,853 |   |
|   |                                                                                                                                                                                                                                |   |                                         |      |   |                                     |   |   |   |
|   | Safety Promissory Note payable due in monthly installments of $20,870 including interest at 5.85% until May 2011, when the unpaid balance is due, collateralized by equipment with an original cost of $648,000.                    |   |                                         | 665,682   |   |                                     |   | 769,568 |   |
|   |                                                                                                                                                                                                                                |   |                                         |      |   |                                     |   |   |   |
|   | Safety Revolving Note Payable                                                                                                                                                                                                       |   |                                         | 3,544,000 |   |                                     |   | 2,365,935 |   |
|   |                                                                                                                                                                                                                                |   |                                         |      |   |                                     |   |   |   |
|   | Nexus notes payable to bank, due in aggregate monthly installments of approximately $5,600 including interest ranging from 0.90% to 12% until June 2013, collateralized by vehicles with an original cost of approximately $249,000 |   |                                         | 69,674    |   |                                     |   | 115,234 |   |
|   |                                                                                                                                                                                                                                |   |                                         |      |   |                                     |   |   |   |
|   | Other notes payable                                                                                                                                                                                                                 |   |                                         | 25,120    |   |                                     |   | 65,830 |   |
|   |                                                                                                                                                                                                                                |   |                                         |      |   |                                     |   |   |   |
|   | Total notes payable                                                                                                                                                                                                                 |   |                                         | 5,914,656 |   |                                     |   | 5,111,420 |   |
|   |                                                                                                                                                                                                                                |   |                                         |      |   |                                     |   |   |   |
|   | Less current portion                                                                                                                                                                                                                |   |                                         | (650,742) |   |                                     |   | (647,576) |   |
|   |                                                                                                                                                                                                                                |   |                                         |      |   |                                     |   |   |   |
|   | Long term portion                                                                                                                                                                                                                   |   | $                                            | 5,263,914 |   |                                     | $      | 4,463,844 |   |
|   |                                                                                                                                                                                                                                |   |                                         |      |   |                                     |   |   |   |

In March 2008, upon the consummation of the funding of the acquisition transaction between the Company and Safety, Safety was extended a bank line of credit (the “Line of Credit”), which among other features includes:

 

 

(a)     An $8,000,000 Revolving Line of Credit (initial duration is two years) available for working capital financing for Safety and all of its current and future subsidiaries including an inter-company facility for credit to foreign operations.

(b)     A monthly borrowing base determination based upon domestic accounts receivable (availability at December 31, 2008 was approximately $3,706,000).

(c)     Interest rate determined at LIBOR plus margin determined on a quarterly basis with reference to funded debt to domestic EBITDA ratio.  Margin range is 1.2% to 1.95% for an EBITDA ratio of over 2.25:1.  Maximum ratio is 2.5:1.

(d)     The ability to issue letters of credit in an aggregate principal amount not to exceed $4,000,000 subject to certain provisions.

Principal maturities of notes payable over the next five years are as follows:
|   | 2009   | $                  | 650,742   |   |
|--------|--------|--------------------|-----------|--------|
|   | 2010   |               | 4,216,217 |   |
|   | 2011   |               | 654,252   |   |
|   | 2012   |               | 393,445   |   |
|   | Total  | $                  | 5,914,656 |   |
|   |   |     |      |   |
|   |   |          |      |   |

**13.   Series F Preferred Stock**

On October 6, 2005, the Company issued 1,000,000 shares of Series F Convertible Preferred Stock, par value $0.01 per share (the “Series F Preferred Stock”), to YA, a related party, pursuant to a securities purchase agreement. Net proceeds from the issuance amounted to $1,000,000 less costs of $154,277, or $845,723. The Series F Preferred Stock            provides for preferential dividends at an annual rate of 12%. Also, the Series F Preferred Stock has a preferential liquidation amount of $0.10 per share or $100,000. The Series F Preferred Stock is convertible into shares of Common Stock at a conversion price equal to $0.10 per share, subject to availability. In 2005, the Company recorded a $1,000,000 dividend relative to a beneficial conversion feature. As of December 31, 2008, none of the Series F Preferred Stock has been            converted into shares of Common Stock.

**14.   Series G Preferred Stock**

On February 6, 2006, the Company entered into an Investment Agreement with YA pursuant to which the Company exchanged with YA 1,000,000 shares of Series G Convertible Preferred Stock (the "Series G Preferred Stock") for 4,500,000 shares of the Company’s Common Stock owned by YA. Each share of Series G Preferred Stock may be converted, at YA’s            discretion, into 4.5 shares of the Company’s Common Stock. Each share of Series G Preferred Stock has a liquidation preference of $0.10. The holders of Series G Preferred Stock are not entitled to receive any dividends. The Company paid a $10,000 structuring fee to YA in connection with the transaction. As of December 31, 2008, 641,920 shares of the Series G Preferred Stock have been converted into 2,888,640 shares of the Common Stock.

The Company also entered into an Investor Registration Rights Agreement with the YA pursuant to which the Company agreed to file a registration statement covering the resale of shares of its Common Stock issuable upon the conversion of the Series G Preferred Stock. The Company also filed a Certificate of Designation with the State of Delaware amending its            Certificate of Incorporation to include the rights and terms of the Series G Preferred Stock.

**15.   Series H Preferred Stock**

On March 17, 2008, the Company issued 10,000 shares of Series H Stock to YA pursuant to a securities purchase agreement. Net proceeds from the issuance amounted to $10,000,000 less costs of $850,000, or $9,150,000. The Series H Stock provides for preferential dividends at an annual rate of 12%. The Series H Stock ranks *pari passu* with the            Company’s Series I Stock and is senior to all other series of the Company’s preferred stock and common stock. Also, the Series H Stock has a preferential liquidation amount of $1,000 per share or $10,000,000, plus all accumulated and unpaid dividends. Each share of Series H Stock is convertible into 33,334 shares of Common Stock at a conversion price equal to $0.03 per share,

 

 

            subject to availability. As of December 31, 2008, none of the Series H Stock has been converted into shares of the Common Stock and accrued and unpaid dividends amounted to $950,137.

