UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10-K





(Mark
      One)x
              
              ANNUAL
      REPORT UNDER SECTION 13 OR 15(d)
                OF
      THE SECURITIES EXCHANGE ACT OF
1934




For
the Fiscal Year Ended June 30, 2009





 ̈
                
                TRANSITION
      REPORT UNDER SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF
      1934




For the Transition Period
From ______to______.




Commission
File Number: 0-30810




ELECTRONIC
CONTROL SECURITY INC.


(Exact
name of registrant as specified in its charter)




New Jersey
              22-2138196(State or Other Jurisdiction of
              (I.R.S. Employer Identification No.)Incorporation or Organization)




790 Bloomfield Avenue, Clifton, New Jersey
              07012(Address of Principal Executive Offices)
              (Zip Code)




Registrant's
telephone number, including area code: (973) 574-8555




Securities
registered under Section 12(b) of the Exchange Act: None


Securities
registered under Section 12(g) of the Exchange Act:


$0.001
Par Value Common Stock


(Title of
Class)




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




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




Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
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. x Yes
 ̈ No





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).  Yes 
 ̈ No   ̈




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





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.




Large
      accelerated filer
                 ̈
                
                Accelerated
      filer
                 ̈Non-accelerated
      filer
                 ̈
                
                Smaller
      reporting company
                x




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




As of
September 22, 2009, there were 10,149,259 outstanding shares of the issuer's
Common Stock. The aggregate market value of the shares of the issuer's Common
Stock held by non-affiliates was $1,252,000 on June 30, 2008. Such market value
was calculated using the closing price of such Common Stock as of such date as
quoted on the OTC Bulletin Board.




DOCUMENTS
INCORPORATED BY REFERENCE




Information
required by Part III, Items 10, 11, 12, 13 and 14, is incorporated by reference
to portions of the registrant’s definitive proxy statement for its 2009 annual
meeting of stockholders, which will be filed on or before October 28,
2009.







TABLE
OF CONTENTS




PagePART
      IItem
      1.
                        Business
                        1Item
      1A.
                        Risk
      Factors
                        8Item
      1B.
                        Unresolved
      Staff Comments
                        13Item
      2.
                        Properties
                        14Item
      3.
                        Legal
      Proceedings
                        14Item
      4.
                        Submission
      of Matters to a Vote of Security Holders
                        14PART
      IIItem
      5.
                        Market
      for Common Equity, Related Stockholder Matters and Issuer Purchases of
      Equity Securities
                        15Item
      6.
                        Selected
      Financial Data
                        15Item
      7.
                        Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                        15Item
      7A.
                        Quantitative
      and Qualitative Disclosures about Market Risk
                        20Item
      8.
                        Financial
      Statements and Supplementary Data
                        20Item
      9.
                        Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                        20Item
      9A.
                        Controls
      and Procedures
                        20Item
      9B.
                        Other
      Information
                        21PART
      IIIItem
      10.
                        Directors,
      Executive Officers and Corporate GovernanceItem
      11.
                        Executive
      CompensationItem
      12.
                        Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder MattersItem
      13.
                        Certain
      Relationships and Related Transactions and Director
      IndependenceItem
      14.
                        Principal
      Accountant Fees and ServicesItem
      15.
                        Exhibits,
      Financial Statement Schedules
                        F-1




ii




FORWARD
LOOKING STATEMENTS




THE
FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL STATEMENTS
AND RELATED NOTES CONTAINED ELSEWHERE IN THIS FORM 10-K. CERTAIN STATEMENTS MADE
IN THIS DISCUSSION ARE “FORWARD LOOKING STATEMENTS” WITHIN THE MEANING OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. FORWARD LOOKING STATEMENTS CAN
BE IDENTIFIED BY TERMINOLOGY SUCH AS “MAY”, “WILL”, “SHOULD”, “EXPECTS”,
“INTENDS”, “ANTICIPATES”, “BELIEVES”, “ESTIMATES”, “PREDICTS”, OR “CONTINUE” OR
THE NEGATIVE OF THESE TERMS OR OTHER COMPARABLE TERMINOLOGY AND INCLUDE, WITHOUT
LIMITATION, STATEMENTS BELOW REGARDING: THE COMPANY'S INTENDED BUSINESS PLANS;
EXPECTATIONS FOR CONTINUING IN BUSINESS; EXPECTATIONS AS TO PRODUCT PERFORMANCE;
EXPECTATIONS AS TO MARKET ACCEPTANCE OF THE COMPANY'S TECHNOLOGY; AND BELIEF IN
THE SUFFICIENCY OF CASH RESERVES. BECAUSE FORWARD LOOKING STATEMENTS INVOLVE
RISKS AND UNCERTAINTIES, THERE ARE IMPORTANT FACTORS THAT COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED BY THESE FORWARD
LOOKING STATEMENTS. ALTHOUGH THE COMPANY BELIEVES THAT EXPECTATIONS REFLECTED IN
THE FORWARD LOOKING STATEMENTS ARE REASONABLE, IT CANNOT GUARANTEE FUTURE
RESULTS, PERFORMANCE OR ACHIEVEMENTS. MOREOVER, NEITHER THE COMPANY NOR ANY
OTHER PERSON ASSUMES RESPONSIBILITY FOR THE ACCURACY AND COMPLETENESS OF THESE
FORWARD LOOKING STATEMENTS. THE COMPANY IS UNDER NO DUTY TO UPDATE ANY FORWARD
LOOKING STATEMENTS AFTER THE DATE OF THIS REPORT TO CONFORM SUCH STATEMENTS TO
ACTUAL RESULTS.


iii




PART
I




Item
1. Business




Overview




Electronic
Control Security Inc. (“ECSI” or the “Company” or “we” or “us”) designs,
develops, manufactures and markets technology-based integrated security systems.
We also provide consulting services consisting of risk assessment and
vulnerability studies to ascertain a customer's security requirements in
developing a comprehensive risk management and mitigation program, as well as
product design and engineering services, and support systems integrators and
dealers/installers providing the same services. We market our products
domestically and internationally to:





•
            national
      and local government entities including the Department of Defense
      (DoD)and
      Department of Energy (DoE);


•
            large chemical and petrochemical
      facilities and major office
complexes;


•
            energy facilities, including
      nuclear power stations, power utilities and pipelines;
      and


•
            commercial transportation
      centers, such as airports and
seaports;


•
            border security and border
      crossing inspection stations;
and


•
            water and agricultural resources
      including reservoirs, dams, fish hatcheries and
    rivers.




We
believe we are one of a few comprehensive security solution providers in the
industry. We analyze security risks and develop security solutions specifically
tailored to mitigate those risks, including designing, engineering and
manufacturing individual components of a system as may be necessary to deliver a
fully integrated security system that meets the facility requirements. We are
frequently engaged by security system integrators, security system
dealers/installers, and commercial architects and engineers because we are able
to deliver an integrated platform for a fully integrated security solution to
support our customers' requirements for the completion of a given
project.




We
believe we have developed an excellent reputation as a provider of integrated
security systems since our inception in 1976 because we:





•
            offer a complete range of
      solutions-driven responses to accommodate our customers'
      needs,


•
            offer technologically superior
      products,


•
            are able to design, engineer and
      manufacture systems customized to our customers' specific
      requirements,


•
            deliver systems that are easy to
      operate and maintain while providing superior life cycle cost performance
      compared to systems offered by our
  competitors,


•
            have
      established solid credentials in protecting high value targets, and offer
      our customerswhat
      we believe may be the best warranty in the
  industry.


•
            are ISO 9001:2000 registered and
      will seek to maintain our ISO
status




Security
Industry Overview




The
Security Institute of America estimates that the worldwide market for security
products and services in 2010 will exceed $7.5 billion. The industry encompasses
a wide ranging, highly fragmented group of products and service providers which
includes entities that market comprehensive security systems and offer security
consulting services, dealers/installers, small single product companies,
equipment manufacturers, consultants and systems integrators.




We
believe the security industry has experienced significant growth over the last
decade, both in the total dollar amounts generated from sales and the number of
entrants offering security related products, and continues to grow rapidly
because:





•
            western nations have been the
      target of high profile terrorist attacks over the last several years that
      have squarely focused attention on security issues and threat
      mitigation;


•
            perimeter security for airports,
      maritime, chemical, transportation, energy and pharmaceutical facilities
      has been mandated by Homeland
Security;


•
            newer, more effective and
      efficient security equipment incorporating advancements in security
      technology is replacing obsolete
  equipment;


•
            advanced electronic
      communications systems have created a growing need for information
      technology security to prevent the misuse of proprietary information and
      other intellectual property;
and


•
            private industry is operating in
      more remote geographic locations and higher risk
      environments.







Products,
Systems and Technologies




The
services and technologies required to create a secure environment must address
the entire range of security concerns that challenge government and commercial
institutions, including the protection of:





•
            life;


•
            tangible assets, such as
      buildings, vessels and personal
  possessions;


•
            intangible assets, such as
      intellectual property, sensitive research and other confidential
      information; and


•
            electronic data and information
      technology.




Integrated
security systems are comprised of one or more subsystems and components that
perform a variety of security functions for a facility or group of facilities
under the direction of a single command center and communication network. We
offer both integrated, turnkey security solutions that incorporate many of our
systems, and stand alone systems that comprise an individual
technology.




The
integrated security systems and/or stand alone products we market
include:





•
              Computer Based Command, Control
      and Communications Networks. The command network consists of a central
      processor, a common database and software that links various subsystems
      and components, allowing them to communicate with each other, and
      integrates the subsystems and components into a single
      system.


•
            Intrusion Detection Systems.
      Fixed location and rapid deployable infrared and fiber optic perimeter
      intrusion detection systems that detect an intruder passing through the
      sensors.


•
            Video Motion Detection and
      Assessment Systems. As an adjunct to our perimeter intrusion detection
      systems, we offer video surveillance equipment using closed circuit
      television cameras, digital processing and fiber optic links to monitor
      and assess the nature of an annunciated threat at the control
      center.


•
            Electronic Surveillance System.
      This system creates a detection and verification band outside and parallel
      to a secured perimeter and is geared toward high-level security demands
      such as border control, military bases, airports, power stations, oil and
      gas storage facilities, nuclear power plants, industrial sites, and
      prisons.


•
            Entry Portal Control (EPC)
      Integrated Solutions for vehicles and personnel including bollards, lift
      gates, road blockers, tire shredders, traffic control lighting, signage
      and those elements for access control to government and commercial
      sites.


•
            Environmental Monitoring Systems.
      Our WISE® system  (Water Infrastructure Security Environment),
      formerly  SentinalTM, remotely monitors drinking water quality
      throughout the water distribution system to detect and instantly report
      the evidence of chemical, biological, or radiological
      contamination.


•
            Computer Intrusion Detection
      Equipment. An information technology security system designed to protect
      computer local area networks (LANs) from illegal access via the Internet
      or by persons seeking to breach the LANs hard
    wiring.




In order
to provide clients with the highest quality and most advanced systems, we
incorporate technologies and products developed and manufactured by us or that
have been licensed from other entities. Frequently, we enter into technology
transfer agreements covering the technologies or products to be used so that we
can design and execute the best possible security solutions for a client within
the confines of their security budget. Products incorporate state-of-the-art
components that are configured into flexible systems tailored specifically to
meet the needs of risk mitigation in high threat environments.




We
believe that the products we offer are qualitatively comparable to or more
effective than those offered by our competitors because our
products:





•
            provide low nuisance and false
      alarm rates;


•
            are reliable in virtually any
      environmental condition;


•
            in many cases can be user
      specified and adapted to their environment;
  and


•
            are subject to low installation
      and maintenance costs.




We
believe that we have built a solid reputation as a provider of leading-edge,
high technology security solutions and services. Our view is shared and
supported by the many international government sectors and commercial clients
that engage our services and products on a continuing basis.




Consulting
Support Services




The
consulting support services we provide our dealer/installers and system
integrators are an integral part of the security solution. Effective and
efficient use of technology can be achieved only if properly utilized. Toward
that end, we:


2





•
            assist our customers, if
      requested, in conducting risk assessment and vulnerability/criticality
      studies to ascertain their security requirements and develop a
      comprehensive risk management and mitigation program;
      and


•
            provide security system design
      support services.




Our
support services generally represent the first steps in assisting the
dealer/installer or systems integrator to develop a security solution. The risk
assessment, threat, vulnerability and criticality analyses the system integrator
utilizes allow us to help develop effective responses and programs necessary to
address and mitigate the range of threats, and to implement the appropriate
solutions.




Our
customers benefit from an integrated, interactive process to determine levels of
risk. The systems integrator consults with our design staff to determine systems
configurations and human operation requirements that will provide the most
cost-effective options for mitigating risk. Our security engineers are
technically accomplished and fully familiar with the latest trends in planning,
programming, and designing systems utilizing standard peripheral components,
mini/micro architecture, and “user friendly” software/ firmware applications.
Many of our security engineers have the federal government's highest security
clearances.




We also
provide security system design support services involving the evaluation and
specifications of security systems and components that meet a client's operating
and budgetary requirements. Typically, these services are provided within the
context of a comprehensive security evaluation and implementation program in
conjunction with the systems' integrator.




We work
closely with the customer and facility owner, architect, engineer, system
integrators and/or construction manager to develop and design security
monitoring and control systems that afford a normal but secure environment for
management, staff and visitors. Our design personnel are expert in their
knowledge of the various technologies (mature and emerging) and their
application to security challenges, both in the United States and abroad,
because they continue to be intimately involved in developing security systems
for government facilities in the United States and overseas.




Product
Design




We design
and develop new products based upon market requirements and as deemed necessary
to meet clients' specific needs. We research and assess threat and vulnerability
issues and design and engineer our products in-house, with outside consultants
as necessary, and in conjunction with joint venture partners to meet the needs
of clients based upon the results of such research. We investigate new and
emerging technologies that have application in the security industry and seek to
license these technologies which we then incorporate into our product
line.




Markets
for Our Products




We have
identified a number of markets for our products and have developed programs to
gain access to those target markets. Generally, private industry and government
facilities that possess sensitive information, valuable assets or by virtue of
the nature of their business may be subject to terrorist threats, recognize the
need to implement security measures to protect personnel and property. In many
instances, laws have been enacted and mandates decreed for compliance with some
minimum-security standards. Airport security is a prime example. We target these
entities as well as entities where we can demonstrate the need for security
measures.




Primary
markets that we target include:





•
            the U.S. Government, its agencies
      and departments, including the Department of Defense and the Department of
      Energy;


•
            large industrial facilities,
      including pharmaceutical companies and major office
      complexes;


•
            energy facilities, including
      nuclear power plants, utilities, chemical-petrochemical
      pipelines;


•
            commercial aviation and maritime
      facilities;


•
            rail transportation;
      and


•
            foreign/export opportunities in
      all of the above-targeted
areas.




The U.S.
Government, along with many of its agencies and departments, represents a
significant market for our products. We actively market our products to the
following U.S. Government agencies, all of which have purchased our products in
the past and continue to be among our top customers:





•
            The U.S. Department of Defense
      and a number of its subdivisions have been using our products for force
      and asset protection at numerous military bases and air force
      installations around the world. Certain of our products have been
      certified and included as part of the government's tested and approved
      technologies.


3


•
            The U.S. Department of Energy, in
      connection with the clean-up and operation of military bases and
      government-owned nuclear processing facilities, offers an expansive and
      varied market. We are involved with the supply and support services at
      nine sites on an ongoing
basis.


•
            The Department of Transportation
      includes airports, trucking and distribution centers and marine terminals.
      Our products and systems directly apply to the security needs of this
      multi-billion dollar market
opportunity.




Our
open-ended contract with the General Services Administration (GSA), which has
been extended through July 31, 2014, authorizes the U.S. Government and a
network of eligible sources to purchase materials and services from us without
having to undergo a full competition. In September 2003, we announced the
finalization of a 5-year indefinite delivery/indefinite quantity contract for
the Integrated Base Defense Security System (IBDSS) with the United States Air
Force (USAF) to secure highly strategic military facilities throughout the
world. During Fiscal 2008, the Company was awarded a number of orders for
Tactical Automated Sensor Systems (TASS). On April 22, 2009, the contract was
increased and extended to August 30, 2009.  A task order awarded in
August was completed during the second quarter of 2010. The IBDSS program has
been  re-bid as “Force Protection Security System (FPS2),”and an
award was made during the first quarter of fiscal 2010.  The Company
expects to be a technology supplier to the three large system integrators
selected for the  FPS2 program
over the next five years.