**16.   Series I Preferred Stock**

On March 13, 2008, the Company issued 550,000 shares of Series I Stock to Safety pursuant to a Merger Agreement. The initial value of the Series I Stock issued as merger consideration was $3,300,000. Upon issuance, the Series I Stock was placed in escrow to offset any indemnification claims or purchase price adjustments pursuant to the Merger Agreement.            As of March 27, 2008, Safety secured an extension on a pending contract and qualified to release $1,800,000 in stated value or 300,000 shares of Series I Stock from escrow on December 31, 2008. The remainder of the Series I Stock will be released from escrow on the earlier of (1) March 15, 2009 or (2) the date fifteen (15) days following the completion of the financial review by the Company’s independent auditors of the Company’s consolidated financial statements for the            six (6) month period ended December 31, 2008. The Series I Stock provides for preferential dividends at an annual rate of 12%. The Series I Stock ranks pari passu with the Company’s Series H Stock and is senior to all other series of the Company’s preferred stock and common stock. Also, the Series I Stock has a preferential liquidation amount of $6.00 per share or $3,303,300, plus all accrued and unpaid dividends. Each share of Series I Stock is convertible into 200            shares of the Company’s Common Stock at a conversion price of $0.03 per share, subject to availability. As of December 31, 2008, none of the Series I Stock has been converted into shares of Common Stock and accrued and unpaid dividends amount to $164,515.

**17.   Stock Options**

Stock Options Issued Under the 2005 Option Plan:

In 2005, the Company issued to directors and an officer of the Company options to purchase 7,960,000 shares of Common Stock in the future. In January and February 2006, the Company issued 100,000 and 600,000 options to an employee and a consultant respectively, to purchase shares of Common Stock of the Company in the future. Of these options 100,000 were            forfeited in September 2006. In May and July 2006, the Company issued 100,000 and 750,000 options to two employees respectively, to purchase shares of Common Stock of the Company in the future. Of these options, 100,000 were forfeited in February 2008. In December 2006, the Company issued 250,000 options to an employee to purchase shares of Common Stock of the Company in the future. On May 10, 2007, the Company modified the terms of 519,210 of the options previously issued to an            employee, upon the appointment of that employee to the position of Chief Financial Officer. Also, on May 10, 2007 a director resigned forfeiting 720,000 options and, on May 16, 2007, a new director was appointed and granted 720,000 options to purchase shares of Common Stock in the future, vesting at 90,000 per quarter for eight quarters.

Of the options granted in 2005, 2006 and 2007, options to purchase 437,047 shares of Common Stock vested during the six month period ended December 31, 2008 and the Company recorded $63,187 as compensation expense related to the vesting of these options. During the six month period ending December 31, 2007, options to purchase 765,380 shares of Common            Stock vested and the Company recorded $109,070 as compensation expense related to the vesting of these options. There are 400,000 options available to be granted remaining in the 2005 Option Plan.

Stock Options Issued Under the 2008 Option Plan:

In July 2008, the board of directors of the Company approved the issuance to directors, officers and one employee of the Company options to purchase 73,850,000 shares of Common Stock in the future. Of the options granted in July 2008, options to purchase 32,298,986 shares of Common Stock vested in the six month period ending December 31, 2008 and the            Company recorded $1,168,545 as compensation expense related to the vesting of these options. There are 1,150,000 options available to be granted remaining in the 2008 Option Plan.

The compensation expense related to non-vested options not yet recognized under all option plans amounted to $1,792,624 as of December 31, 2008, which cost is expected to be recognized over the next 8 quarters.

A summary of options outstanding under these arrangements as of December 31, 2008 and June 30, 2008 are presented below:

 

 
|                               |   | December 31, 2008 |   | June 30, 2008    |
|------------------------------------|--------|-------------------|--------|------------------|
|                               |   | Weighted Average  |   | Weighted Average |
|                               |   | Options           |   | Exercise Price   |   | Grant Date Fair Value |   | Options |   |   | Exercise Price |   | Grant Date Fair Value |
| Outstanding at beginning of period |   | 9,560,000         |   | $0.103           |   | $0.107 |   | 9,660,000 |   |   | $0.103 |   | $0.107 |
| Granted                            |   | 73,850,000        |   | 0.050            |   | 0.036 |   | - |   |   | - |   | - |
| Exercised                          |   | -                 |   | -                |   | - |   | - |   |   | - |   | - |
| Forfeited                          |   | -                 |   | -                |   | - |   | (100,000) |   |   | 0.140 |   | - |
| Outstanding at end of period       |   | 83,410,000        |   | $0.056           |   | $0.044 |   | 9,560,000 |   |   | $0.103 |   | $0.107 |
| Options exercisable at period end  |   | 41,591,106        |   | $0.061           |   | $0.052 |   | 8,855,073 |   |   | $0.101 |   | $0.097 |

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions; risk-free interest rate of between 4.07% and 4.95% and volatility between 60% and 456% and expected lives of ten years. All options granted have a three year service period.

Not included in the table above, but included in consolidated compensation expense are options issued by our subsidiaries to purchase shares of the subsidiaries’ common stock in the future. Compensation expense for these options is calculated by comparing our subsidiaries to comparable publicly traded companies in their industry for stock volatility            purposes and using the Black-Scholes option-pricing model.

**18.   Common Stock Warrants**

On March 13, 2008, the Company granted warrants to purchase up to 22,000,000 shares of its Common Stock as part of the purchase consideration in the acquisition of Safety (see Note 8). The warrants will be held in escrow together with the Series I Preferred Stock to offset any indemnification claims or purchase price adjustments. As the Series I Preferred            Stock is released from escrow, a proportional number of warrants will also be released. The warrants have an exercise price of $0.03 with a term of five years from the date of issuance of March 17, 2008. As of March 27, 2008, Safety secured a pending contract extension and accordingly warrants to purchase 12,000,000 of Common Stock were released from escrow on December 31, 2008.

On March 14, 2008, in connection with the Securities Purchase Agreement with YA, the Company issued to YA a warrant to purchase up to 83,333,333 shares of common stock (See Note 9). The YA Warrant vested when granted and has an exercise price equal to $0.03 with a term of five years from the date of issuance.

During 2007 and 2006, the Company granted 800,000 and 1,400,000 warrants, respectively, to two entities and one consultant. The warrants vested when granted and were issued in connection with our debenture financing, financial advisory services and an investor relations consultant. The exercise price of these warrants range from $0.11 to $1.00.

All warrants were valued using the Black Scholes pricing model with the following assumptions; risk-free interest rate of between 2.2% and 4.95%, volatility of between 60% and 456% and expected life of five years.

**19.   Adoption of SFAS No. 157**

As defined in SFAS No. 157, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). We utilize market data or assumptions that market participants would use in pricing an asset or liability, including assumptions about            risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated or generally unobservable. We primarily apply the market approach for recurring fair value measurements and attempt to utilize the best available information. SFAS No. 157 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets            for identical assets or liabilities (level 1 measurement) and lowest priority to unobservable inputs (level 3 measurement). The three levels of fair value hierarchy defined by SFAS No. 157 are as follows:

Level 1 — Quoted prices are available in active markets for identical assets or liabilities as of the reporting date.

 

 

Level 2 — Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard models that consider various            assumptions, including quoted forward prices for commodities, time value, volatility factors, and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. At December 31, 2008, we have no significant Level 2 measurements.

Level 3 — Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value. At December 31, 2008, we have no significant Level 3 measurements.

As of December 31, 2008, the Company’s assets held for sale had a carrying value of $415,595, which was measured by quoted prices in active markets for identical assets.

The Company has not changed any reported amounts for net income from continuing operation, net income or any per share amounts as a result of this adoption.

**20.   Business Segments**

The Company analyzes its assets, liabilities, cash flows and results of operations by operating unit or subsidiary. In the case of our platform companies, which are our first level subsidiaries, the Company relies on local management to analyze each of its subsidiaries and report to us based on a consolidated entity. As a result, the Company, in its            application of SFAS 131, will make its financial decisions based on the overall performance of a first level subsidiary. Our subsidiaries derive their revenues and cash flow from different activities, (1) services in the case of Safety and Nexus, and (2) products in the case of PMX.

The following table reflects the Company’s segments for the six month period ended December 31, 2008:
| Homeland Security                        Capital Corporation                        Consolidated |   | Holding                        Company                        (HSCC) |        | Services                        Company                        (Nexus) |   | Products                        Company                        (PMX) |   | Services                        Company                        (Safety) |      | Consolidated |   |
|--------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------|-------------|------------------------------------------------------------------------|--------|----------------------------------------------------------------------|--------|-------------------------------------------------------------------------|-----------|--------------|--------|
| Revenues                                                                                         |   | $                                                                    | -           |                                                                   | $      | 2,184,482                                                            |   | $                                                                       | 12,962    |         | $      | 37,682,248 |   | $ | 39,879,692 |   |
| Gross margin                                                                                     |   |                                                                 | -           |                                                                   |   | 760,199                                                              |   |                                                                    | 2,583     |         |   | 5,803,021 |   |   | 6,565,803 |   |
| Operating expenses                                                                               |   |                                                                 | 2,305,341   |                                                                   |   | 701,981                                                              |   |                                                                    | 220,254   |         |   | 3,644,395 |   |   | 6,871,971 |   |
| Depreciation expense                                                                             |   |                                                                 | 4,800       |                                                                   |   | 26,378                                                               |   |                                                                    | -         |         |   | 653,878 |   |   | 685,056 |   |
| Other expenses                                                                                   |   |                                                                 | 1,037,578   |                                                                   |   | 9,900                                                                |   |                                                                    | -         |         |   | 169,439 |   |   | 1,216,917 |   |
| Income tax expense                                                                               |   |                                                                 | -           |                                                                   |   | -                                                                    |   |                                                                    | -         |         |   | 143,000 |   |   | 143,000 |   |
| Net income (loss)                        from continuing                        operations       |   |                                                                 | (3,347,719) |                                                                   |   | 21,940                                                               |   |                                                                    | (217,671) |         |   | 1,192,309 |   |   | (2,351,141) |   |
| Current assets                                                                                   |   |                                                                 | 128,954     |                                                                   |   | 1,960,382                                                            |   |                                                                    | 2,495     |         |   | 23,664,286 |   |   | 25,756,127 |   |
| Total assets                                                                                     |   |                                                                 | 827,457     |                                                                   |   | 2,151,187                                                            |   |                                                                    | 2,495     |         |   | 34,033,548 |   |   | 37,014,687 |   |
| Interest expense                                                                                 |   |                                                                 | 859,032     |                                                                   |   | 11,402                                                               |   |                                                                    | -         |         |   | 135,755 |   |   | 1,006,189 |   |
| Capital expenditures                                                                             |   |                                                                 | -           |                                                                   |   | 5,807                                                                |   |                                                                    | -         |         |   | 307,514 |   |   | 313,321 |   |
|                                                                                             |   |                                                                 |        |                                                                   |   |                                                                 |   |                                                                    |      |         |   |   |   |   |   |   |