We also
target state and local governments and government authorities and agencies
fulfilling the roles described above.




Large
Industrial Facilities and Major Office Complexes. These types of facilities,
such as pharmaceutical companies, frequently house sensitive data where research
and product development occur and are likely to acquire integrated security
packages to create a “smart building.” The technologies required to create a
smart building in today's environment must address life, safety, power,
lighting, information technology protection and other security systems to create
a normal yet secure environment for employees, visitors and service
personnel.




Energy
Facilities, Including Nuclear Power Plants, Utilities, Chemical-Petrochemical
Pipeline Facilities. Nuclear power stations and utilities that house sensitive
information and dangerous materials represent a large and lucrative market for
our products. Chemical-petrochemical, natural gas and pipeline companies, many
of which operate in high risk environments and remote geographic locations,
invest huge sums in the assets necessary to operate those businesses and adopt
appropriate measures to protect their investments through the acquisition of
security equipment and systems.




Commercial
Aviation and Maritime Transportation. Infrastructure security has been at the
forefront of security consciousness for many years. The federal government
appropriated significant funds for the acquisition and installation of new,
high-technology security systems at these facilities. There are approximately
1,200 facilities in the U.S. that the Federal Aviation Agency has identified and
mandated for perimeter and access control security systems upgrade to be
completed over the next several years and we will bid to provide products and
services for many of these sites.




Foreign/Export
Opportunities. Government operations and private industries in foreign countries
are all subject to the same security issues that challenge similar entities in
the United States. We, along with our strategic teaming partners and
international sales representatives, continue to seek penetration of these
markets.




Marketing




We have
developed a multi-tiered marketing plan, allowing us to effectively market
products to each of the separate government and industry segments identified as
target markets both in the United States and internationally. Our marketing
strategy highlights product strengths as they apply to each particular
industry.




The
primary goals of our marketing strategy are to:





•
            broaden the base of potential
      clients, and


•
            demonstrate the efficacy of our
      products.




We have
entered into strategic partnerships, teaming, and representative relationships
with major multi-national corporations in each of the industries that comprise
our target markets. These companies generally enjoy a strong market presence in
their respective industries and we believe that our association with these
entities affords the Company and our products added credibility. These entities
frequently subcontract our services and purchase our products in connection with
larger projects. During Fiscal 2009, we entered into teaming agreements
with  Boeing Advanced Intelligence & Security Systems, Leadcom
Integrated Solutions, Ltd., OMGLS International Inc. and GMS Integrated
Systems..


4




During
the fourth quarter of fiscal 2009, the Company submitted proposals on projects
for Department of Defense facilities and certain nuclear power stations in the
United States and southeast Asia valued at approximately $3,850,000. One of
these nuclear projects was awarded and partially shipped during the fourth
quarter of fiscal 2009. Most of these proposals are still pending and awaiting
approval, funding and award.  We anticipate decisions relating to
these remaining proposals within the first half of fiscal 2010 with deliveries
scheduled through the last six months of fiscal 2010 and the first half of
fiscal 2011.




Members
of our management team have many years of experience in the security industry.
Each member is assigned a corporate account and thereby establishes
relationships with government and commercial organizations in a specific market.
We attempt to maintain direct contact with key employees of the major corporate
accounts and government agencies encompassing our target markets.




We are
projecting our international business to develop through a network of
independent sales representatives. Agreements are in place with various entities
that allow us to maintain a presence in 21 countries worldwide. These agreements
generally extend for a period of two years and provide the dealer/installer with
price discounts from current price schedules as an incentive to market our
products in their geographic area. We rely on our dealer/installer base to
represent our product line throughout the world and to apprise us of potential
projects where the products can be incorporated. In addition, we rely on our
dealers/installers to introduce our company and products to key government and
private enterprise personnel in their respective geographic
regions.




We also
market directly to providers of integrated security systems, security systems
dealers/installers, systems engineers and other entities that may be contracted
for a security system on behalf of a client.




A
presence is maintained at the major trade conferences that address our target
markets and we advertise in the relevant conference publications.




We employ
a variety of pricing strategies for our services. Proposals for consulting
services are based on an estimate of hours multiplied by standard rates. Systems
integration projects are based on the estimated cost of the components including
subcontractors and equipment, plus a profit margin. Pricing for engineering and
maintenance services vary widely depending on the scope of the specific project
and the length of engagement.




Business
Growth Strategy




In order
to achieve a sustainable and continuous growth rate, we believe that we must
devote additional resources to marketing and product development. Specifically,
we have or intend to:





•
            Expand our base of
      dealers/installers/integrators worldwide. This is an effective and cost
      efficient means of increasing sales. These entities serve as our local
      agents to market products and provide customer support. Furthermore, these
      entities are familiar with local laws and frequently have local contacts
      in government and business at decision-making
    levels.


•
            Expand our global
      presence.  We entered into sales agreements with a number of
      multi-national companies to represent and support our products in Africa,
      India, China, and the Middle
East.


•
            Design and develop new systems.
      We will continue to develop new security systems to expand our portfolio
      of proprietary products. We believe that this will help us to open new
      markets and retain our position as a leading edge provider of technology
      based security equipment.


•
            License new and emerging
      technologies. We will continue to identify, analyze and acquire new and
      emerging technologies for application in the security industry. We will
      seek to acquire technologies that will enhance our existing systems and
      develop new products.


•
            Upgrade existing products. We
      have and will continue to upgrade existing products by taking advantage of
      technological advancements to ensure that they remain
      state-of-the-art.




Customers




We
provide products and services to certain customers who maintain their own
integration engineering and installation departments. During the past five years
we have provided products to approximately 50 nuclear power stations, Department
of Energy and other government agencies covering over 220
projects.


5




Under
usual business conditions, given the nature of our customers and products, we
receive relatively large orders for products and services from a relatively
small number of customers. We have committed to expand our customer base and,
for the fiscal year ended June 30, 2009, there were three customers from which
we had significant sales volume.  The Department of Defense accounted
for 40 %, Leadcom Integrated Solutions, Ltd., 27 % and Securetech LLC, 10
%.   In Fiscal Year 2008, Leadcom Integrated Solutions, Ltd., the
Department of Energy and the Department of Defense accounted for 35%, 21% and
16%, respectively, of our net revenues.




Competition




As the
public and private sectors become increasingly concerned with security issues,
we believe that the security and anti-terrorism industry will experience
substantial growth. Competition is intense among a fragmented and wide ranging
group of product and service providers, including security equipment
manufacturers, providers of integrated security systems, systems integrators,
consulting, engineering and design firms and others that provide individual
elements of a system. Many of our current and potential competitors possess
greater name recognition and financial, technical and marketing resources than
we do. As a result, they may be able to respond more quickly to new or emerging
technologies and changes in customer requirements, or to devote greater
resources to the development, promotion, sale and support of their products than
we can. Because of growth in the marketplace, we anticipate increased
competition from other sources, ranging from emerging to established companies.
We believe that the principal factors affecting competition in the industry
include applied technology, product performance, price and customer service. We
cannot be certain that we will be able to compete successfully in the future
against existing or potential competitors.




We
believe we are able to sustain our competitive position in the industry
because:





•
            our principal officers, security
      analysts, design personnel and sales persons have an aggregate of over 200
      years of experience in the security
  industry;


•
            we have the ability to analyze
      security risks, design, engineer and manufacture products customized to a
      client's requirements;


•
            our products address a wide range
      of security requirements;


•
            our products are among the most
      technologically advanced and the highest quality
      available;


•
            our products are flexible in that
      many of them can be configured and customized to meet a client's specific
      needs and can be integrated in new or existing security
      systems;


•
            our products are reliable, and
      relatively easy and inexpensive to install and maintain;
      and


•
            we have been successful in
      teaming with large multinational companies to market and incorporate our
      products into their product offerings, thereby contributing to the
      credibility and efficacy of our
products.




Manufacturing




We
maintain manufacturing operations at our facilities in New Jersey and Alabama.
These activities include the procurement of materials, product assembly and
component integration, product assurance, quality control and final
testing.




We
purchase the individual components that comprise our products or subcontract the
manufacture of specific subsystems to third parties. We believe that we are not
overly dependent on any one supplier for the components of our products. In the
event of any disruption in supply or discontinuation of production by any of our
present suppliers, we believe that the components used in our products are
available from numerous sources at competitive prices. Various aspects of the
software programming required in connection with our computer products are
designed and written by in-house personnel or are subcontracted to third
parties.




We have
not entered into any long-term contracts for the purchase of components but
rather rely on rolling forecasts to determine the number of units we will sell
and the components required. We maintain an inventory of certain long-lead items
required in the manufacture of our products, as reflected in our balance sheet.
To date, we have been able to obtain supplies of these components and we believe
that adequate quantities are available to meet our needs.




To date,
compliance with environmental laws has not impacted our manufacturing or other
operations, although there can be no assurance that this will continue to be the
case.




Intellectual
Property and Other Proprietary Rights




Proprietary
protection for our technological expertise, products and product candidates are
important to our business. Currently, we rely upon trade secrets, application
experience and continuing technological innovation to develop and maintain our
competitive position. We also rely on a combination of trade secret protection
and non-disclosure agreements to establish and protect our proprietary
rights.


6




Our
success is dependent to a great extent on our proprietary knowledge, innovative
skills, technical expertise and marketing ability. Our intention is not to rely
primarily on patents or other intellectual property rights to protect or
establish our market position.




We
obtained trademarks in the United States, South Korea, United Kingdom and Saudi
Arabia for “FOIDS®” (Fiber Optic Intelligent Detection System); “IPID®”
(Infrared Perimeter Intrusion Detection); “RDIDS®” (Rapid Deployment Intrusion
Detection System); “IDMS®” (Intrusion Detection & Monitoring System);
“LanDataSecure®” (LAN and WAN Security Monitoring); “WISE®” (Water
Infrastructure Sensing Equipment), “Vacusonic®” (a water purification process),
and “Gamma Shark®” (a water radiation detection system).   We
have also filed for trademarks in other countries.




We
require all employees, consultants and contractors to execute non-disclosure
agreements as a condition of employment with or engagement by the Company. We
cannot be certain, however, that we can limit unauthorized or wrongful
disclosures of unpatented trade secret information.




Although
we continue to implement protective measures and intend to defend our
proprietary rights, policing unauthorized use of our technology or products is
difficult and we cannot be certain that these measures will be effective or
successful.




Research
and Development




The
forces that drive the design and development of new products include the need to
meet new security threats, incorporate newly developed technologies and satisfy
a client's unique security requirements. We research and assess threat and
vulnerability issues at selected facilities within our target markets and design
and engineer products in-house with outside consultants as necessary and in
conjunction with joint venture partners to meet the needs of clients based upon
the results of such research. We investigate new and emerging technologies in
the security industry and seek to license certain technologies which we then
incorporate into our products.




During
the years ended June 30, 2009 and 2008, we expended $161,336 and $98,336,
respectively, on research and development activities.




Product
Warranty




IPID®
sensors are warranted for ten (10) years, under normal use, against defects in
workmanship and material from date of installation of the system on the
customer's premises. All other components are warranted to the extent of the
warranty given by the actual manufacturer.  FOIDS® processors are
warranted for a ten (10) year period. For the years ended June 30, 2009 and
2008, net expenses attributable to warranties were well below the amounts
accrued.  An unanticipated cost in fiscal 2007 was incurred due to a
supplier who had produced and delivered defective sensor housings which were not
immediately evident but which were discovered after they had been fully
assembled, shipped and installed at various sites during 2006 and
2007.  We had filed suit against the housing manufacturer seeking in
excess of $530,000 in damages.  In June 2009, an arbitration decision
was made in the Company’s favor against Bennett Plastics in the amount
of  $148,000.  However, based on the financial condition of
Bennett Plastics, we were advised by counsel to negotiate an immediate cash
settlement of $125,000 which we negotiated and settled on June 26,
2009.  We also negotiated and settled all outstanding attorney fees
owed to Lasser Hochman, LLC as part of the settlement.




Technology
Licensing Arrangements




As we
endeavor to design and manufacture the most effective and efficient technology
based security solutions, we review and investigate new and emerging
technologies that have application in the security industry. Frequently, we seek
to incorporate these technologies into our systems. We are party to agreements
to use certain proprietary IT and security systems
including  Meridian  Technologies Inc. (for fiber optic
networking affording video voice and data over single fiber), El-Go Team (for
bollards, barriers, lift gates, tire shredders, traffic lights and signage), You
Tech (for day/night pan/tilt/zoom long range infrared/laser illumination with
video motion detection capability from two to 20 kilometers), a magnetic fence
and/or in-ground sensor system, and Vindicator/Honeywell for data acquisition
..




Employees




As of
September 22, 2009,we
employed 14 key individuals on a full-time basis including six design and
engineering staff, four manufacturing and assembly employees, three marketing
employees, two project managers and three administrative employees. A number of
employees serve in multiple capacities. For example, Arthur Barchenko serves as
our President but is also an integral member of our marketing team. Our
manufacturing staff may oversee site installation of the
products.


7




We have
relationships with 11 independent sales representative and/or dealer-installer
organizations covering specific regions in the U.S.A., Central America, South
America, United Kingdom, India, the Middle East, and Southeast
Asia.




Based on
our teaming agreements with large system integrators, we are able to address
large projects by  utilizing the technical expertise of these teaming
partners in support our factory engineering and/or in-field personnel
requirements on any given project.




None of
our employees are covered by a collective bargaining agreement or represented by
a labor union. We consider our relationship with our employees to be
satisfactory.




Item
1A. RISK FACTORS




An
investment in our common stock involves risks and uncertainties. You should
consider the following factors carefully, in addition to the other information
contained in this Form 10-K, before deciding to purchase our
securities.




Risks
Relating to Our Business




There
is an existing Event of Default under our senior secured convertible debentures
issued in our January 2006 private financing ,and the obligations under such
debentures  are secured by a lien on  all of our assets
including our intellectual property.





We are
currently in default under our senior secured convertible debentures that we
issued in our January 2006 financing. These debentures came due on January 11,
2009. We currently owe approximately $452,500_ under the debentures. The Company
and the debenture holders are currently holding discussions to consider various
proposals designed to address this issue. No assurance can be provided that the
Company and the debenture holders will in fact be able to reach a resolution of
this matter.





We
currently do not have the cash resources to pay these obligations, which are
secured by all of our assets including our intellectual property, and such
assets are therefore be subject to seizure by the holders of the debentures. We
were not able to repay the $490,000 balance that was due on January 6, 2009. To
date, during the fourth quarter of fiscal 2009, we have reduced the debt by
$37,500 and have remained current on the interest payments.  Until the
amounts owing are paid in full, the holders of the debentures are entitled to
foreclose on our assets to satisfy amounts owed to them.




Our
senior secured convertible debentures contain numerous events of default and
covenants. Events of default under the debentures include:





•
            failure to pay principal or any
      premium on any debenture when
due,


•
            failure to pay any interest, late
      fees or liquidated damages on any debenture after a period of three
      trading days,


•
            failure to perform other
      covenants under the debenture that are not cured by the earlier of seven
      trading days after notice by holder or 15 trading days after we are aware
      of such default,


•
            default under the other financing
      documents that is not cured by the earlier of five trading days after
      notice or ten trading days after we are aware of such
      default,


•
            any representation or warranty
      under the financing documents that is untrue or incorrect in any material
      respect, or certain events of bankruptcy or insolvency of us or any of our
      subsidiaries, or any default by us or our subsidiaries under any
      instrument in excess of $150,000 that results in such obligation becoming
      due and payable prior to
maturity,


•
            our becoming party to a change of
      control transaction, or disposing of greater than 40% of our assets or
      redeeming more than a de minimus number of outstanding equity
      securities,




Upon an
event of default, the outstanding principal of the debentures plus all accrued
and unpaid interest shall become immediately due and payable to the holders of
the debentures.




The
debentures contain various covenants that limit our ability to:





•
            incur additional debt, other than
      permitted debt as defined in the
  debenture,


•
            incur specified liens, other than
      permitted liens as defined in the
  debenture,


•
            amend our certificate of
      incorporation or by-laws in a material adverse manner to the holder,
      or




8




•
            repay or repurchase more than a
      de minimus number of shares of common
  stock.




We
depend on government contracts for a large part of our total sales, and
therefore our business is vulnerable to fluctuations in government
spending.




Because
many of our contracts are with governmental entities, our business is subject to
risks that are out of our control, including global economic developments, wars,
political instability, changes in the tax and regulatory environments, foreign
exchange rate volatility and fluctuations in government spending. For example,
the 2009 Homeland Security Appropriations Act provides $7.1 billion in
discretionary spending for the Department of Energy and Department of Defense.
However, because many customers are governmental entities with variable and
uncertain budgets, the amount of business that we might receive from them may
vary from year to year, regardless of the perceived quality of our
business.




Some of
our contracts are subject to cancellation by clients upon short notice with
little or no penalty so we cannot be certain that our backlog will be filled.
The contracts we enter into with government entities are often awarded prior to
legislative funding appropriations to support those contracts. Consequently, the
entire amount of orders and contracts received from these entities may never be
funded. If a substantial portion of our backlog orders are cancelled, our
business, operating results and financial condition could be materially and
adversely affected. In addition, the cancellation of a substantial portion of
booked orders would negatively impact other areas of our business. For example,
if we have booked orders from a large customer and the customer cancels their
order, it would greatly affect our operating results for the period during which
we would have recognized revenues from that customer. This could cause our stock
price to fluctuate and make it difficult to evaluate the Company. Moreover,
cancellation of a booked order after we have ordered components and materials to
manufacture systems could result in the Company having excess inventory with no
corresponding income.




During
the fiscal year ended June 30, 2009, three  customers accounted for
substantially all of our revenues; the Department of Defense comprised 40% of
revenues, Leadcom Integrated Solutions, 27%, and Securetech LLC,
10%.  A substantial decrease in revenues generated from contracts from
these customers could have an adverse effect on our business unless we were able
to identify other customers. For the fiscal year ended June 30, 2008, three
customers accounted for substantially all of our revenues, with the Department
of Defense, Leadcom Integrated Solutions and the Department of Energy accounting
for 35%, 21% and 16%, respectively, of net revenues   If we are
unsuccessful in diversifying our customer base, we may experience a significant
decrease in business resulting in a material adverse effect on our financial
condition and results of operations.




Because
our sales tend to be concentrated among a small number of customers during any
period, our operating results may be subject to substantial fluctuations.
Accordingly, our revenues and operating results for any particular quarter may
not be indicative of our performance in future quarters, making it difficult for
investors to evaluate our future prospects based solely on the results of any
one quarter.




Given the
nature of our customers and products, we receive relatively large orders for
products from a relatively small number of customers. Consequently, a single
order from one customer may represent a substantial portion of our sales in any
one period and significant orders by any customer during one period may not be
followed by further orders from the same customer in subsequent periods. Our
sales and operating results are subject to very substantial periodic variations.
Since quarterly performance is likely to vary significantly, our results of
operations for any quarter are not necessarily indicative of the results that we
might achieve for any subsequent period. Accordingly, quarter-to-quarter
comparisons of our operating results may not be meaningful.




We
rely on rolling forecasts when ordering components and materials for the
manufacture of our products which could cause us to overestimate or
underestimate our actual requirements. This may result in an increase in our
costs or prevent us from meeting customer demand.




We use
rolling forecasts based on anticipated orders to determine component
requirements. Lead times for materials and components vary significantly and
depend on factors such as specific supplier requirements, contract terms and
current market demand for such components. As a result, our component
requirement forecasts may not be accurate. If management overestimates our
component requirements, we may have excess inventory, which would increase our
costs. If management underestimates component requirements, we may have
inadequate inventory, which could interrupt manufacturing and delay delivery of
product to customers. Any of these occurrences would negatively impact our
business and results of operations.


9




Our
product offerings involve a lengthy sales cycle and management may not
anticipate sales levels appropriately, which could impair
profitability.




Our
products and services are designed for medium to large commercial, industrial
and government facilities, such as military installations, office buildings,
nuclear power stations and other energy facilities, airports, correctional
institutions and high technology companies desiring to protect valuable assets
and/or prevent intrusion into high security facilities. Given the nature of our
products and customers, sales cycles can be lengthy as customers conduct
intensive investigations of specific competing technologies and providers.
Moreover, orders received from governments may be subject to funding
appropriations, which may not be approved. For these and other reasons, the
sales cycle associated with our products is typically lengthy and subject to a
number of significant risks over which we have little or no
control.




We
anticipate that business from programs and projects inside the United States
will comprise a significant increase during Fiscal 2010 based on the number of
proposals outstanding that we believe will be funded and released for
manufacture during this period.




Most of
the $3,850,000 in quotations referenced above are scheduled for award and
release during the fiscal year 2010. Therefore, our domestic business should be
significantly higher than in prior periods.




We
anticipate that business from projects outside the United States will comprise
an increasing part of our business and, accordingly, we are subject to risks
associated with doing business outside the United States.




During
the fiscal years ended June 30, 2009 and 2008, we generated approximately 37%
and 63%, respectively, of our business from projects outside the United States.
We anticipate that the revenue portion from overseas operations will not
increase significantly during Fiscal 2010 as a percentage of sales. Our
international business operations are subject, generally, to the financial and
operating risks of conducting business internationally, including, but not
limited to:





•
            unexpected
      changes in or impositions of legislative or regulatory
      requirements;•
            potential
      hostilities and changes in diplomatic and trade relationships;
      and•
            political
      instability.




One or
more of these or other factors not referenced herein or now known to us could
materially impact our business and results of operations could
suffer.




We
depend on our relationships with strategic partners as a source of business and
our business and results of operations could suffer if these relationships are
terminated.




We have
entered into strategic partnerships or teaming arrangements with several large
multinational corporations that promote our products and services and
incorporate our products into their projects. In the event that we are unable to
maintain these strategic relationships for any reason, our business, operating
results and financial condition could be adversely affected.




We
compete against entities that have significantly greater name recognition and
resources than we do, enabling them to respond more quickly to changes in
customer requirements and allocate these resources to marketing
efforts.




The
security industry is highly competitive and continues to become increasingly so
as security issues and concerns have become a primary consideration at both
government and private facilities worldwide. Competition is intense among a wide
ranging and fragmented group of product and service providers, including
security equipment manufacturers, providers of integrated security systems,
systems integrators, consulting firms, engineering and design firms and others
that provide individual elements of a system, some of which are larger than us
and possess significantly greater name recognition, assets, personnel, sales and
financial resources. These entities may be able to respond more quickly to
changing market conditions by developing new products that meet customer
requirements or are otherwise superior to our products and may be able to more
effectively market their products than we can because of the financial and
personnel resources. We cannot assure investors that we will be able to
distinguish ourselves in a competitive market. To the extent that we are unable
to successfully compete against existing and future competitors, our business,
operating results and financial condition would be materially and adversely
affected.




We
rely on third parties for key components used in our products.




We rely
on suppliers for several key components utilized in the manufacture of our
products. Our reliance on suppliers involves certain risks, including a
potential inability to obtain an adequate supply of required components, price
increases, timely delivery and component quality. We cannot assure you that
there will not be additional disruptions of our supplies in the future.
Disruption or termination of the supply of components could delay shipments of
products and could have a material adverse affect on our business, operating
results and financial condition.


10




If
our subcontractors fail to perform their contractual obligations, our prime
contract performance and our ability to obtain future business could be
materially and adversely impacted.




Some of
our contracts involve subcontracts with other companies upon which we rely to
perform a portion of the services that we must provide to our customers. There
is a risk that we may have disputes with our subcontractors, including disputes
regarding the quality and timeliness of work performed by the subcontractor. A
failure by one or more of our subcontractors to satisfactorily perform the
agreed-upon services may materially and adversely impact our ability to perform
our obligations as the prime contractor. Subcontractor performance deficiencies
could result in a customer terminating our contract for default. A default
termination could expose us to liability and have a material adverse effect on
our ability to compete for future contracts and orders.




Our
services and reputation may be adversely affected by product defects or
inadequate performance.




In the
event our products do not perform to specifications or are defective in any way,
our reputation may be adversely affected and we may suffer a loss of business
and a corresponding loss in revenues.




If
we are unable to retain key executives or hire new qualified personnel, our
business will be adversely affected.




Our
success greatly depends on our ability to retain existing management and attract
key technical, sales, marketing, information systems, and financial and
executive personnel. We are especially dependent on the continued services of
our senior management team, particularly Arthur Barchenko, our President and our
key marketing personnel. The loss of any of these people could have a materially
detrimental effect on our business. We have not entered into employment
agreements with any of these people. We do not maintain key person life
insurance on any of our personnel. In addition, we are seeking to engage senior
sales staff and if we fail to attract, hire or retain the necessary personnel,
or if we lose the services of any member of our senior management team, our
business could be adversely affected.




Risks
Relating to Our Common Stock




We
have outstanding two classes of preferred stock which have preference over the
common stock as to dividends and liquidation distributions, among other
preferential rights.




As of the
date hereof, we have issued and outstanding 300,000 shares of Series A
Convertible Preferred Stock (“Series A Preferred Stock”) and 791 shares of
Series B Preferred Stock (which together with the Series A Preferred Stock is
referred to as the “Preferred Stock”). The Preferred Stock affords holders a
preference to assets upon liquidation, a cumulative annual dividend and is
convertible into shares of common stock, all of which rights impact the
outstanding shares of common stock. The Preferred Stock's right to annual
dividends makes less likely the possibility that we will declare dividends on
the common stock. In the event of a liquidation of the Company's assets, holders
of Preferred Stock will have a right to receive as a liquidation payment any
remaining assets of the Company prior to any distributions to holders of the
common stock and the holders of the Preferred Stock may be able to block actions
otherwise approved by the holders of the common stock if such action is adverse
to their rights. In addition, holders of common stock will suffer dilution upon
any conversion of the Preferred Stock which could reduce the market value of the
common stock.




Our
common stock price has fluctuated considerably and may not appreciate in
value.




Prices
for our common stock have in the past, and could continue to, fluctuate
significantly and will be influenced by many factors, including the liquidity of
the market for the common stock, investor perception of the industry in which we
operate and our products, and general economic and market conditions. Factors
which could cause fluctuation in the price of our common stock
include:





•
            conditions
      or trends in the industry,•
            failure
      to keep pace with changing technology,•
            costs
      associated with developing new products and services,•
            costs
      associated with marketing products and services may increase
      significantly,•
            the
      timing of sales and the recognition of revenues from
  them,•
            government
      regulations may be enacted which affect how we do business and the
      products which may be used at government facilities,•
            downward
      pressure on prices due to increased competition,•
            changes
      in our operating expenses,•
            sales
      of common stock,•
            actual
      or anticipated variations in quarterly results, and•
            changes
      in financial estimates by securities
analysts.




11




The stock
market in general has experienced extreme price and volume fluctuations. The
market prices of shares
of security-related companies experienced fluctuations that often have been
unrelated or disproportionate to the operating results of these companies.
Continued market fluctuations could result in extreme volatility in the price of
our common stock, which could cause a decline in the value of our common stock.
Price volatility might be worse if the trading volume of our common stock is
low.




Our
common stock is considered a “penny stock” and may be difficult to
trade.




The SEC
has adopted regulations that generally define “penny stock” as an equity
security with a market or exercise price of less than $5.00 per share, subject
to specific exemptions. The market price of our common stock is less than $5.00
per share, and therefore may be designated as a “penny stock” according to SEC
rules. Under these rules, broker-dealers who recommend such securities to
persons other than institutional accredited investors must:





•
            make
      a special written suitability determination for the
    purchaser,•
            receive
      the purchaser's written agreement to a transaction prior to
      sale,•
            provide
      the purchaser with risk disclosure documents which identify certain risks
      associated with investing in “penny stocks” and which describe the market
      for these “penny stocks” as well as a purchaser's legal remedies,
      and•
            obtain
      a signed and dated acknowledgment from the purchaser demonstrating that
      the purchaser has actually received the required risk disclosure document
      before a transaction in a “penny stock” can be
  completed.




Under
these rules, broker-dealers may find it difficult to effectuate customer
transactions and trading activity in our securities may be adversely affected.
As a result, the market price of our securities may be depressed, and it may be
more difficult to sell our securities. In addition, you may find it difficult to
obtain accurate quotations of our common stock and may experience a lack of
buyers to purchase such stock or a lack of market makers to support the stock
price.




Our
common stock is traded over the counter, which may result in higher price
volatility and less market liquidity for our common stock.




Our
common stock is quoted on the OTC Bulletin Board. As such, our common stock may
have fewer market makers, lower trading volume and a larger spread between bid
and asked prices than securities listed on an exchange such as the New York
Stock Exchange, the American Stock Exchange or the Nasdaq Stock Market. These
factors may result in higher price volatility and less market liquidity for our
common stock.




Compliance
with changing regulation of corporate governance and public disclosure may
result in additional expenses.




Keeping
abreast of, and in compliance with, changing laws, regulations and standards
relating to corporate governance and public disclosure, including the
Sarbanes-Oxley Act of 2002, new SEC regulations and, in the event we are
approved for listing on a registered exchange at some point, stock exchange
rules, will require an increased amount of management attention and external
resources. We intend to continue to invest all reasonably necessary resources to
comply with evolving standards, which may result in increased general and
administrative expenses and a diversion of management time and attention from
revenue-generating activities to compliance activities.




Our
principal stockholders have significant voting power and may take actions that
may not be in the best interest of other stockholders.




Our
executive officers, directors and principal stockholders control approximately
35% of our currently outstanding shares of common stock.  If these
stockholders act together, they may be able to exert significant control over
our management and affairs requiring stockholder approval, including approval of
significant corporate transactions. This concentration of ownership may have the
effect of delaying or preventing a change in control and might adversely affect
the market price of our common stock. This concentration of ownership may not be
in the best interests of all our stockholders.




We
do not anticipate paying cash dividends on our common stock in the near future,
and the lack of dividends may have a negative effect on our stock
price.




We have
never declared or paid any cash dividends or distributions on our capital stock.
We currently intend to retain our future earnings to support operations and to
finance expansion and therefore we do not anticipate paying any cash dividends
on our common stock in the near future.


12




Investors
in our securities will suffer dilution.




The
issuance of shares of our common stock, or shares of our common stock underlying
warrants, options, preferred stock or convertible debentures, will dilute the
equity interest of existing stockholders who do not have anti-dilution rights
and could have a significant adverse effect on the market price of our common
stock. The sale of our common stock acquired, or converted or exercised into, at
a discount could have a negative impact on the market price of our common stock
and could increase the volatility in the market price of our common stock. In
addition, we may seek additional financing which may result in the issuance of
additional shares of our common stock and/or rights to acquire additional shares
of our common stock. The issuance of our common stock in connection with such
financing may result in substantial dilution to the existing holders of our
common stock who do not have anti-dilution rights. The sale of our common stock,
or securities convertible or exercisable into shares of our common stock, could
trigger the anti-dilution rights of our outstanding securities that have such
rights, specifically our preferred stock, convertible debentures and some of our
warrants, which could result in further dilution to the existing holders of our
common stock who do not have anti-dilution rights. With respect to the senior
secured convertible debentures and warrants that we issued in our January 2006
private financing, in the event that we issue common stock in an equity
financing at a price less than the then conversion price and exercise price for
the debentures and the warrants, respectively, (i) the conversion price of the
debentures shall be immediately adjusted to the price at which such common stock
was issued, subject to specified exempt issuances, and (ii) the exercise price
of the warrants shall be reduced to the price at which such common stock was
issued and the share amount shall be increased such that the aggregate exercise
price payable, after taking into account the decrease in the exercise price,
shall be equal to the aggregate exercise price prior to such adjustment. Those
additional issuances of our common stock and potential triggering of existing
anti-dilution rights would result in a reduction of an existing holder's
percentage interest in the company.




A
significant number of our shares will be eligible for sale, and their sale could
depress the market price of our common stock.




Sales of
a significant number of shares of our common stock in the public market could
harm the market price of our common stock.




There is
an approximate aggregate of  10.1 million shares of our common stock,
some or all of which may also be offered from time to time in the open market
pursuant to Rule 144, and these sales may have a depressive effect on the market
for our shares of common stock. In general, a non-affiliated person who has held
restricted shares for a period of six months may, under Rule144, sell into the
market shares of our common stock. Such sales may be repeated once every three
months, and any of the restricted shares may be sold by a non-affiliate after
they have been held for two years.