The following table reflects the Company’s segments for the six month period ended December 31, 2007, excluding the discontinued operations of SHC:
| Homeland Security Capital                        Corporation Consolidated |   | Holding Company (HSCC)                                                                                          |   | Services                        Company                        (Nexus) |   | Products                        Company (PMX)                      |   | Consolidated                                                            |   |
|---------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------|--------|--------------------------------------------------------------------|--------|-------------------------------------------------------------------------|--------|
| Revenues                                                                  |   | $                   - |   | $     6,285,798                                    |   | $          7,298 |   | $           6,343,096 |   |
| Gross margin                                                              |   | -                                                                                                               |   | 1,064,232                                                              |   | 2,150                                                              |   | 1,606,382                                                               |   |
| Operating expenses                                                        |   | 945,456                                                                                                         |   | 1,397,875                                                              |   | 170,194                                                            |   | 2,513,525                                                               |   |
| Depreciation expense                                                      |   | 4,289                                                                                                           |   | 30,492                                                                 |   | -                                                                  |   | 34,781                                                                  |   |
| Other income (expenses) – net                                       |   | (1,025,357)                                                                                                     |   | (63,327)                                                               |   | -                                                                  |   | (1,088,684)                                                             |   |
| Net income (loss) from continuing                        operations       |   | (1,975,102)                                                                                                     |   | 112,538                                                                |   | (168,044)                                                          |   | (2,030,608)                                                             |   |
| Current assets                                                            |   | 6,765                                                                                                           |   | 4,684,416                                                              |   | 213                                                                |   | 4,691,394                                                               |   |
| Total assets                                                              |   | 4,655,652                                                                                                       |   | 4,941,479                                                              |   | 213                                                                |   | 9,597,344                                                               |   |
| Interest expense                                                          |   | 567,057                                                                                                         |   | 64,178                                                                 |   | -                                                                  |   | 631,235                                                                 |   |
| Capital expenditures                                                      |   | -                                                                                                               |   | 14,589                                                                 |   | -                                                                  |   | 14,589                                                                  |   |
|                                                                      |   |                                                                                                            |   |                                                                   |   |                                                               |   |                                                                    |   |

 

 

**21.   Loss Per Share**

The basic loss per share was computed by dividing the net loss attributable to common shareholders by the weighted average common shares outstanding during each period. Potential common equivalent shares of 645,894,693 and 10,618,026 at December 31, 2008 and 2007 are not included in the computation of per share amounts in the periods as the effect would            be anti-dilutive.

Diluted earnings per share are computed using outstanding shares plus the common stock options and warrants that can be converted into common stock. Diluted earnings per share are not indicated for the three months ended December 31, 2008 and 2007 or the six months ended December 31, 2008 and 2007 because these periods indicate losses and the computation            would also be anti-dilutive.

The reconciliations of thebasic and diluted Earnings Per Share for income from continuing operations are as follows:
|                                                  |               | Three Months                        Ended                        December 31,                        2008 |         |         | Three Months                        Ended                        December 31,                        2007 |         |         | Six Months                        Ended                        December 31,                        2008 |         |         | Six Months                        Ended                        December 31,                        2007 |         |
|-------------------------------------------------------|--------------------|-----------------------------------------------------------------------------------------------------------|--------------|--------------|-----------------------------------------------------------------------------------------------------------|--------------|--------------|---------------------------------------------------------------------------------------------------------|--------------|--------------|---------------------------------------------------------------------------------------------------------|--------------|
|                                                  |               |                                                                                                      |         |         |                                                                                                      |         |         |                                                                                                    |         |         |                                                                                                    |         |
| **Basic and Diluted Earnings Per Share:**             |               |                                                                                                      |         |         |                                                                                                      |         |         |                                                                                                    |         |         |                                                                                                    |         |
|                                                  |               |                                                                                                      |         |         |                                                                                                      |         |         |                                                                                                    |         |         |                                                                                                    |         |
| **(Loss) income (Numerator)**                         | $                  | (410,051)                                                                                                 |         | $            | (2,227,932)                                                                                               |         | $            | (2,351,141)                                                                                             |         | $            | (2,030,608)                                                                                             |         |
|                                                  |               |                                                                                                      |         |         |                                                                                                      |         |         |                                                                                                    |         |         | __                                                                                                      |         |
| Less: Preferred stock dividends                       |               | (356,910)                                                                                                 |         |         | —                                                                                                   |         |         | (713,820)                                                                                               |         |         |                                                                                                    |         |
|                                                  | $                  | (766,961)                                                                                                 |         | $            | (2,227,932)                                                                                               |         | $            | (3,064,961)                                                                                             |         | $            | (2,030,608)                                                                                             |         |
|                                                  |               |                                                                                                      |         |         |                                                                                                      |         |         |                                                                                                    |         |         |                                                                                                    |         |
| Income from discontinued operations                   |               | —                                                                                                   |         |         | --                                                                                                        |         |         | --                                                                                                      |         |         | 3,593,951                                                                                               |         |
| Net (loss) income attributable to common stockholders |               | (766,961)                                                                                                 |         |         | (2,227,932)                                                                                               |         |         | (3,064,961)                                                                                             |         |         | 1,563,343                                                                                               |         |
|                                                  |               |                                                                                                      |         |         |                                                                                                      |         |         |                                                                                                    |         |         |                                                                                                    |         |
| Shares (Denominator)                                  |               |                                                                                                      |         |         |                                                                                                      |         |         |                                                                                                    |         |         |                                                                                                    |         |
|                                                  |               |                                                                                                      |         |         |                                                                                                      |         |         |                                                                                                    |         |         |                                                                                                    |         |
| Weighted-average number of common shares              |               |                                                                                                      |         |         |                                                                                                      |         |         |                                                                                                    |         |         |                                                                                                    |         |
| Basic                                                 |               | 47,506,560                                                                                                |         |         | 44,631,048                                                                                                |         |         | 48,183,683                                                                                              |         |         | 43,193,149                                                                                              |         |
| Diluted                                               |               | 47,506,560                                                                                                |         |         | 44,631,048                                                                                                |         |         | 48,183,683                                                                                              |         |         | 43,193,149                                                                                              |         |
|                                                  |               |                                                                                                      |         |         |                                                                                                      |         |         |                                                                                                    |         |         |                                                                                                    |         |
| **Earnings per Common Share:**                        |               |                                                                                                      |         |         |                                                                                                      |         |         |                                                                                                    |         |         |                                                                                                    |         |
| **Basic and diluted**                                 |               |                                                                                                      |         |         |                                                                                                      |         |         |                                                                                                    |         |         |                                                                                                    |         |
| (Loss) income from continuing operations              | $                  | (0.02)                                                                                                    |         | $            | (0.05)                                                                                                    |         | $            | (0.06)                                                                                                  |         | $            | (0.05)                                                                                                  |         |
|                                                  |               |                                                                                                      |         |         |                                                                                                      |         |         |                                                                                                    |         |         |                                                                                                    |         |
| (Loss) income from discontinued operations            |               | —                                                                                                   |         |         | --                                                                                                        |         |         | --                                                                                                      |         | $            | 0.08                                                                                                    |         |
|                                                  |               |                                                                                                      |         |         |                                                                                                      |         |         |                                                                                                    |         |         |                                                                                                    |         |
| Basic and diluted (loss) earnings per share           | $                  | (0.02)                                                                                                    |         | $            | (0.05)                                                                                                    |         | $            | (0.06)                                                                                                  |         | $            | 0.03                                                                                                    |         |
|                                                  |     |                                                                                                      |    |    |                                                                                                      |    |    |                                                                                                    |    |    |                                                                                                    |    |