We
could issue “blank check” preferred stock without stockholder approval with the
effect of diluting then current stockholder interests and impairing their voting
rights.




Our
Certificate of Incorporation authorizes the issuance of up to an additional
3,898,000 shares of “blank check” preferred stock with designations, rights and
preferences as may be determined from time to time by our Board of Directors.
Accordingly, our Board of Directors is empowered, without stockholder approval,
to issue a series of preferred stock with dividends, liquidation, conversion,
voting or other rights which could dilute the interest of, or impair the voting
power of, our common stockholders. The issuance of a series of preferred stock
could be used as a method of discouraging, delaying or preventing a change in
control. For example, it would be possible for our Board of Directors to issue
preferred stock with voting or other rights or preferences that could impede the
success of any attempt to change control of our Company.




The
liability of our directors is limited under State of New Jersey corporate
law.




As
permitted by the corporate laws of the State of New Jersey, our Certificate of
Incorporation includes a provision that eliminates the personal liability of our
directors for monetary damages for breach or alleged breach of their fiduciary
duties as directors, subject to certain exceptions. In addition, our by-laws
provide that we are required to indemnify our officers and directors under
certain circumstances, including those circumstances in which indemnification
would otherwise be discretionary, and we are required to advance expenses to our
officers and directors as incurred in connection with proceedings against them
for which they may be indemnified.





Item
1B.  Unresolved Staff Comments





Not
applicable.


13




Item
2. Properties




Our
corporate headquarters are located at 790 Bloomfield Avenue, Clifton, New Jersey
where we lease approximately 12,200 square feet of space divided among
administrative (2,600 square feet) and manufacturing (9,600 square feet) space.
We have renewed our lease for this space through April 30, 2018 at a rent of
$7,098 per month with an option to renew through April 30, 2028. We also lease
approximately 2,500 square feet of manufacturing space at 102 Commerce Circle,
Madison, Alabama. We have leased this space through February 2010 at a cost of
$2,200 per month.  However, as permitted under the terms of this
lease, we have notified the lessor that we intend to consolidate our
manufacturing into our New Jersey facility and will terminate our lease
effective September 30, 2009.  We believe that the New Jersey facility
is sufficient to meet our present and future requirements.




Item
3. Legal Proceedings




In fiscal
2007, we filed suit against a supplier who had delivered defective housings to
us for our sensor products and we sought in excess of $530,000 in damages. In
June 2009, an arbitration decision was made in the Company’s favor against
Bennett Plastics in the amount of $148,000. However, based on the financial
condition of Bennett Plastics, we were advised by counsel to negotiate an
immediate cash settlement of $125,000 which we negotiated and settled on June
26, 2009. We also negotiated and settled all outstanding attorney fees owed to
Lasser Hochman, LLC as part of the settlement.


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




No
matters were submitted to a vote of stockholders during the three-month period
ended June 30, 2009.


14




PART
II




Item
5. Market for Common Equity, Related Stockholder Matters AND Issuer Purchases of
Equity Securities




The
common stock of the Company trades on the OTC Bulletin Board under the trading
symbol EKCS. The prices set forth below reflect the quarterly high and low sales
prices for shares of common stock since the Company's stock commenced trading as
reported by the National Quotation Bureau, Inc. These quotations reflect
inter-dealer prices, without retail markup, markdown or commission, and may not
represent actual transactions.





Closing
      BidHigh
                      
                      
                      LowFiscal
      2009April
      1 – June 30, 2009
                      
                      $
                      0.19
                      
                      
                      $
                      0.07January
      1 – March 31, 2009
                      
                      $
                      0.08
                      
                      
                      $
                      0.07Oct.
      1 – December 31, 2008
                      
                      $
                      0.14
                      
                      
                      $
                      0.06July
      1 – September 30, 2008
                      
                      $
                      0.34
                      
                      
                      $
                      0.18Fiscal
      2008April
      1 – June 30, 2008
                      
                      $
                      0.81
                      
                      
                      $
                      0.33January
      1 – March 31, 2008
                      
                      $
                      0.40
                      
                      
                      $
                      0.20Oct.
      1 – December 31, 2007
                      
                      $
                      0.89
                      
                      
                      $
                      0.33July
      1 – September 30, 2007
                      
                      $
                      1.04
                      
                      
                      $
                      0.86




As of
September 21, 2009, ECSI had approximately 188 holders of record of common
stock. This number of holders of record does not include beneficial owners of
the Company's common stock whose shares are held in the names of various
security holders, dealers, and clearing agencies.




Dividend
Policy




The
Company has not paid any cash dividends on its common stock and does not
anticipate paying cash dividends in the foreseeable future. The Company intends
to retain any earnings to finance the growth of its business. There can be no
assurance that the Company will ever pay cash dividends. See Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operations.




Item
6.  Selected Financial Data




Not
Applicable




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




The
following discussion should be read together with our Financial Statements and
the Notes related to those statements, as well as the other financial
information included in this Form 10-K. Some of our discussion is
forward-looking and involves risks and uncertainties. For information regarding
risk factors that could have a material adverse effect on our business, refer to
the RISK FACTORS section in Item 1 of this Annual Report on Form
10-K.




Overview




We
design, develop, manufacture and market technology-based integrated security
systems. We also provide support services to system integrators consisting of
risk assessment and vulnerability studies to ascertain a client's security
requirements in order to develop a comprehensive risk management and mitigation
program.




We market
our products domestically and internationally to:





•
            security
      systems integrators;•
            national
      and local government entities;•
            large
      industrial facilities and major office complexes;•
            energy
      facilities, including nuclear plants, power utilities and pipelines;
      and•
            commercial
      transportation centers, such as airports and
  seaports.




15




We
believe that we are one of the few true totally comprehensive security solution
providers in the industry.
We are able to analyze a security risk and develop security solutions
specifically tailored to mitigate that risk, including design, engineering and
manufacturing individual components of a system as may be necessary to deliver a
fully integrated security system customized to a client’s requirements. We are
frequently engaged by security systems integrators, dealers/installers, and
commercial architects and engineers because we are able to deliver the
integrated platform of design, engineering services and fully integrated
security solutions that support their requirements for the completion of a given
project.




We
believe that we have developed a superior reputation as a provider of integrated
security systems since our inception in 1976 because we:





•
            offer
      the complete range of solutions-driven responses to accommodate our
      customers' needs;•
            offer
      technologically superior products;•
            are
      able to design, engineer and manufacture systems customized to our
      clients' specific requirements;•
            deliver
      systems that are easy to operate and maintain while providing superior
      life cycle cost performance compared to systems offered by
      competitors;•
            have
      established solid credentials in protecting high value targets;
      and•
            offer
      customers perhaps the best warranty in the
  industry.




Critical
Accounting Policies




We
prepare our financial statements in conformity with accounting principles
generally accepted in the United States of America. The preparation of these
financial statements requires management to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses. On an
ongoing basis, management evaluates its estimates, including those related to
inventory reserves, allowance for doubtful accounts and deferred taxes. Actual
results may differ from these estimates under different assumptions or
conditions. Management believes the following critical accounting policies and
the related judgments and estimates affect the preparation of our financial
statements.




Inventory
Valuation — Inventories are valued at lower of cost or market. We
routinely evaluate the composition of our inventory to identify obsolete or
otherwise impaired inventories. Inventories identified as impaired are evaluated
to determine if reserves are required. We do not currently have any reserves
against inventory.




Allowance
for Doubtful Accounts — The allowance for doubtful accounts is
comprised of two parts, a specific account analysis and a general reserve.
Accounts where specific information indicates a potential loss may exist are
reviewed and a specific reserve against amounts due is recorded. As additional
information becomes available such specific account reserves are updated.
Additionally, a general reserve is applied to the aging categories based on
historical collection and write-off experience.




Accounting
for Income Taxes — We record a valuation allowance to our deferred tax
assets to the amount that is more likely than not to be realized. While we
consider historical levels of income, expectations and risks associated with
estimates of future taxable income and ongoing prudent and feasible tax planning
strategies in assessing the need for the valuation allowance, in the event that
we determine that we would be able to realize deferred tax assets in the future
in excess of the net amount recorded, an adjustment to the deferred tax asset
would increase income in the period such determination has been made. Likewise,
should we determine that we would not be able to realize all or part of the net
deferred tax asset in the future, an adjustment to the deferred tax asset would
be charged against income in the period such determination was made. A valuation
allowance in the amount of $2,057,155  has been recorded against our
deferred tax asset at June 30, 2009.




We
account for stock-based compensation in accordance with the fair value
recognition provisions of SFAS No. 123R. Under SFAS No. 123R, stock-based
compensation cost is measured at the grant date based on the value of the award
and is recognized as expense over the vesting period of the individual equity.
We use the Black-Scholes option-pricing model to estimate the fair value of
options. In order to calculate the fair value of the options, assumptions are
made for certain components of the model, including risk-free interest rate,
volatility, expected dividend yield rate and expected option life. Although we
use available resources and information when setting these assumptions, changes
to the assumptions could cause significant adjustments to the
valuation.




16




Results
of Operations




Year
Ended June 30, 2009 (“Fiscal 2009 Period”) Compared to Year Ended June 30, 2008
(“Fiscal 2008 Period”)




Revenues. We had net revenues
of $3,472,696 for the Fiscal 2009 Period, as compared to revenues of $2,916,410
for the Fiscal 2008 Period, an increase of approximately 19%. Of the revenues
reported in the Fiscal 2009 period, approximately 60% are attributable to
domestic projects and 40% are attributable to international projects. The
increase in sales in the Fiscal 2009 Period is primarily attributable to private
sector purchase orders.




Gross Margins. Gross margins
for the Fiscal 2009 Period were 28% of revenue as compared to 35% of revenue for
the Fiscal 2008 Period. The decrease in gross margins is primarily attributable
to a change in the order mix of equipment sales and support services. We
encountered an increase in material cost while experiencing a decrease in higher
margin design and engineering support service billings which,
combined, resulted in the decrease in gross margins for the Fiscal 2009
Period.




Research and Development
(R&D). R&D expenses increased 64% in the Fiscal 2009 Period to
$161,336 from $98,336 in the Fiscal 2008 Period.  The increase in
research and development expenses is primarily attributable to new product
development such as a Long Range PTZ/IR Illuminated CCTV/Intelligent Video
Motion Detection System and the High and Low Volume Entry Control Systems for
vehicle and personnel.




Selling, General and Administrative
(SG&A). SG&A expenses increased approximately 10% in the Fiscal
2009 Period to $1,318,910 from $1,201,211 for the Fiscal 2008 Period. The
increase in selling, general and administrative expenses is attributable to
costs relating to the U.N. project in Ethiopia where we incurred significant
increases in freight and marketing related expenses. We also recognized a bad
debt write-off  in the amount of $295,845 related to two overseas
projects in Asia and the Middle East.  Although we attempted to
resolve these issues during the past year, we have been unable to collect these
amounts.




Stock Based Compensation. In
the 2009 Period, we issued stock options to our directors and various employees
valued at $63,279. The value of these options is being amortized over the
vesting period of the underlying award. In the 2008 Period, we issued stock
options to various consultants and to the directors that were valued at
$136,543.  Stock-based compensation is non-cash and, therefore, has no
impact on cash flow or liquidity.




Interest Expense. Interest
expense in the Fiscal 2009 Period was $147,526 as compared to $200,472 for the
Fiscal 2008 Period.  Included in interest expense is the amortization
of deferred finance costs relating the offering costs and the value of the
warrant issued on the private placement of the convertible
debentures.  Amortization expense in the Fiscal 2009 Period was
$35,288 as compared to $66,363 for the Fiscal 2008 Period. The decrease is
attributable to the fact that the debentures matured in January
2009




Amortization of Beneficial
Conversion Feature. In accordance with EITF No. 00-27, we recorded an
additional discount upon the issuance in January 2006 of our convertible
debentures to reflect the beneficial conversion feature of the debt and
amortizing this amount to the earlier of the date of conversion or the maturity
date. In the 2009 and 2008 periods, the Company recorded amortization of $9,926
and $18,440 respectively.




Income Tax Benefit. We did
not recognize any tax benefits from net operating losses in Fiscal 2009 or
2008.




Net Loss. Net loss before
dividends for the Fiscal 2009 period was $(667,059) as compared to a loss of
$(852,807) in Fiscal 2008.




Dividends
Related to 10% Series B Convertible Preferred Stock.




We
recorded dividends totaling $121,933 on our Series B Convertible Preferred Stock
in Fiscal 2009 and $110,751 in Fiscal 2008. In lieu of a cash payment, we have
elected, under the terms of the agreement whereby these securities were sold, to
add this amount to the stated value of the Series B Convertible Preferred
Stock.




These
dividends are non-cash and, therefore, have no impact on our net worth or cash
flow.




Liquidity
and Capital Resources




At June
30, 2009, we had working capital of $1.1 million compared to $1.6 million
at June 30, 2008. Net cash provided by operating activities for Fiscal 2009 was
$68,503 as compared to $56,858 for Fiscal 2008.




Inventory
has decreased by $7,400 in Fiscal 2009, and we anticipate a further decrease
during the first half of 2010 for shipments on committed projects that have or
are being released.




Day's
sales outstanding (DSO) were 181 days at June 30, 2009 as compared with 253 DSO
at June 30, 2008. This is due to certain payments being held until final
completion of projects in Fiscal 2009.


17




Accounts
payable and accrued expenses have decreased by $775,002 in the Fiscal 2009
period as payments to vendors have been made to match the collection of
receivables.




Investing
activities for Fiscal 2009 included equipment and software purchases totaling
$7,338, primarily related to upgrade two major product lines. We do not have any
material commitments for capital expenditures going forward. Investing
activities for Fiscal 2008 included $2,120 for product upgrades.




In
January 2006, we raised net proceeds of $831,000 from the proceeds of the
private placement of $1 million in principal amount of our Senior Secured
Convertible Debentures ("the Debentures").  Our obligations with
respect to the Debentures are secured by a lien on all of our assets, including
our intellectual property.  As of June 30, 2009, approximately
$452,500 in principal amount of the debentures remains outstanding. The
principal and interest owing on the debentures became due as of January 11, 2009
but were not repaid. The Company and certain of the debenture holders are
currently holding discussions to consider various proposals designed to address
this issue. No assurance can be provided that the  Company and the
debenture holders will in fact be able to reach a resolution of this
matter.




In
connection with the Clarion acquisition we assumed an existing loan in the
amount of $95,300. The loan is payable in 34 monthly installments of $2,750 plus
interest at the rate of prime plus 1/2% per annum. The balance was satisfied in
fiscal 2009.




In Fiscal
2008, the Company financed the purchase of equipment from a vendor in the amount
of $101,762, evidenced by a bearing interest at the rate of 8% per annum. As the
Company purchases product from the vendor a portion of each invoice will be
charged to reduce the note balance. Management expects that the note will be
repaid in approximately 12 months. The balance at June 30, 2009 was
$65,017.




In July
2007, $150,000 of the loan balance due to officers was converted into 200,000
shares of the Company's Common Stock.




We expect
that cash on hand together with collection of accounts receivable will be
sufficient to provide for our working capital needs for the next 12
months.




Discussion
of Results, Business Outlook and Identifiable Industry Trends




Spending
in the security industry has stabilized over the last year as the U.S. Congress
has continued to allocate money to fund homeland security initiatives including
Department of Energy and Department of Defense programs. We expect this trend
will continue for the foreseeable future. As a result, the level of new
proposals continues and our committed backlog, including the IBDSS awards from
the U.S. Air Force, is the largest backlog in our history. We cannot, however,
assure you that we will complete any or all of the orders comprising our backlog
within the anticipated time frame. Our experience has taught us that all of
these anticipated releases and new contracts are subject to cancellation or
delay, thus we cannot be certain of the total realized revenue amount of our
backlog and do not even reference the total dollar amount of our present backlog
or submitted proposals.




Our sales
dependency has continued to shift from our President and Chief Executive
Officer, Arthur Barchenko, to program and project managers to meet our revenue
objectives. During the last year, we continued to mitigate the concentration of
sales efforts by (i)  engaging independent sales representatives to market
our products and generate sales opportunities and (ii) expanding sales
efforts through dealer-installers and system integrators in geographic regions
on which we have not focused our resources in years past such as the Caribbean,
Latin America, Egypt and the Middle East, China and Africa, where we are
developing projects that management believes will result in ongoing
revenue.




During
the Fiscal 2009 period, we submitted bids on 22 new projects for work to be
performed at our Clifton, New Jersey facilities. We cannot be certain that we
will be successful in winning any of the bids tendered. Even if we do receive
orders, contracts are subject to cancellation by customers upon short notice
with little or no penalty, as is typical in our industry.




In June
2009, in an effort to reduce our manufacturing costs, we made the decision to
consolidate our manufacturing and to move our FOIDS facility in Alabama into our
New Jersey plant. Our lease for approximately 2,500 square feet in Madison,
Alabama, rents for $2,200 per month and expires in February 2010.  As
permitted under the terms of that lease, we have notified the lessor that we
intend to terminate our lease effective September 30, 2009.  We
believe that the New Jersey facility is sufficient to meet our present and
future requirements.




We
believe these steps and others we expect to implement over the course of Fiscal
Year 2010 will help us to achieve revenue stability with improved gross margins
and consistent and steady growth in the years ahead.


18




We are
committed to offering our customers comprehensive, integrated security systems
that employ the latest technologies and address the most critical security
requirements. The security industry continues to evolve rapidly as new
technologies are developed specifically to meet security challenges and existing
technologies are being adapted for new uses. In addition, the public and private
sectors continue to analyze and distinguish new security risks and industry
participants seek to develop technologies and products to fill these newly
discerned requirements. We remain committed to pursuing teaming and OEM
agreements that may add to our revenues and enhance both our product line and,
ultimately, our ability to compete in our industry.




Business
Outlook




As global
economic prospects began to change during 2009, orders and commitments
stabilized. Currently, proposals for new orders continue to grow. However, our
historical results have taught us that the release of funds that support
proposals may never be forthcoming. Furthermore, as is customary in the security
industry, our contracts are subject to cancellation or delay at any time with
little notice or penalty. Government based purchase orders which are subject to
legislative appropriations are particularly sensitive to economic and political
conditions. Thus, we cannot be certain of the total realized value and revenue
which we will generate from committed orders. We expect to receive releases and
task orders for a significant portion of our contract commitments sometime
within the next four to eight months, although we cannot be certain that we will
complete any or all of such orders within the anticipated time
frame.




The
security industry as a whole has not changed. The security market historically
has been a product oriented opportunity for manufacturers, both within the
United States and internationally. The difficulty the industry traditionally
faced has been the ability to develop a standard security platform that would
permit systems integrators to design a seamless interface between the multiple
products and subsystems required to address threats in high-security
environments. A number of companies are attempting to develop platforms that
address seamless integration of multiple technologies. We expect this trend
continuing for the foreseeable future, since the demand for integrated platforms
will continue.




We
recognized this trend early in our existence and to that end, we developed,
marketed and installed integrated platforms which encompass multiple
technologies. We continue to seek to improve our integrated systems and have
retained a highly-competent systems oriented software programmer and two
computer-oriented electronic engineers to further develop and enhance the
integrated platform for current and future projects.




Business
Approach




Over the
last several years we have tried to develop contacts and relationships through
our marketing programs and staff with clearly defined and targeted potential
strategic partners. The strategic relationship framework provides a
comprehensive and thorough mechanism for developing and implementing corporate
strategy. Our advisory board determined early in our existence that, given our
size and the criticality of our business situation, the strategic relationship
framework would provide us with a non-resource exhaustive and more expedient and
efficient means of entering new markets. This approach has met with considerable
success and we continue to seek strategic alliances.




We
believe we are positioned for economic success during Fiscal 2010 which should
continue into 2011 and beyond. A number of factors contribute to this
outlook.





•
            Our
      estimate that orders recently received, including nuclear power station
      security upgrades; Hanscom Air Force Base equipment purchases; and
      Honeywell, Sandia and Indyne relationships resulting in product purchase
      orders will yield significant sales in 2010.•
            The
      conclusion of agreements with new strategic partners for the U.S. Navy
      base security upgrade program will be a source of material orders during
      Fiscal 2010 and for the next two years.•
            We
      have entered into agreements with a number of large system integrators for
      the U.S. Air Force FPS2
      initiative as a technology
supplier.




Recently
Issued Accounting Pronouncements




In
April 2009, the FASB issued FASB Staff Position No. 107-1, “Interim
Disclosures about Fair Value of Financial Instruments” (“FSP 107-1”), which
amends Statement of Financial Accounting Standards No. 107, “Disclosures
about Fair Value of Financial Instruments,” to require disclosures about the
fair value of financial instruments for interim reporting periods in addition to
annual reporting periods. FSP 107-1 is effective for all interim and annual
reporting periods ending after June 15, 2009.


19




In May
2009, the FASB issued SFAS No. 165 "Subsequent Events" ("SFAS 165"). SFAS 165
establishes general standards of accounting for and disclosure of events that
occur after the balance sheet date but before financial statements are issued or
are available to be issued. SFAS 165 sets forth (1) The period after the balance
sheet date during which management of a reporting entity should evaluate events
or transactions that may occur for potential recognition or disclosure in the
financial statements, (2) The circumstances under which an entity should
recognize events or transactions occurring after the balance sheet date in its
financial statements and (3) The disclosures that an entity should make about
events or transactions that occurred after the balance sheet date. SFAS 165 is
effective for interim or annual financial periods ending after June 15, 2009.
The Company performed a review for subsequent events through the date of this
report. No recognized or non-recognized subsequent events were
noted.




In June
2009, the FASB issued SFAS No. 166 "Accounting for Transfers of Financial
Assets-an amendment of FASB Statement No. 140" ("SFAS 166"). SFAS 166 improves
the relevance, representational faithfulness, and comparability of the
information that a reporting entity provides in its financial statements about a
transfer of financial assets; the effects of a transfer on its financial
position, financial performance, and cash flows; and a transferor's continuing
involvement, if any, in transferred financial assets. SFAS 166 is effective as
of the beginning of each reporting entity's first annual reporting period that
begins after November 15, 2009, for interim periods within that first annual
reporting period and for interim and annual reporting periods thereafter. The
Company is evaluating the impact the adoption of SFAS 166 will have on its
financial statements.




In June
2009, the FASB issued SFAS No. 167 "Amendments to FASB Interpretation No. 46(R)"
("SFAS 167"). SFAS 167 improves financial reporting by enterprises involved with
variable interest entities and to address (1) the effects on certain provisions
of FASB Interpretation No. 46 (revised December 2003), "Consolidation of
Variable Interest Entities", as a result of the elimination of the qualifying
special-purpose entity concept in SFAS 166 and (2) constituent concerns about
the application of certain key provisions of Interpretation 46(R), including
those in which the accounting and disclosures under the Interpretation do not
always provide timely and useful information about an enterprise's involvement
in a variable interest entity. SFAS 167 is effective as of the beginning of each
reporting entity's first annual reporting period that begins after November 15,
2009, for interim periods within that first annual reporting period, and for
interim and annual reporting periods thereafter. The Company is evaluating the
impact the adoption of SFAS 167 will have on its financial
statements.




In June
2009, the FASB issued SFAS No. 168 "The FASB Accounting Standards Codification
and the Hierarchy of Generally Accepted Accounting Principles-a replacement of
FASB Statement No. 162". The FASB Accounting Standards Codification
("Codification") will be the single source of authoritative nongovernmental U.S.
generally accepted accounting principles. Rules and interpretive releases of the
SEC under authority of federal securities laws are also sources of authoritative
GAAP for SEC registrants. SFAS 168 is effective for interim and annual periods
ending after September 15, 2009. All existing accounting standards are
superseded as described in SFAS 168. All other accounting literature not
included in the Codification is non-authoritative. The Company is evaluating the
impact the adoption of SFAS 168 will have on its financial
statements.




Item
7A.  Quantitative and Qualitative Disclosures about Market
Risk




Not
applicable.




Item
8. Financial Statements




The
information called for by this Item 8 is included following the “Index to
Financial Statements” contained in this Annual Report on Form 10-K.




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




None.




Item
9A(T) Controls and Procedures.




EVALUATION
OF DISCLOSURE CONTROLS AND PROCEDURES.




We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our Exchange Act reports is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms, and that such information is accumulated and communicated
to management, including our President and Chief Executive Officer (who also
serves as our principal executive officer and principal financial and accounting
officer) to allow timely decisions regarding required disclosure based closely
on the definition of "disclosure controls and procedures" in Rule
13a-15(e).


20




As of the
end of the period covered by this report, we carried out an evaluation, under
the supervision and with participation of management, including our President
and Chief Executive Officer (who also serves as our principal executive officer
and principal financial and accounting officer), of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on the
foregoing, our President and Chief Executive Officer concluded that our
disclosure controls and procedures were effective.




MANAGEMENT’S
REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING.




Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting. Internal control over financial reporting is a
process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
reporting purposes in accordance with accounting principles generally accepted
in the United States. Because of inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.




The
Company’s management, including our principal executive officer who also serves
as our principal financial and accounting officer, does not expect that our
disclosure controls will prevent all errors and all fraud.  A control
system, no matter how well conceived and operated, can provide only reasonable,
not absolute, assurance that the objectives of the control system are
met.  Further, 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.  Because of the inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance 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.  The design
of any system of controls also is based in part upon 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.




Our
management, including our principal executive officer who also serves as our
principal financial and accounting officer, conducted an evaluation of the
effectiveness of our internal control over financial reporting based on the
framework in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on his evaluation under the
framework in Internal Control
-  Integrated Framework , our management concluded that our internal
control over financial reporting was effective as of June 30, 2009.




This
annual report does not include an attestation report of the Company's registered
public accounting firm regarding internal control over financial reporting.
Management's report was not subject to attestation by the company's registered
public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permit the company to provide only management's report
in this Annual Report.




During
the year ended June 30, 2009, there have been no changes in our internal
controls over financial reporting that have materially affected, or are
reasonably likely to materially affect, these controls.




Item
9B. Other Information.




None.


21




PART
III




The
information called for by Items  10,  11,  12, 13
and  14 will be contained in the Company's definitive proxy statement
which the Company intends to file within 120 days after the end of the Company's
fiscal year ended June 30, 2009 and such information is incorporated herein by
reference.




Item
13. Exhibits





Exhibit
                  No.
                
                Description
                
                Location
                  Reference3.1
                
                Certificate
      of Incorporation of Electronic Control Security Inc.
                
                13.2
                
                Certificate
      of Amendment to Certificate of Incorporation of Electronic Control
      Security Inc.
                
                23.3
                
                Certificate
      of Amendment to Certificate of Incorporation
                
                33.4
                
                By-Laws
      of Electronic Control Security Inc.
                
                13.5
                
                Certificate
      of Incorporation of SEM Consultants III, Inc.
                
                13.6
                
                By-Laws
      of SEM Consultants III, Inc.
                
                13.7
                
                Certificate
      of Incorporation of ECSI International, Inc.
                
                13.8
                
                By-Laws
      of ECSI International, Inc.
                
                13.9
                
                Certificate
      of Incorporation of ECSI FOIDS, Inc.
                
                13.10
                
                By-Laws
      of ECSI FOIDS, Inc.
                
                13.11
                
                Certificate
      of Incorporation of ECSI-DSA, Inc.
                
                13.12
                
                By-Laws
      of ECSI-DSA, Inc.
                
                13.13
                
                Memorandum
      of Association of ECSI Security Communications, Inc., a Middle East
      Corporation
                
                23.14
                
                Articles
      of Association of ECSI Security Communications, Inc., a Middle East
      Corporation
                
                24.1
                
                Form
      of Common Stock Purchase Warrant issued June 30, 2004
                
                34.2
                
                Form
      of Common Stock Purchase Warrant issued January 13, 2006
                
                44.3
                
                Form
      of Senior Secured Convertible Debenture due January 11,
    2009.
                
                44.4
                
                Registration
      Rights Agreement dated as of January 11, 2006, by and among
                  Electronic
      Control Security Inc. and the investors specified therein.
                
                410.1
                
                Lease
      Agreement with 580 Brighton Road Associates for space in Clifton, New
      Jersey.
                
                110.2
                
                Securities
      Purchase Agreement dated June 30, 2004.
                
                310.3
                
                Registration
      Rights Agreement dated June 30, 2004.
                
                310.4
                
                Securities
      Purchase Agreement dated as of January 11, 2006, by and among
                  Electronic
      Control Security Inc. and the purchasers named therein.
                
                410.5
                
                Security
      Agreement, dated January 11, 2006, by and among Electronic
      Control
                  Security
      Inc. and the investors specified therein.
                
                414.1
                
                Code
      of Ethics and Business Conduct
                
                431
                
                Certifications
      of Chief Executive Officer.
                
                632
                
                Certification
      of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
                
                6




* * *
*





1.
            Incorporated
      by reference to such exhibit filed with Electronic Control Security Inc.'s
      Registration Statement on Form 10-SB filed with the Commission on February
      16, 2001.2.
            Incorporated
      by reference to such exhibit filed with Electronic Control Security Inc.'s
      Registration Statement on Form SB-2 filed with the Commission on June 6,
      2002.3.
            Incorporated
      by reference to such exhibit filed with Electronic Control Security Inc.'s
      Current Report on Form 8-K filed with the Commission on July 1,
      2004.4.
            Incorporated
      by reference to such exhibit filed with Electronic Control Security Inc.'s
      Current Report on Form 8-K filed with the Commission on January 18,
      20065.
            Incorporated
      by reference to such exhibit filed with Electronic Control Security Inc.'s
      Current Report on Form 8-K filed with the Commission on March 8,
      2005.6.
            Filed
      as an Exhibit hereto.


22




SIGNATURES




Pursuant
to the requirements of The Exchange Act of 1934 as amended, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.





By:
              /s/
      Arthur BarchenkoName:
      Arthur BarchenkoTitle:
      President, Chief Executive Officer(and
      Principal Financial and Accounting OfficerDated:
      September 30, 2009




In
accordance with the Exchange Act, this report has been signed below by the
following person on behalf of the registrant and in the capacities and on the
dates indicated.





Person
              
              Capacity
              
              Date/s/
      Arthur Barchenko
              
              President,
      Chief Executive Officer
              
              September
      30, 2009Arthur
      Barchenko
              
              (and
      Principal Financial and Accounting Officer) and Director/s/
      Natalie Barchenko
              
              Treasurer
      and Director
              
              September
      30, 2009Natalie
      Barchenko/s/
      Edward Snow
              
              Director
              
              September
      30, 2009Edward
      Snow/s/
      Stephen Rossetti
              
              Director
              
              September
      30, 2009Stephen
      Rossetti/s/
      Gordon E. Fornell
              
              Director
              
              September
      30, 2009Gordon
      E. Fornell/s/
      Ronald Thomas
              
              Director
              
              September
      30, 2009Ronald
      Thomas


23




ELECTRONIC
CONTROL SECURITY INC.


AND
SUBSIDIARIES





CONSOLIDATED
FINANCIAL STATEMENTS


With
Report of Independent Registered Public Accounting Firm





Report of Independent Registered Public Accounting
      Firm
              F-1Consolidated
      Balance Sheets
              F-2Consolidated
      Statements of Operations
              F-3Consolidated
      Statement of Changes in Shareholders’ Equity
              F-4Consolidated
      Statements of Cash Flow
              F-5Notes
      to Consolidated Financial Statements
              F-6-F-19










REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Board of Directors and Shareholders of Electronic Control Security Inc. and
Subsidiaries





We have
audited the accompanying consolidated balance sheets of Electronic Control
Security, Inc. and Subsidiaries as of June 30, 2009 and 2008, and the related
consolidated statements of operations, changes in shareholders' equity, and cash
flows for each of the two years in the period ended June 30, 2009. These
consolidated financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.





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





In our
opinion the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Electronic
Control Security, Inc. and Subsidiaries as of June 30, 2009 and 2008, and the
consolidated results of their operations and cash flows for each of the two
years in the period ended June 30, 2009 in conformity with accounting principles
generally accepted in the United States of America.





DEMETRIUS
& COMPANY, L.L.C.