**22.     Cash Flows**

Supplemental disclosure of cash flow information for the six months ended December 31, 2008 and December 31, 2007 are as follows:
|        |                                       |   | December 31,                        2008 |   |   | December 31,                        2007 |   |
|--------|--------------------------------------------|--------|------------------------------------------|--------|--------|------------------------------------------|--------|
|   | Cash paid during the six month period for: |   |                                     |   |   |                                     |   |
|   | Interest                                   | $      | 147,157                                  |   | $      | 476,122                                  |   |
|   | Taxes                                      | $      | 0                                        |   | $      | 0                                        |   |

 

 

 

**23.   Related Party Transactions**

 

Safety leases approximately 21,000 square feet of office space from a company controlled by our President. Under terms of the lease agreement, monthly installments of $28,669 are due through May 2018. The Company recognized rent expense under this agreement of $172,014 during the six months ended December 31, 2008.

At December 31, 2008, the Company had a note payable to our President which resulted from our acquisition of Safety. The note is in the amount of $1,571,507, which includes accrued interest from March 17, 2008. The interest rate on the note is 6% and is payable upon the earlier of (i) the receipt of a certain trade accounts receivable, or (ii) a demand            notice.

On June 1, 2007, the Company loaned $500,000 to SAAH, an entity controlled by our Chairman and Chief Executive Officer. The loan is evidenced by a note bearing 5% interest per annum and is due on or before May 31, 2011, with no prepayment penalties. The loan is guaranteed in its entirety by our Chairman and Chief Executive Officer. At December 31, 2008            the balance of the note, including interest was $402,953.

On October 23, 2007, the Company entered into an agreement with SAAC, a company controlled by our Chairman and Chief Executive Officer, to receive a monthly fee of up to $7,500 for providing SAAC with office space and certain office and administrative services for up to 24 months. Certain employees of the Company will perform required services pursuant to            the SAAC Agreement. The Company has billed $45,000 for the aforementioned services for the six months ended December 31, 2008.

On March 14, 2008, the Company entered into a Purchase Agreement with YA wherein YA purchased $6,310,000 in secured notes and $6,190,000 in Series H Convertible Preferred Stock in addition to a Warrant exercisable for 83,333,333 shares of the Company’s Common Stock. The Company used the proceeds from this Purchase Agreement to fund the acquisition            of Safety and restructure indebtedness.

On November 26, 2008, the Company entered into a Common Stock Purchase Agreement with YA, where the Company purchased from YA 2,043,494 shares of its Common Stock, par value $0.001 per share, for a purchase price of $178,655. The transaction was funded with a noted issued to YA for the total purchase price and bears interest at 13% with principal and            accrued interest due March 24, 2010. On November 28, 2008, the Company entered into a Common Stock Purchase Agreement with YA, where the Company purchased from YA 1,526,937 shares of its Common Stock, par value $0.001 per share, for a purchase price of $71,345. The transaction was funded with a note issued to YA for the total purchase price and bears interest at 13% with principal and accrued interest due March 24, 2010. These notes issued to YA are secured by the Common Stock            purchased from YA, with such Common Stock being held in escrow until all obligations pursuant to the YA Notes have been paid in full.

**24.   Continuing Operations**

The primary source of financing for the Company since its inception has been through the issuance of common stock, preferred stock and convertible debt. Our financial statements are prepared using generally accepted accounting principles applicable to a going concern which contemplates the realization of assets and liquidation of liabilities in the normal            course of business. We have historically incurred losses which have resulted in a total retained deficit of $62,412,158 at December 31, 2008. Management recognizes it will be necessary to continue to generate positive cash flow from operations and have availability to other sources of capital to continue as a going concern.

 

 

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

*The following information should be read in conjunction with the consolidated financial statements of the Company and the notes thereto appearing elsewhere in this filing. Statements in this Management’s Discussion and Analysis or Plan of Operation and elsewhere in this quarterly report that are not statements of historical or current fact            constitute “forward-looking statements.”*

**Overview**

Homeland Security Capital Corporation was incorporated in Delaware on August 12, 1997, and its corporate headquarters is located at 1005 North Glebe Road, Suite 550, Arlington, Virginia  22201. The Company’s telephone number is (703) 528-7073. The Company focuses on the acquisition and development of businesses whose primary operations are            in the homeland security sector.

The Company’s original business from 1997 through 2003 was to develop and manufacture, at third party facilities, digital set top boxes and digital video servers for the interactive television and high speed Internet markets.

On June 3, 2003, the Company elected to become a business development company ("BDC"), to be regulated pursuant to Section 54 of the Investment Company Act of 1940, as amended. On December 30, 2005, at a special stockholders meeting, the stockholders of the Company voted to amend the Certificate of Incorporation of the Company to change the name to            “Homeland Security Capital Corporation” and voted to withdraw the Company's election as a BDC. Accordingly, the Company changed its business plan to primarily seek investments in, and acquisition of, companies that provide homeland security products and services.

The Company currently conducts its ongoing operations through two majority-owned subsidiaries and one joint venture. On February 7, 2006, the Company, through its Nexus subsidiary, acquired 100% of the common stock of Corporate Security Solutions, a security integration firm having operations in the Mid-Atlantic region with a focus on the New York market.            On September 15, 2006, the Company formed PMX and on September 18, 2006 PMX became a U.S.-based joint venture 51% controlled by the Company with Polimaster, Inc., a company focused on the field of radiological detection and isotope identification. On March 13, 2008, the Company acquired 100% of Safety, a provider of global environmental, hazardous and radiological infrastructure remediation and advanced construction services in the United States and the United Kingdom.            Safety’s core capabilities and service offerings include: (1) construction, remediation and demolition, (2) environmental services, (3) environmental technologies, and (4) chemical, biological, radiological, nuclear and explosive response (CBRNE).

The Company’s near term focus is to grow these businesses both organically and through complimentary acquisitions. The Company targets growth companies that are generating revenues but face challenges in scaling their businesses to capitalize on homeland security opportunities. The Company will enhance the operations of these companies by helping            them generate new business, grow revenues, build infrastructure and improve cash flows.

**Change In Fiscal Year**

On May 13, 2008, the Company’s Board of Directors approved a change in the Company’s fiscal year end from December 31 to June 30. For the period ended June 30, 2008, the Company filed its Annual Report on Form 10-K as a transition report and included information for the six month transitional period from January 1, 2008 to June 30, 2008,            reflecting the consolidated results of operations for Safety from March 1, 2008 to June 30, 2008 and the consolidated results of operations of HSCC (any reference herein to “HSCC” refers to the holding company entity), Nexus and PMX from January 1, 2008 to June 30, 2008. Included in this Current Report on Form 10-Q are the results of the Company for the three and six month periods ended December 31, 2008.

**Results of Operations**

The Company concluded the acquisition of 100% of Safety in March 2008. Safety is a significantly larger company than the Company’s other consolidated subsidiaries and management believes that comparing the results of operations with the previous three and six month periods ending December 31, 2007 would not be meaningful and may be misleading.            Therefore, the Company has determined to show the specific contributions by each subsidiary for the individual categories outlined below for the three and six month periods ended December 31, 2008.

 

 

**Three Month Period Ended December 31, 2008**

**Contract revenue**

For the three months ended December 31, 2008, the Company recorded contract revenue of $22,212,461. Included in this total is $21,096,372 in contract revenue recorded by Safety, $1,114,289 recorded by Nexus and $1,800 recorded by PMX. Contract revenue consisted of fees earned on environmental remediation services, security systems installation,            integration, service contracts and product sales and training.

**Contract cost**

For the three months ended December 31, 2008, contract cost was $18,480,949. Included in this total is $17,634,525 in contract costs incurred by Safety and $846,424 incurred by Nexus. Contract cost consists of materials, labor and other costs incurred by the Company associated with environmental remediation, security systems installation, and integration            and service contracts and, in the case of PMX, products purchased for resale.

**Operating expenses**

Operating expenses for the three months ended December 31, 2008 were $3,387,548. Included in this total is $2,214,925 in expenses incurred by Safety, $301,495 in expenses incurred by Nexus, $124,246 in expenses incurred by PMX and $746,882 in expenses incurred by HSCC.

**Other income and expense**

The Company had net other expense of $611,015 for the three months ended December 31, 2008. Other expense included interest expense of $504,537 primarily related to HSCC’s secured notes with YA ($431,093) and notes payable for Safety ($68,652) and Nexus ($4,792), amortization of debt offering costs of $123,092 ($106,250 from HSCC’s financial            instruments and $16,842 from Safety) and amortization of debt discount of $12,019 all from HSCC, offset by interest and other income of $28,633 primarily from HSCC’s notes from, and services to, SAAC.

**Income taxes**

The Company incurred income taxes in the three months ended December 31, 2008 in the amount of $143,000 as a result of income taxable to state jurisdictions that is not subject to offset by NOL carryovers.

**Net loss**

As a result of the foregoing, the Company recorded a net loss from continuing operations of $410,051 for the three months ended December 31, 2008.

**Six Month Period Ended December 31, 2008**

**Contract revenue**

For the six months ended December 31, 2008, the Company recorded contract revenue of $39,879,692. Included in this total is $37,682,248 in contract revenue recorded by Safety, $2,184,482 recorded by Nexus and $12,962 recorded by PMX. Contract revenue consisted of fees earned on environmental remediation services, security systems installation,            integration, service contracts and product sales and training.

**Contract cost**

For the six months ended December 31, 2008, contract cost was $33,313,889. Included in this total is $31,879,227 in contract costs incurred by Safety, $1,424,283 incurred by Nexus, and $10,379 incurred by PMX. Contract cost consists of materials, labor and other costs incurred by the Company associated with environmental remediation, security systems            installation, and integration and service contracts and, in the case of PMX, products purchased for resale.

 

 

**Operating expenses**

Operating expenses for the six months ended December 31, 2008 were $7,557,027. Included in this total is $4,298,273 in expenses incurred by Safety, $728,359 in expenses incurred by Nexus, $220,254 in expenses incurred by PMX and $2,310,141 in expenses incurred by HSCC.

**Other income and expense**

The Company had net other expense of $1,216,917 for the six months ended December 31, 2008. Other expense included interest expense of $1,006,189 primarily related to HSCC’s secured notes with Yorkville ($859,032) and notes payable for Safety ($135,755) and Nexus ($11,402), amortization of debt offering costs of $246,185 ($212,501 from HSCC’s            financial instruments and $33,684 from Safety) and amortization of debt discount of $24,037 all from HSCC, offset by interest and other income of $59,494 primarily from HSCC’s notes from, and services to, SAAC.

**Income taxes**

The Company incurred income taxes in the six months ended December 31, 2008 in the amount of $143,000 as a result of income taxable to state jurisdictions that is not subject to offset by NOL carryovers.