Wayne,
New Jersey


September
30, 2009




F-1


Electronic
Control Security Inc.
 Consolidated
Balance Sheets
 
 June
      30,2009
                                
                                
                                2008ASSETSCurrent
      assetsCash
      and cash equivalents
                                
                                $
                                15,735
                                
                                
                                $
                                72,592Accounts
      receivable, current portion, net of allowance of allowance
      of  $100,000 and $100,000, respectively
                                
                                
                                1,252,255
                                
                                
                                
                                1,447,880Accounts
      receivable, retainage
                                
                                
                                -
                                
                                
                                
                                797,888Inventories
                                
                                
                                2,145,133
                                
                                
                                
                                2,152,533Other
      current assets
                                
                                
                                121,579
                                
                                
                                
                                337,461Total
      current assets
                                
                                
                                3,534,702
                                
                                
                                
                                4,808,354Property,
      equipment and software development costs - net
                                
                                
                                212,115
                                
                                
                                
                                306,788Intangible
      assets - net
                                
                                
                                1,115,123
                                
                                
                                
                                1,198,367Goodwill
                                
                                
                                196,962
                                
                                
                                
                                50,000Deferred
      income taxes
                                
                                
                                442,450
                                
                                
                                
                                460,750Other
      assets
                                
                                
                                8,786
                                
                                
                                
                                156,382$
                                5,510,138
                                
                                
                                $
                                6,980,641LIABILITIES
      AND SHAREHOLDERS' EQUITYCurrent
      LiabilitiesAccounts
      payable and accrued expenses
                                
                                $
                                1,900,297
                                
                                
                                $
                                2,675,299Current
      maturities of long-term debt
                                
                                
                                65,017
                                
                                
                                
                                106,9918%
      Convertible debentures (net of discounts of $-0- and
    $45,214)
                                
                                
                                452,500
                                
                                
                                
                                444,786Payroll
      taxes payable
                                
                                
                                0
                                
                                
                                
                                613Total
      current liabilities
                                
                                
                                2,417,814
                                
                                
                                
                                3,227,689Noncurrent
      liabilitiesDue
      to officers and shareholders
                                
                                
                                405,760
                                
                                
                                
                                444,308Deferred
      income taxes
                                
                                
                                48,650
                                
                                
                                
                                66,950Total
      liabilities
                                
                                
                                2,872,224
                                
                                
                                
                                3,738,947Shareholders'
      equitySeries
      A Convertible Preferred stock, cumulative, $.01 par value; $2.00
      liquidation preference; 5,000,000 shares authorized, 300,000 and 300,000
      shares issued and outstanding, respectively
                                
                                
                                3,000
                                
                                
                                
                                3,000Series
      B 10% Convertible Preferred stock, cumulative, $.001 par value; $1,522 and
      $1,485 per share liquidation preference; 2,000 shares authorized, 791
      shares issued and outstanding, respectively
                                
                                
                                1
                                
                                
                                
                                1Common
      Stock, $.001 par value; 30,000,000 shares authorized; 10,249,259 and
      10,249,259 shares issued; 10,149,259 and 10,149,259 shares
      outstanding
                                
                                
                                10,249
                                
                                
                                
                                10,249Additional
      paid-in capital
                                
                                
                                12,921,154
                                
                                
                                
                                12,735,943Accumulated
      deficit
                                
                                
                                (10,291,280
                                )
                                
                                
                                (9,502,288
                                )Accumulated
      other comprehensive income
                                
                                
                                4,790
                                
                                
                                
                                4,790Treasury
      stock, at cost, 100,000 shares
                                
                                
                                (10,000
                                )
                                
                                
                                (10,000
                                )Total
      shareholders' equity
                                
                                
                                2,637,914
                                
                                
                                
                                3,241,694$
                                5,510,138
                                
                                
                                $
                                6,980,641
 
 See Notes
to Consolidated Financial Statements.
  F-2
 
 Electronic
Control Security Inc.
 Consolidated
Statements of Operations
 
 YearEndedJune
      30,2009
                    
                    
                    2008Revenues
                    
                    $
                    3,472,696
                    
                    
                    $
                    2,916,410Cost
      of revenues
                    
                    
                    2,508,474
                    
                    
                    
                    1,894,215Gross
      profit
                    
                    
                    964,222
                    
                    
                    
                    1,022,195Research
      and development
                    
                    
                    161,336
                    
                    
                    
                    98,336Selling,
      general  and administrative expenses
                    
                    
                    1,318,910
                    
                    
                    
                    1,201,211Stock
      based compensation
                    
                    
                    63,279
                    
                    
                    
                    136,543Loss
      from operations
                    
                    
                    (579,303
                    )
                    
                    
                    (413,895
                    )Other
      (income) expenseInterest
      expense
                    
                    
                    147,526
                    
                    
                    
                    200,472Legal
      settlement
                    
                    
                    (69,696
                    )
                    
                    
                    220,000Amortization
      of beneficial conversion feature on convertible debt
                    
                    
                    9,926
                    
                    
                    
                    18,440Total
      other (income) expense
                    
                    
                    87,756
                    
                    
                    
                    438,912Loss
      before income taxes
                    
                    
                    (667,059
                    )
                    
                    
                    (852,807
                    )Income
      taxes
                    
                    
                    -
                    
                    
                    
                    -Loss
      before dividends
                    
                    
                    (667,059
                    )
                    
                    
                    (852,807
                    )Dividends
      related to convertible preferred stock
                    
                    
                    121,933
                    
                    
                    
                    110,751Net
      loss attributable to common shareholders
                    
                    $
                    (788,992
                    )
                    
                    $
                    (963,558
                    )Net
      loss per share:Basic
                    
                    $
                    (0.08
                    )
                    
                    $
                    (0.10
                    )Diluted
                    
                    $
                    (0.08
                    )
                    
                    $
                    (0.10
                    )Weighted
      average number of common shares and equivalents:Basic
                    
                    
                    10,149,259
                    
                    
                    
                    10,044,762Diluted
                    
                    
                    10,149,259
                    
                    
                    
                    10,044,762
 
 See Notes
to Consolidated Financial Statements.
  F-3
 
 Electronic
Control Security Inc.
 Consolidated
Statements of Changes in Shareholders Equity
 
 Series A Convertible
                          
                          
                          Series B 10%Convertible
                          
                          
                          
                          
                          
                          
                          
                          
                          Additional
                          
                          
                          
                          
                          
                          OtherPreferred Stock
                          
                          
                          Preferred Stock
                          
                          
                          Common Stock
                          
                          
                          Paid-in
                          
                          
                          Accumulated
                          
                          
                          Comprehensive
                          
                          
                          Treasury
                          
                          
                          
                          
                          
                          ComprehensiveShares
                          
                          
                          Amount
                          
                          
                          Shares
                          
                          
                          Amount
                          
                          
                          Shares
                          
                          
                          Amount
                          
                          
                          Capital
                          
                          
                          Deficit
                          
                          
                          Income
                          
                          
                          Stock
                          
                          
                          Total
                          
                          
                          Income (Loss)Balances
      at July 1, 2007
                          
                          
                          325,000
                          
                          
                          $
                          3,250
                          
                          
                          
                          791
                          
                          
                          $
                          1
                          
                          
                          
                          9,740,267
                          
                          
                          $
                          9,740
                          
                          
                          $
                          12,118,260
                          
                          
                          $
                          (8,538,730
                          )
                          
                          $
                          4,790
                          
                          
                          $
                          (10,000
                          )
                          
                          $
                          3,587,311Conversion
      of preferred stock
                          
                          
                          (25,000
                          )
                          
                          
                          (250
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          28,409
                          
                          
                          
                          28
                          
                          
                          
                          222
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          0Dividend
      on preferred stock
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          110,751
                          
                          
                          
                          (110,751
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          0Conversion
      of convertible debentures
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          17,892
                          
                          
                          
                          18
                          
                          
                          
                          13,379
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          13,397Conversion
      of stockholder loan
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          200,000
                          
                          
                          
                          200
                          
                          
                          
                          149,800
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          150,000Issuance
      of stock and warrants for services
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          23,400
                          
                          
                          
                          23
                          
                          
                          
                          17,752
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          17,775Issuance
      of stock in lieu of  amounts payable
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          239,291
                          
                          
                          
                          239
                          
                          
                          
                          189,236
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          189,475Stock
      based compensation
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          136,543
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          136,543Net
      loss
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (852,807
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (852,807
                          )
                          
                          
                          (852,807
                          )Balances
      at June 30, 2008
                          
                          
                          300,000
                          
                          
                          
                          3,000
                          
                          
                          
                          791
                          
                          
                          
                          1
                          
                          
                          
                          10,249,259
                          
                          
                          
                          10,249
                          
                          
                          
                          12,735,943
                          
                          
                          
                          (9,502,288
                          )
                          
                          
                          4,790
                          
                          
                          
                          (10,000
                          )
                          
                          
                          3,241,694
                          
                          
                          
                          (852,807
                          )Dividend
      on preferred stock
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          121,933
                          
                          
                          
                          (121,933
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          0Stock
      based compensation
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          63,279
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          63,279Net
      loss
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (667,059
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (667,059
                          )
                          
                          
                          (667,059
                          )Balances
      at June 30, 2009
                          
                          
                          300,000
                          
                          
                          $
                          3,000
                          
                          
                          
                          791
                          
                          
                          $
                          1
                          
                          
                          
                          10,249,259
                          
                          
                          $
                          10,249
                          
                          
                          $
                          12,921,154
                          
                          
                          $
                          (10,291,280
                          )
                          
                          $
                          4,790
                          
                          
                          $
                          (10,000
                          )
                          
                          $
                          2,637,914
                          
                          
                          $
                          (667,059
                          )
 
 See Notes
to Consolidated Financial Statements.
  F-4
 
 Electronic
Control Security Inc.
 Consolidated
Statements of Cash Flows
 
 YearEndedJune
      30,2009
                  
                  
                  2008DECREASE
      IN CASH AND CASH EQUIVALENTSCash
      flows from operating activities:Net
      loss before deemed dividends
                  
                  $
                  (667,059
                  )
                  
                  $
                  (852,807
                  )Adjustments
      to reconcile loss to net cash provided by operating
      activities:Depreciation
      and amortization
                  
                  
                  220,543
                  
                  
                  
                  293,410Stock
      based compensation
                  
                  
                  63,279
                  
                  
                  
                  136,543Amortization
      of beneficial conversion feature on convertible debt
                  
                  
                  9,926
                  
                  
                  
                  18,440Increase
      (decrease) in cash attributable to changes inAccounts
      receivable
                  
                  
                  993,513
                  
                  
                  
                  (454,286
                  )Inventory
                  
                  
                  7,400
                  
                  
                  
                  9,016Other
      current assets
                  
                  
                  215,882
                  
                  
                  
                  20,661Other
      assets
                  
                  
                  634
                  
                  
                  
                  232Accounts
      payable and accrued expenses
                  
                  
                  (775,002
                  )
                  
                  
                  885,835Payroll
      taxes payable
                  
                  
                  (613
                  )
                  
                  
                  (186
                  )Net
      cash provided by operating activities
                  
                  
                  68,503
                  
                  
                  
                  56,858Cash
      flows from investing activities:Acquisition
      of property plant and equipment
                  
                  
                  (7,338
                  )
                  
                  
                  (2,120
                  )Net
      cash used in investing activities
                  
                  
                  (7,338
                  )
                  
                  
                  (2,120
                  )Cash
      flows from financing activities:Proceeds
      from exercise of stock options and warrants
                  
                  
                  -
                  
                  
                  
                  17,775Principal
      payments on 8% Convertible debentures
                  
                  
                  (37,500
                  )Payments
      on long-term debt
                  
                  
                  (41,974
                  )
                  
                  
                  (29,681
                  )Loans
      from officers and shareholders - net
                  
                  
                  (38,548
                  )
                  
                  
                  (28,347
                  )Net
      cash used in financing activities
                  
                  
                  (118,022
                  )
                  
                  
                  (40,253
                  )Net
      increase (decrease) in cash and cash equivalents
                  
                  
                  (56,857
                  )
                  
                  
                  14,485Cash
      and cash equivalents at beginning of period
                  
                  
                  72,592
                  
                  
                  
                  58,107Cash
      and cash equivalents at end of period
                  
                  $
                  15,735
                  
                  
                  $
                  72,592Noncash
      financing and investing activities:Stock
      issued upon conversion of stockholder loan
                  
                  $
                  -
                  
                  
                  $
                  150,000Stock
      issued upon conversion of debentures
                  
                  $
                  
                  
                  
                  $
                  13,397Stock
      issued in lieu of amounts payable
                  
                  $
                  -
                  
                  
                  $
                  189,475Supplemental
      disclosures of cash flow information
                    Cash
      paid during the period for:Interest
                  
                  $
                  76,763
                  
                  
                  $
                  72,820Taxes
                  
                  $
                  -
                  
                  
                  $
 
 See Notes
to Consolidated Financial Statements.
  F-5





ELECTRONIC
CONTROL SECURITY, INC.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





Note
1 - Nature of Operations





Electronic
Control Security, Inc. (the “Company”) is engaged in the design, manufacture and
marketing of electronic security and lighting systems for high threat
environments.  The Company also performs consulting services, which
consists principally of designing security system solutions in support of their
technologies to system integrators, for medium to large government and
commercial facilities worldwide.





In March
2005, the Company, through its wholly owned subsidiary, Clarion Sensing Systems
Acquisition Corp, acquired all of the assets and assumed certain of the
liabilities of  Clarion Sensing Systems, Inc., an Indiana corporation
("Clarion"). Clarion is a provider of proprietary nuclear, biological, chemical
and radiological (NBCR) remote monitoring sensor systems designed for air and
water contamination detection sensing applications.





Note
2 - Summary of Significant Accounting Policies





Principles
of Consolidation





The
financial statements include the accounts of the Company, its wholly owned
subsidiaries, and its majority owned subsidiary. All significant inter-company
accounts and transactions have been eliminated.





Accounts
Receivable





Trade
accounts receivable is recorded net of an allowance for expected
losses.  The allowance is estimated from historical performance and
projections of trends.





Inventories





Inventories
are stated at the lower of cost (first-in, first-out) or market.





Property
and Equipment and Depreciation





Depreciation
is provided for by straight-line and accelerated methods over the estimated
useful lives of the assets, which vary from three to ten years.  Cost
of repairs and maintenance are charged to operations in the period
incurred.





Software
Development Costs





Software
development costs are expensed as incurred until technological feasibility is
established. Software development costs incurred subsequent to establishing
technological feasibility are capitalized and amortized. Amortization is
provided based on the greater of the ratios that current gross revenues for a
product bear to the total of current and anticipated future gross revenues for
that product, or the straight-line method over the estimated useful life of the
product. The estimated useful life for the straight-line method is determined to
be 5 years. There were no software development costs for the years ended June
30, 2009 and 2008.





Earnings
per Share





In
determining basic or diluted earnings per share (EPS), the effects of dividends
related to the Company's convertible preferred stock is added to the net
loss.





Basic EPS
is computed by dividing net income or net loss by the weighted average number of
common shares outstanding for the period. Diluted EPS reflects the potential
dilution from the exercise or conversion of other securities into common stock,
but only if dilutive. The following securities have been excluded from the
dilutive per share computation as they are antidilutive.




F-6




ELECTRONIC
CONTROL SECURITY, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


2009
                    
                    
                    2008Stock
      options
                    
                    
                    1,442,000
                    
                    
                    
                    1,124,500Warrants
                    
                    
                    —
                    
                    
                    
                    556,522Convertible
      debentures
                    
                    
                    603,333
                    
                    
                    
                    653,333Convertible
      Preferred Stock
                    
                    
                    2,069,564
                    
                    
                    
                    1,906,984





Foreign
Currency Translation





The
functional currency of the Company's foreign subsidiaries is the local currency.
Accordingly, the Company translates all assets and liabilities into U.S. dollars
at current rates. Revenues, costs, and expenses are translated at average rates
during each reporting period. Gains and losses resulting from the translation of
the consolidated financial statements are excluded from results of operations
and are reflected as a translation adjustment and a separate component of
stockholders' equity.





Gains and
losses resulting from foreign currency transactions are recognized in the
consolidated statement of operations in the period they occur.





Cash
and Cash Equivalents





The
Company considers all short-term deposits with a maturity of three months or
less to be cash equivalents.





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 reported amounts of revenues and expenses during
the reporting period.  Actual results could differ from those
estimates.





Long-lived
assets





The
Company records impairment losses on long-lived assets used in operations when
events and circumstances indicate that the assets might be impaired and the
undiscounted cash flows estimated to be generated by those assets are less than
the carrying amounts of those assets





Revenue
Recognition





The
Company recognizes product revenue at the time of shipment. Revenues from
consulting and design services are recognized at the time the services are
rendered.





The
Company also provides professional and technical services under a specific
contract, based on a time and material plus fixed profit basis. Revenue on this
contract is recognized to the extent of costs incurred plus a proportionate
amount of profit earned. Contract costs including indirect costs are subject to
audit by agencies of the United States Government. Management believes future
adjustments, if any, from government cost audits will not have a material effect
on the financial statements.





Warranty
Reserve





All of
the Company’s products carry a warranty and the Company maintains a reserve for
warranty work based on historical experience and anticipation of possible
warranty work.




F-7


ELECTRONIC
CONTROL SECURITY, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS




Research
and Development





Research
and development expenditures are expensed as incurred. Research and development
costs for the years ended June 30, 2009 and 2008 amounted to $161,336 and
$98,336, respectively.





Income
Taxes





The
Company uses the liability method to determine its income tax expense as
required under Statement of Financial Accounting Standards (“SFAS”) No. 109
(SFAS 109). Under SFAS 109, deferred tax assets and liabilities are computed
based on differences between financial reporting and tax basis of assets and
liabilities, and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. Valuation allowances are
established when necessary to reduce deferred tax assets, if it is more likely
than not that all or a portion of it will not be realized.





In June
2006, the Financial Accounting Standards Board (FASB) issued Interpretation No.
48 “Accounting for Uncertainty in Income Taxes—an interpretation of FASB
Statement No. 109” (“FIN 48”). This Interpretation clarifies the accounting for
uncertainty in income taxes recognized in an enterprise’s financial statements
in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return. This Interpretation also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure, and transition. This Interpretation is effective for fiscal years
beginning after December 15, 2006.  Interest and penalties, if any,
related to income taxes are reported in Interest Expense and in Selling, General
and Administrative Expenses.  The application of this standard did not
have a material effect on the Company's results of operations or its financial
condition. During the year ended June 30, 2009, the Company recognized no
adjustments from uncertain tax positions.





Intangible
Assets





The cost
of licenses, patents, and trademarks are being amortized on the straight-line
method over their useful lives, ranging from 5 to 20 years.





Advertising
Costs





Advertising
costs are reported in selling, general and administrative expenses, and include
advertising, marketing and promotional programs.  These costs are
charged to expense in the year in which they are
incurred.  Advertising costs for the years ended June 30, 2009 and
2008 were approximately $-0- and $10,300, respectively.




Shipping
and Handling




Shipping
and handling costs are recorded as costs of revenues and are approximately
$37,400 and $18,700 for the years ended June 30, 2009 and 2008,
respectively.  The increase in shipping and handling costs is directly
attributable to the United Nations project in Ethiopia.




Stock
Based Compensation





Effective
July 1, 2007, the Company adopted SFAS Statement of Financial Accounting
Standards Statement No. 123(R) "Share Based Payment" ("SFAS 123(R)) utilizing
the "modified prospective" method as described in SFAS 123(R). In the "modified
prospective" method, compensation cost is recognized for all share-based
payments granted after the effective date and for all unvested awards granted
prior to the effective date. In accordance with SFAS 123(R), prior period
amounts were not restated. SFAS 123(R) also requires the tax benefits associated
with these share-based payments to be classified as financing activities in the
Statement of Cash Flows, rather than operating cash flows as required under
previous regulations. There was no effect to the Company's financial position or
results of operations as a result of the adoption of this Standard.




F-8




ELECTRONIC
CONTROL SECURITY, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


Fair
Value of Financial Instruments





The
carrying values of cash, accounts receivable, accounts payable, accrued expenses
and other current liabilities are representative of their fair value due to the
short-term maturity of these instruments.  The carrying value of the
Company’s long-term debt is considered to approximate its fair value, based on
current market rates and conditions.





Recent
Pronouncements




In
April 2009, the FASB issued FASB Staff Position No. 107-1, “Interim
Disclosures about Fair Value of Financial Instruments” (“FSP 107-1”), which
amends Statement of Financial Accounting Standards No. 107, “Disclosures
about Fair Value of Financial Instruments,” to require disclosures about the
fair value of financial instruments for interim reporting periods in addition to
annual reporting periods. FSP 107-1 is effective for all interim and annual
reporting periods ending after June 15, 2009.




In May
2009, the FASB issued SFAS No. 165 "Subsequent Events" ("SFAS 165"). SFAS 165
establishes general standards of accounting for and disclosure of events that
occur after the balance sheet date but before financial statements are issued or
are available to be issued. SFAS 165 sets forth (1) The period after the balance
sheet date during which management of a reporting entity should evaluate events
or transactions that may occur for potential recognition or disclosure in the
financial statements, (2) The circumstances under which an entity should
recognize events or transactions occurring after the balance sheet date in its
financial statements and (3) The disclosures that an entity should make about
events or transactions that occurred after the balance sheet date. SFAS 165 is
effective for interim or annual financial periods ending after June 15, 2009.
The Company performed a review for subsequent events through the date of this
report. No recognized or non-recognized subsequent events were
noted.




In June
2009, the FASB issued SFAS No. 166 "Accounting for Transfers of Financial
Assets-an amendment of FASB Statement No. 140" ("SFAS 166"). SFAS 166 improves
the relevance, representational faithfulness, and comparability of the
information that a reporting entity provides in its financial statements about a
transfer of financial assets; the effects of a transfer on its financial
position, financial performance, and cash flows; and a transferor's continuing
involvement, if any, in transferred financial assets. SFAS 166 is effective as
of the beginning of each reporting entity's first annual reporting period that
begins after November 15, 2009, for interim periods within that first annual
reporting period and for interim and annual reporting periods thereafter. The
Company is evaluating the impact the adoption of SFAS 166 will have on its
financial statements.




In June
2009, the FASB issued SFAS No. 167 "Amendments to FASB Interpretation No. 46(R)"
("SFAS 167"). SFAS 167 improves financial reporting by enterprises involved with
variable interest entities and to address (1) the effects on certain provisions
of FASB Interpretation No. 46 (revised December 2003), "Consolidation of
Variable Interest Entities", as a result of the elimination of the qualifying
special-purpose entity concept in SFAS 166 and (2) constituent concerns about
the application of certain key provisions of Interpretation 46(R), including
those in which the accounting and disclosures under the Interpretation do not
always provide timely and useful information about an enterprise's involvement
in a variable interest entity. SFAS 167 is effective as of the beginning of each
reporting entity's first annual reporting period that begins after November 15,
2009, for interim periods within that first annual reporting period, and for
interim and annual reporting periods thereafter. The Company is evaluating the
impact the adoption of SFAS 167 will have on its financial
statements.




F-9


ELECTRONIC
CONTROL SECURITY, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


In June
2009, the FASB issued SFAS No. 168 "The FASB Accounting Standards Codification
and the Hierarchy of Generally Accepted Accounting Principles-a replacement of
FASB Statement No. 162". The FASB Accounting Standards Codification
("Codification") will be the single source of authoritative nongovernmental U.S.
generally accepted accounting principles. Rules and interpretive releases of the
SEC under authority of federal securities laws are also sources of authoritative
GAAP for SEC registrants. SFAS 168 is effective for interim and annual periods
ending after September 15, 2009. All existing accounting standards are
superseded as described in SFAS 168. All other accounting literature not
included in the Codification is non-authoritative. The Company is evaluating the
impact the adoption of SFAS 168 will have on its financial
statements.




Note
3 - Inventories





Inventories
at June 30, 2009 and 2008 consist of the following:


2009
                    
                    
                    2008Raw
      materials
                    
                    $
                    335,418
                    
                    
                    $
                    358,877Work-in-process
                    
                    
                    232,426
                    
                    
                    
                    467,297Finished
      goods
                    
                    
                    1,577,289
                    
                    
                    
                    1,326,359$
                    2,145,133
                    
                    
                    $
                    2,152,533





Note
4 – Property, Equipment and Software Development Costs





Property,
equipment and software development costs consist of the following:





2009
                  
                  
                  2008Furniture
      and fixtures
                  
                  $
                  70,551
                  
                  
                  $
                  70,551Machinery
      and equipment
                  
                  
                  865,850
                  
                  
                  
                  858,512Improvements
                  
                  
                  23,008
                  
                  
                  
                  23,008Software
                  
                  
                  106,415
                  
                  
                  
                  106,415Software
      development costs
                  
                  
                  526,760
                  
                  
                  
                  526,7601,592,584
                  
                  
                  
                  1,585,246Less:
      accumulated depreciation and amortization
                  
                  
                  1,380,469
                  
                  
                  
                  1,278,458$
                  212,115
                  
                  
                  $
                  306,788





Depreciation
expense was $102,011 and $143,808 for the years ended June 30, 2009 and 2008,
respectively.





Note
5 – Intangibles





June
      30, 2009
                      
                      
                      June
      30, 2008Gross
                        Carrying
                      
                      
                      Accumulated
                      
                      
                      Gross
                        Carrying
                      
                      
                      AccumulatedAmount
                      
                      
                      Amortization
                      
                      
                      Amount
                      
                      
                      AmortizationAmortized
      intangible assets:Licenses
                      
                      $
                      74,000
                      
                      
                      $
                      61,933
                      
                      
                      $
                      74,000
                      
                      
                      $
                      50,467Patent
                      
                      
                      852,793
                      
                      
                      
                      203,111
                      
                      
                      
                      852,793
                      
                      
                      
                      156,240Trademarks
                      
                      
                      577,263
                      
                      
                      
                      125,073
                      
                      
                      
                      577,263
                      
                      
                      
                      96,210Other
                      
                      
                      8,881
                      
                      
                      
                      7,697
                      
                      
                      
                      8,881
                      
                      
                      
                      5,920$
                      1,512,937
                      
                      
                      $
                      397,814
                      
                      
                      $
                      1,512,937
                      
                      
                      $
                      314,570




F-10




ELECTRONIC
CONTROL SECURITY, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS




Amortization
expense charged to operations was $83,245 for each of the years ended June 30,
2009 and 2008.  Future annual amortization expense for the licenses
and other intangible assets is expected to be approximately $9,300 for the next
..5 years and $75,700 for the patents and trademarks through 2022, their
estimated remaining useful lives.





In
January 2009, the Company agreed to release the minority shareholders of its
Middle East subsidiary of all claims, including amounts receivable from them in
the amount of $146,962 in exchange for their shares in the subsidiary. The
Company recorded this additional investment in the subsidiary as
Goodwill.





Note
6 - Long-Term Debt





In
connection with the Clarion acquisition, the Company assumed an existing loan in
the amount of $95,300. The loan was payable in 34 monthly installments of $2,750
plus interest at the rate of prime plus 1/2% per annum. The balance was fully
satisfied in fiscal 2009.




In fiscal
2008, the Company financed the purchase of equipment from a vendor in the amount
of $101,762, evidenced by a note bearing interest at the rate of 8%. As the
Company purchases product from the vendor a portion of each invoice will be
charged to reduce the note balance. Management expects that the note will be
repaid over the next 12 months. Collateral for the note is the underlying
equipment. The balance in the note at June 30, 2009 was $65,017.





Note
7 - Convertible Debentures





In
January 2006, the Company completed a private placement of $1 million in
principal amount of its Senior Secured Convertible Debentures ("the
Debentures"). At closing, the Company received net proceeds of approximately
$831,000 from the proceeds of the Debentures, after the payment of offering
related fees and expenses. The Company’s obligations with respect to the
Debentures are secured by a lien on all of the assets of the Company, including
its intellectual property. The Debentures have a term of three years and were
originally convertible at the option of the holder at any time into shares of
the Company's common stock, par value $0.001 per share (the “Common Stock”) at
an original conversion price of $1.15 per share at issuance (which, as reflected
below, has since been adjusted), subject to certain adjustments. Interest is
payable on a quarterly basis at a rate equal to the greater of 8% per annum or
the prime rate for the applicable interest period plus 2.5%. At the option of
the Company, interest payments are payable either in cash or in shares of Common
Stock (provided there is an effective registration statement at the time of
payment), subject to certain conditions. The Company elected to pay the interest
in cash.





Investors
in the private placement received three-year warrants to purchase up to an
aggregate of 434,783 shares of the Company’s Common Stock at a per share
exercise price of $2.00 (the "Warrants").  The Warrants may be
exercised on a cashless basis following the first anniversary of issuance if a
registration statement covering the Common Stock issuable upon exercise of the
Warrants is not in effect at the time of exercise.





In
connection with the financing the Company paid to two placement agents, a cash
fee in the aggregate amount of $72,500 and also to such persons three-year
warrants to purchase an aggregate of 121,739 shares of common Stock at a per
share exercise price of $2.00 and otherwise on substantially the same terms as
the Warrants issued to the investors, including without limitation, expiration
date, potential adjustments and cashless exercise rights.




F-11




ELECTRONIC
CONTROL SECURITY, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS




For
financial reporting purposes, the Company recorded a discount of $223,096 to
reflect the value of the Warrants and a discount of $193,350 to reflect the
value of issuance costs and will be amortizing this amount to the earlier of the
date of conversion or maturity. In addition, in accordance with EITF No. 00-27,
the Company recorded additional discount on the debentures of $118,748 to
reflect the beneficial conversion feature of the debt and is amortizing this
amount to the date of maturity.  The amortization of the discounts and
beneficial conversion amounted to $45,214 and $84,803, respectively, for the
years ended June 30, 2009 and 2008.





In May
2006, in connection with the execution of the factoring agreement the conversion
price and exercise price of the Debentures and Warrants were reduced to
$0.75





Prior to
fiscal 2008, a total of $500,000 in principal was converted into 666,666 shares
of the Company’s Common stock and in fiscal 2008 an additional $13,397 in
principal was converted into 17,892 shares of the Company's common
stock.





All of
the Warrants issued in connection with this offering have since expired
unexercised.





The
principal owing on the debentures became due as of January 11, 2009 but was not
repaid. The Company and the debenture holders are currently holding discussions
to consider various proposals designed to address this issue. No assurance can
be provided that the Company and the debenture holders will in fact be able to
reach a resolution of this matter. Although no definitive agreement has been
reached, in April 2009, the Company commenced principal repayments at the rate
of $12,500 per month.  Interest expense amounted to $38,352 for the
year ended June 30, 2009 and has been paid in full as of June 30,
2009.





Note
8 - Due to Officers and Shareholders





These amounts represent interest
bearing advances and are due on demand. At the present time, the officers and
shareholders do not contemplate requesting repayment of these loans within the
next fiscal year. On July
11, 2007, $150,000 of the outstanding loan balance was converted in 200,000
shares of the Company's common stock.





Note
9 - Legal Settlement





In
October 2007, the Company entered into a settlement agreement with one of its
vendors. Under the agreement, the Company was required to pay $200,000 and issue
20,000 shares of its Common Stock. Of the cash portion, the Company remitted
$20,000 up front and assigned the right to receive $180,000 from certain
contract retainages. The Company has also agreed that, commencing one year from
the date of issuance, it may be required to buy back the stock issued for
$20,000. As of this date the company is current in meeting its
obligations.





On
December 22, 2006, a former employee and shareholder of Clarion filed a
complaint against the Company for breach of employment contract and asset
purchase agreement. Damages were sought in excess of $300,000. As of October 30,
2008, the parties agreed to settle the matter for $52,367. The settlement
included an initial payment of $16,367 and $2,000 per month for 18 months and
$2,937 of legal fees.  The Company is current with its
payments.





In June
2006, the Company filed suit against the manufacturer of plastic housing for one
of our sensor products due to the housings being defective.  In June
2009, an arbitration decision was made in the Company’s favor against Bennett
Plastics in the amount of  $148,000.  However, based on the
financial condition of Bennett Plastics, we were advised by counsel to negotiate
an immediate cash settlement of $125,000 which we negotiated and settled on June
26, 2009.  We also negotiated and settled all outstanding attorney
fees owed to Lasser Hochman, LLC as part of the settlement.