**Net loss**

As a result of the foregoing, the Company recorded a net loss from continuing operations of $2,351,141 for the six months ended December 31, 2008.

**Liquidity And Capital Resources             **

The primary source of financing for the Company since its inception has been through the issuance of common stock, preferred stock and convertible debt. The Company had cash on hand of $1,579,825 and $3,182,357 at December 31, 2008 and June 30, 2008, respectively. Our primary needs for cash are to fund our ongoing operations until such time as they begin            to generate sufficient cash flow to fully fund operations and to have cash available to make additional acquisitions of businesses that provide homeland security products and services. While we believe that we have sufficient cash on hand to satisfy our current operating commitments through December 31, 2009, we will require significant additional funding in order to make additional acquisitions.

On March 14, 2008, the Company entered into a Purchase Agreement with YA wherein YA purchased $6,310,000 in secured notes and $6,190,000 in Series H Convertible Preferred Stock in addition to a Warrant exercisable for 83,333,333 shares of the Company’s Common Stock. The Company used the proceeds from this Purchase Agreement to fund the acquisition            of Safety and restructure indebtedness (See Notes 8 and 9 to the Consolidated Financial Statements).

During the six months ended December 31, 2008, we had a net decrease in cash of $1,602,532. Our sources and uses of funds were as follows:

**Cash Flows From Operating Activities**

We used net cash of $1,866,635 in our operating activities during the six months ended December 31, 2008. Cash was used as a result of operating income before non-cash expenses (stock based compensation, depreciation and amortization and other miscellaneous items amounting to $2,537,393) of $186,252, offset by $2,052,887 of net cash used in operating            assets and liabilities.

**Cash Flows From Investing Activities**

 We used net cash of $313,321 in our investing activities during the six months ended December 31, 2008, related to purchases of fixed assets.

**Cash Flows From Financing Activities**

We provided cash of $845,958 from financing activities during the six months ended December 31, 2008, consisting of net borrowings on our line of credit of $1,178,065 reduced by payments on our term debt of $332,107.

As of December 31, 2008, we had net working capital of $9,963,251.

 

 

**Off-Balance Sheet Arrangements**

There are no off-balance sheet arrangements entered into by the Company.

**Critical Accounting Policies And Estimates**

***Revenue Recognition*** –Safety recognizes revenue on their environmental and remediation services performed under time and material and fixed fee contracts. Revenues and costs associated with fixed price contracts are recognized using the percentage of completion (efforts expended)            method. Revenue and cost associated with time and material contracts is recognized as revenue when earned and costs are incurred. Nexus recognizes revenue on their security system installation and integration contracts using the percentage of completion method. PMX recognizes revenue based on the sale of its products and services.

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

***Fair Value of Financial Instruments*** –The carrying amount of items included in working capital approximates fair value because of the short maturity of those instruments. The carrying value of the Company’s debt approximates fair value because it bears interest at rates that            are similar to current borrowing rates for loans of comparable terms, maturity and credit risk that are available to the Company.

***Investments in Assets Held for Sale*** –The Company classifies certain investments in securities as “assets held for sale.” Under this classification securities are reported at fair value (period end market closing prices) with unrealized gains and losses excluded from earnings            and reported in a separate component of shareholder’s equity until the gains or losses are realized or a provision for impairment is recognized.

***Debt Offering Cost*** –Debt offering costs are related to private placements and are amortized on a straight line basis over the term of the related debt, most of which is in the form of secured notes.

***Investment Valuation*** –Investments in equity securities are recorded at fair value, represented as cost, plus or minus unrealized appreciation or depreciation, respectively. The fair value of investments that have no ready market, are determined in good faith by management (in            accordance with SFAS No. 157, and approved by the Board of Directors, based upon assets and revenues of the underlying investee companies as well as the general market trends for businesses in the same industry. Because of the inherent uncertainty of valuations, management estimates of the value of the investments may differ significantly from the values that would have been used had a ready market for the investments existed and the differences could be material.

***Income Taxes*** –Deferred income taxes are provided using the liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards 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 bases. 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 the changes in tax laws and rates on the date of the enactment.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in            the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon            settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the statement of income.

 

 

***Goodwill***– The Company records goodwill on acquisitions where the purchase price exceeds the fair value of the assets acquired and the liabilities assumed. The Company, on a routine basis, measures goodwill to determine if any amount recorded is impaired. If impairment is determined, the            Company adjusts the value of goodwill on the date impairment is first recognized.

***SegmentReporting*** – Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosure About Segments of an Enterprise and Related Information" requires use of the "management approach" model for segment reporting. The            management approach model is based on the way a company's management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company. The Company's operations are classified into four principal reporting segments that provide different products or services.

**ITEM 3.   Quantitative and Qualitative Disclosures About Market Risk**

Risk is an inherent part of the Company’s business and activities. Market risks relating to the Company’s operations result primarily from equity risks, contract risks, credit risks and foreign exchange rate risk. To manage the exposures on a consolidated basis, the Company follows various policies specific to each type of risk. We employ            resources from our accounting departments, credit departments, contracting departments and outside consultants to help us mitigate the potential risks we face. Each risk, along with management’s mitigation policies, is discussed below.

**Equity Market Risk**

The Company holds stock in publicly traded companies. Company management subscribes to various publications and analyzes key industry statistics for the industries in which it holds public company stock. On a regular basis management speaks with representatives of the companies for which it has a stock investment. Based on this analysis and the results of            the discussions with the representatives of the investee companies, management recommends to the Company’s board of directors certain actions that may be appropriate under the individual circumstances. These actions can be to hold or dispose of the equity position in the company(ies). Management may increase the frequency of its analysis or discussions based on trends identified in its investee companies.

**Contract Risks**

A large part of the Company’s business is subject to work conducted under prime or sub contracts. The Company is at risk of contracts being cancelled or funding being removed from a contract without prior notice. To manage this risk individual subsidiary management continuously monitors each active contract by speaking with client’s management            on a regular basis. The Company seeks to mitigate the risk of cost expenditures once it has knowledge a specific contract is subject to cancellation or reduced or cancelled funding. The Company relies on its project management team, which typically is at the client site on a daily basis, to identify these contract risks.

**Credit Risks**

From time to time the Company has credit risks associated with work performed or being performed for a small group of clients. The Company’s management continuously monitors its clients credit profile prior to beginning a project, while the projects are in progress and continues the monitoring process until all outstanding invoices concerning the            specific projects are collected. Management believes this credit monitoring significantly reduces the Company’s exposure to credit risks.

**Foreign Exchange Rate Risks**

The Company operates, through a subsidiary, in the United Kingdom. In the course of normal operations, transfers of currency denominated in the US dollar and the British pound sterling regularly take place. The Company’s foreign currency exchange rate risk management strategy involves the use of foreign currency derivatives, typically foreign            currency forward contracts, with durations of generally 12 months or less. At December 31, 2008, the Company had no financial instruments outstanding that were sensitive to changes in foreign currency exchange rates.

The Company’s net foreign currency investment in foreign subsidiaries and affiliates translated into United States dollars using historic exchange rates at the date of investment in foreign subsidiary was $1,048,007 at December 31, 2008.

 

 

**ITEM 4(T).   CONTROLS AND PROCEDURES**

***Evaluation of Disclosure Controls and Procedures***

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by our company is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the Securities & Exchange Commission. C. Thomas McMillen, our Chief Executive Officer, and            Michael T. Brigante, our Chief Financial Officer, are responsible for establishing and maintaining disclosure controls and procedures for our company.

Our management has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rule 13a-15(e) of the Exchange Act) as of December 31, 2008 (under the supervision and with the participation of the Chief Executive Officer and the Chief Financial Officer), pursuant to Rule 13a-15(b) promulgated under the            Exchange Act. As part of such evaluation, management considered the matters discussed below relating to internal control over financial reporting. Based on this evaluation, our Company’s Chief Executive Officer and Chief Financial Officer have concluded that our Company’s disclosure controls and procedures were not effective as of December 31, 2008 to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the            Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and include controls and procedures designed to provide reasonable assurance that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required            disclosure.

As discussed in our Transition Report on Form 10-K for the period ended June 30, 2008, the Company’s management concluded that our Company’s disclosure controls were not effective for the period then ended. Management has undertaken corrective action to rectify the disclosure deficiencies. However, as of December 31, 2008, such remedial            actions are not yet sufficient to assure effectiveness in our disclosure controls over financial reporting.

The term “internal control over financial reporting” is defined as a process designed by, or under the supervision of, the registrant’s principal executive and principal financial officers, or persons performing similar functions, and effected by the registrant’s board of directors, management and other personnel, to provide            reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
|             | · | pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the registrant;                                                                                                                                                                                                         |
|------------------|----------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **  ** |     | **  **                                                                                                                                                                                                                                                                                                                                                         |
|             | · | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the registrant are being made only in accordance with authorizations of management and directors of the registrant;                        and |
| **  ** |     | **  **                                                                                                                                                                                                                                                                                                                                                         |
|             | · | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the registrant’s assets that could have a material effect on the financial statements.                                                                                                                                                    |

***Changes in Internal Controls over Financial Reporting***

In connection with the evaluation of the Company’s internal controls during the Company’s last fiscal quarter, the Company’s Chief Executive Officer and the Chief Financial Officer have determined that there are no changes to the Company’s internal controls over financial reporting that have materially affected, or are reasonably            likely to materially effect, the Company’s internal controls over financial reporting.

***Inherent Limitations on Effectiveness of Controls***

The Company’s management does not expect that its disclosure controls or its internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a            control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute

 

 

            assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or management override of the controls. The design            of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or            procedures.

 

 

**PART II**

**ITEM 1. LEGAL PROCEEDINGS**

None.

**ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

None.

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

None.

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

None.

**ITEM 5. OTHER INFORMATION**

None.

**ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K**

**(a)     Exhibits**
| **Exhibit**      |   | **Description**                                                                                                                                   |   | **Location**      |
|------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|
| **  ** |   |                                                                                                                                              |   |              |
| 10.1             |   | Company 2008 Stock Incentive Plan                                                                                                                 |   | Provided herewith |
| **  ** |   |                                                                                                                                              |   |              |
| 10.2             |   | Common Stock Purchase Agreement, Dated November 26, 2008, by and between the Company and YA Global Investments, L.P.                              |   | Provided herewith |
| **  ** |   |                                                                                                                                              |   |              |
| 10.3             |   | Common Stock Purchase Agreement, Dated November 28, 2008, by and between the Company and YA Global Investments, L.P.                              |   | Provided herewith |
| **  ** |   |                                                                                                                                              |   |              |
| 31.1             |   | Certification by Chief Executive Officer pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |   | Provided herewith |
| **  ** |   |                                                                                                                                              |   |              |
| 31.2             |   | Certification by Chief Financial Officer pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |   | Provided herewith |
| **  ** |   |                                                                                                                                              |   |              |
| 32.1             |   | Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |   | Provided herewith |
| **  ** |   |                                                                                                                                              |   |              |
| 32.2             |   | Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted                                                           |   | Provided herewith |

(b) Reports on Form 8-K

On October 1, 2008, the Company filed a Current Report on Form 8-K incorporating a press release announcing the placement of the script of the press conference call related to the Company’s results for the fiscal year ended June 30, 2008.

 

 

On October 23, 2008, the Company filed a Current Report on Form 8-K incorporating the slideshow the Company intended to present at upcoming investor meetings.

 

 

**SIGNATURES**

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant ahs duly caused this Report to be signed in its behalf by the undersigned, thereunto duly authorized.
|   | **HOMELAND SECURITY CAPITAL CORPORATION**              |
|--------|--------------------------------------------------------|
|   |                                                   |
|   | */s/ Michael T. Brigante*                              |
|   | Michael T. Brigante                                    |
|   | On behalf of Registrant and as Chief Financial Officer |
|   | February 16, 2009                                      |
|   |                                                   |