F-12




ELECTRONIC
CONTROL SECURITY, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS




Note
10 - Income Taxes





The
provision for taxes for the year ended June 30, 2009 and 2008 includes the
following components:





2009
                  
                  
                  2008CurrentFederal
                  
                  $
                  -
                  
                  
                  $
                  -State
                  
                  
                  -
                  
                  
                  
                  -Foreign
                  
                  
                  -
                  
                  
                  
                  --
                  
                  
                  
                  -DeferredFederal
                  
                  
                  -
                  
                  
                  
                  -State
                  
                  
                  -
                  
                  
                  
                  -Foreign
                  
                  
                  -
                  
                  
                  
                  --
                  
                  
                  
                  -$
                  -
                  
                  
                  $
                  -





The
components of the deferred tax accounts as of June 30, 2009 and 2008 are as
follows:





2009
                  
                  
                  2008Deferred
      tax assetsNet
      operating loss carryforward
                  
                  $
                  2,271,322
                  
                  
                  $
                  2,068,631Stock
      based compensation
                  
                  
                  184,326
                  
                  
                  
                  159,014Other
                  
                  
                  44,000
                  
                  
                  
                  44,0012,499,648
                  
                  
                  
                  2,271,646Deferred
      tax liabilitiesDepreciation
      and amortization
                  
                  
                  48,693
                  
                  
                  
                  67,162Subtotal
                  
                  
                  2,450,955
                  
                  
                  
                  2,204,484Valuation
      allowance
                  
                  
                  (2,057,155
                  )
                  
                  
                  (1,810,684
                  )Net
      deferred tax assets
                  
                  $
                  393,800
                  
                  
                  $
                  393,800




The
valuation allowance at June 30, 2007 was $1,649,197.





The
reconciliation of estimated income taxes attributed to operations at the
statutory tax rates to the reported income tax benefit is as
follows:


2009
                  
                  
                  2008Expected
      federal tax at statutory rate
                  
                  $
                  (253,491
                  )
                  
                  $
                  (326,710
                  )State
      taxes, net of federal tax effect
                  
                  
                  (44,711
                  )
                  
                  
                  (57,790
                  )Foreign
      rate differential
                  
                  
                  (23
                  )
                  
                  
                  (23
                  )Non
      deductible expenses
                  
                  
                  69,013
                  
                  
                  
                  77,986Change
      in valuation allowance
                  
                  
                  229,212
                  
                  
                  
                  307,487Other
                  
                  
                  -
                  
                  
                  
                  -$
                  -
                  
                  
                  $
                  -




F-13




ELECTRONIC
CONTROL SECURITY, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS




At June
30, 2009, the Company had net operating loss carryforwards for federal and state
income tax purposes of $4,870,973 and $4,723,769 respectively, expiring through
2030. The Company has foreign net operating loss carryforwards of $607,032 with
no expiration date.





The
Company and its subsidiaries have adopted FASB Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes” (FIN48) effective July 1, 2007. The
Company has identified its federal consolidated tax return as a “major” taxing
jurisdiction as defined under FIN 48. At June 30, 2009, the company has
evaluated its tax filings with this major tax jurisdiction for the fiscal years
2006 through 2009. These years remain open and can be subjected to an
examination. Based on its evaluation, the Company believes that its income tax
filing positions and deductions would be sustained under examination; and does
not anticipate any adjustments would result in a material change in its
financial position. Therefore, no allowances for uncertain income tax positions,
including interest and penalties, were required to be recorded at June 30, 2009
pursuant to FIN 48. Additionally, no cumulative effect of an accounting change
resulted from the Company’s initial adoption of this FASB
Interpretation.





Note
11- Shareholders’ Equity





Series A Convertible Preferred
Stock





In
January to March 2002, the Company realized gross proceeds of $2,000,000 from
the private placement of 40 Units, each Unit consisting of 25,000 shares of
Series A Convertible Preferred Stock (“Series A  Preferred”) and
12,500 common stock purchase Warrants. The Series A Preferred provides for an
annual dividend of $.20 per share, payable quarterly, (payable in cash or shares
of common stock valued at $2.00 per share), when, as and if declared by the
Board of Directors. Dividends will be paid on a cumulative basis. Each Series A
Preferred share was initially convertible at the option of the holder into one
common share, commencing 120 days after closing. The conversion ratio is subject
to certain adjustments, as defined and has since been adjusted to .88 Series A
Preferred shares for one common share. The Series A Preferred shares have a
liquidation preference in the amount of $2.00 per share and the Company may
redeem them commencing one year from date of issuance if the common shares have
traded at or above $4.00 for a period of twenty consecutive trading
days.  All of the Warrants issued in connection with this offering
have since expired unexercised.





As of
June 30, 2009, 700,000 shares of Series A Preferred were converted into a like
amount of common stock.





Cumulative
but undeclared dividends at June 30, 2009 total approximately
$240,000.





Series
B Convertible Preferred Stock





On June
30, 2004, the Company completed a private placement of 2,000 shares of its 10%
Series B Convertible Preferred Stock (“Series B  Preferred”) and
warrants to purchase up to 2,000,000 shares of common stock for an aggregate
purchase price of $2,000,000. The Preferred Stock provides for a dividend at the
rate of 10% per annum, payable quarterly, (payable in cash orby adding the dollar
amount of such dividends to the Stated Value), dividends will be paid on a
cumulative basis.  The preferred shares have a liquidation preference
in the amount of $1,000 per share and have preference to any payments to the
Preferred A shareholders. Each preferred share is convertible at the option of
the holder into 1,000 shares of common stock. The conversion price is subject to
anti-dilution adjustments, including, among other things, in the event that the
Company sells common stock during the next three years for a price of less than
one dollar per share.  The Company may require the conversion of all
(but not less than all) of the then outstanding shares of Series B Preferred
Stock, if at any time the volume weighted average trading price per share of
common stock for each of 20 consecutive trading days prior to a conversion
notice is greater than $2.50 (subject to adjustment), and the daily trading
volume of the common stock is at least 100,000 shares. In addition all shares of
common stock underlying the Series B Preferred Stock must be covered by an
effective registration statement.




F-14




ELECTRONIC
CONTROL SECURITY, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS




The
Warrants are exercisable for a period of four years from the date of issuance at
an exercise price per share of $1.00 per share and have similar anti-dilution
privileges as the Series B Preferred Stock. The Company may call the Warrants if
the volume weighted average trading price per share of common stock for each of
20 consecutive trading days is greater than 200% of the exercise price, and the
daily trading volume of the common stock is at least 100,000 shares. In addition
all shares of common stock underlying Warrants must be covered by an effective
registration.





In May
2006, in connection with the reset of the conversion and exercise price of the
Debentures and Warrants discussed in Note 8 above, the conversion and exercise
prices of the Series B Preferred and the accompanying warrants were reduced to
$.75. All of the Warrants issued in connection with this offering have since
expired unexercised.





Stock
Option Plans





Incentive
Stock Option Plan





In 1986,
the Company adopted an Incentive Stock Option Plan, which was renewed in 1996
for a second ten-year term. The Company initially had reserved 1,000,000 shares
of common stock for issuance under the Incentive Stock Option Plan, which was
increased to 2,000,000 shares upon the approval of the stockholders at the 2005
annual meeting. The board of directors administers the Incentive Stock Option
Plan but may delegate such administration to a committee of three persons, one
of whom must be a member of the board. The board or the committee has the
authority to determine the number of stock options to be granted, when the stock
options may be exercised and the exercise price of the stock options, provided
that the exercise price may never be less than the fair market value of the
shares of the common stock on the date the stock option is granted (110% in the
case of any employee who owns more than 10% of the combined voting power or
value of all classes of stock). Stock options may be granted for terms not
exceeding ten years from the date of the grant, except for stock options granted
to any person holding in excess of 5% of our common stock, in which case the
stock options may not be granted for a term not to exceed five years from the
date of the grant.  The Incentive Stock Option Plan expired in
September 2006.





Equity
Incentive Plan




In
October 2006, the Board adopted the Equity Incentive Plan, which was approved by
the shareholders at the annual meeting of shareholders held in December
2006.  The Equity Incentive Plan is intended to succeed the Incentive
plan, which expired in September 2006.  2,000,000 shares are reserved
for issuance under the Equity Incentive Plan.  The Equity Incentive
Plan will be administered by the Board of Directors or, at the discretion of the
Board, by a committee consisting of at least two directors. The administrating
body, whether it be the Board of Directors or a committee of the type described
above, is sometimes referred to as the "Committee." The Committee is authorized
from time to time to select and to grant awards under the Equity Incentive Plan
to such key employees, non-employee directors, and consultants of the Company
and its subsidiaries as the Compensation Committee, in its discretion, selects.
The Compensation Committee is authorized to delegate any of its authority under
the Equity Incentive Plan (including the authority to grant awards) to such
executive officers of the Company as it thinks appropriate and is permitted by
Rule 16B-3 of the Exchange Act and Section 162(m) of the Code.  The
Equity Incentive Plan allows for the grant of a number of different types of
awards, including incentive and non-statutory stock options, stock appreciation
rights, restricted stock grants, performance units, cash payments and other
stock-based awards.




F-15




ELECTRONIC
CONTROL SECURITY, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS




Non-Statutory
Stock Option Plan.




The
Company also adopted a Non-Statutory Stock Option Plan and have reserved 250,000
shares of common stock for issuance to directors, employees and non-employees.
Stock options granted pursuant to this plan will be non-transferable and expire,
if not exercised within five years from the date of the grant. Stock options
will be granted in such amounts and at such exercise prices as our board of
directors may determine.





Option
activity for 2009 and 2008 is summarized as follows:





WeightedAverageExerciseOptions
                      
                      
                      PriceOptions
      outstanding, July 1, 2007
                      
                      
                      
                      999,500
                      
                      
                      $
                      .89Granted
                      
                      
                      
                      125,000
                      
                      
                      
                      .75ExercisedForfeited
                      
                      
                      
                      —
                      
                      
                      
                      —Options
      outstanding, June 30, 2008
                      
                      
                      
                      1,124,500
                      
                      
                      
                      .88Granted
                      
                      
                      
                      460,000
                      
                      
                      $
                      .17Forfeited
                      
                      
                      
                      (142,500
                      )
                      
                      
                      .81Options
      outstanding, June 30, 2009
                      
                      
                      
                      1,442,000
                      
                      
                      $
                      .66Aggregate
      intrinsic value
                      
                      
                      $
                      11,200Exercisable
      at June 30, 2009
                      
                      
                      
                      1,404,500
                      
                      
                      $
                      .66Shares
      of common stock availablefor
      future grant under the plans
                      808,000





The
aggregate intrinsic value on this table was calculated based on the positive
difference between the closing market price of the Company’s common stock and
the exercise price of the underlying options. There were no option exercises in
fiscal 2008 or 2009.




F-16




ELECTRONIC
CONTROL SECURITY, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS




The
following table summarizes information about stock options outstanding at June
30, 2009.





Options
      ExercisableWeighted
      Average
                  
                  
                  
                  
                  
                  WeightedRemaining
                  
                  
                  
                  
                  
                  
                  
                  
                  AverageNumber
                  
                  
                  Contractual
                  
                  
                  Exercise
                  
                  
                  Number
                  
                  
                  ExerciseRanges of price
                  
                  Outstanding
                  
                  
                  Life
                  
                  
                  Price
                  
                  
                  Exercisable
                  
                  
                  Price$.07
                  
                  
                  140,000
                  
                  
                  
                  8.03
                  
                  
                  $
                  .07
                  
                  
                  
                  140,000
                  
                  
                  $
                  .07$.22
                  
                  
                  320,000
                  
                  
                  
                  7.37
                  
                  
                  $
                  .22
                  
                  
                  
                  320,000
                  
                  
                  $
                  .22$.30
                  
                  
                  40,000
                  
                  
                  
                  2.11
                  
                  
                  $
                  .30
                  
                  
                  
                  40,000
                  
                  
                  $
                  .30$.75
                  
                  
                  537,000
                  
                  
                  
                  5.84
                  
                  
                  $
                  .75
                  
                  
                  
                  499,500
                  
                  
                  $
                  0.75$1.00-1.07
                  
                  
                  180,000
                  
                  
                  
                  5.15
                  
                  
                  $
                  1.02
                  
                  
                  
                  180,000
                  
                  
                  $
                  1.02$1.20
                  
                  
                  225,000
                  
                  
                  
                  5.56
                  
                  
                  $
                  1.20
                  
                  
                  
                  225,000
                  
                  
                  $
                  1.20$.30-$1.20
                  
                  
                  1,442,000
                  
                  
                  
                  6.16
                  
                  
                  $
                  .66
                  
                  
                  
                  1,404,500
                  
                  
                  $
                  .66




The fair
value of each option grant is estimate on the date of grant using the
Black-Scholes option-pricing model. The Company uses historical data to estimate
expected volatility, the period of time that option grants are expected to be
outstanding, as well as employee termination behavior. The risk-free rate is
based on the U.S. Treasury yield in effect at the time of grant for the
estimated life of the option. The following weighted-average assumptions were
used to estimate the fair value of options granted during the fiscal years ended
June 30, 2009 and 2008.using the Black-Scholes option-pricing:




2009
                    
                    
                    2008Risk
      free interest rate
                    
                    
                    2.26
                    %
                    
                    
                    3.02
                    %Expected
      life
                    
                    
                    4.63
                    
                    
                    
                    4.5Expected
      volatility
                    
                    
                    118.
                    %
                    
                    
                    119.
                    %Dividend
      yield
                    
                    
                    0
                    %
                    
                    
                    0
                    %Weighted-average
      grant date fair value per share
                    
                    $
                    0.10
                    
                    
                    $
                    0.22





As of
June 30, 2009, there was $28,046 of total unrecognized compensation cost
related to nonvested options granted. That cost is expected to be recognized
over a weighted-average period of 1.5 years.





Escrow
Shares





In
connection with purchase of the Clarion Assets, the Company issued 394,682
shares of its Common Stock. The Shares are being held in escrow pursuant to the
terms of an escrow agreement among ECSI, Clarion and the Clarion Stockholders in
order to indemnify the Company from and against, any adverse consequences which
may result from an inaccuracy in or breach of any representation, warranty,
covenant or other provision set forth in any of the Asset Purchase Agreement or
related agreements. During such time as the Shares are held in escrow, they
shall be entitled to participate in any dividends or other distributions upon
the common stock and to vote (as directed by a representative of the Clarion
Stockholders) in all matters presented to holders of common stock but shall not
be assignable or transferable, other than by operation of law.





The
Shares were to be released from escrow for distribution to the Clarion
Stockholders upon the earlier of (i) March 3, 2008 or (ii) after the fiscal year
in which the Subsidiary achieved sales in excess of $3,000,000 and net earnings
before taxes in excess of $600,000.  Based upon a breach of the terms
and conditions of the Escrow Agreement noted in the paragraph above, a legal
notification was sent to the officers, directors and investors of Clarion
Sensing Systems in March and April of 2008, and the shares have been returned to
Treasury.




F-17




ELECTRONIC
CONTROL SECURITY, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS




Note
12 - Concentrations and Economic Dependency





The
Company had three customers that accounted for 40%, 27% and 10%, respectively of
net revenues for year ended June 30, 2009 and 26%, 22% and 10%, respectively, of
net revenues for year ended June 30, 2008.  Two customers accounted
for 74% of the accounts receivables as of June 30, 2009. At June 30, 2009
approximately 18% of accounts receivable were from foreign customers.The Company performs
ongoing credit evaluations of its customers’ financial condition and generally
requires no collateral from its customers.





During
the year, the Company had cash deposits in a bank in excess of FDIC
limits.  The Company periodically reviews the financial condition of
the bank to minimize its exposure.





Note
13 – Commitments and Contingencies





Lease
Agreements





Future
minimum annual rental payments required under non-cancelable operating leases
for years after June 30, 2009 are as follows:





2010
                  
                  $
                  93,7872011
                  
                  
                  98,4772012
                  
                  
                  103,4002013
                  
                  
                  108,570Thereafter
                  
                  
                  629,913$
                  1,034,147





Rent
expense under all operating leases was $108,082 and $116,281 for the years ended
June 30, 2009 and 2008.





License
Agreement





The
Company has acquired intellectual property, equipment and a tooling license from
Mason & Hanger National, Inc. and a patent license from Lucent Technologies,
Inc. for the Fiber Optic Intelligence Detection Systems (FOIDSâ). In conjunction with
these two license agreements whereby royalties totaling 5.4% are due on revenues
from the Fiber Optic Intelligence Detection System (FOIDSâ).





Contingent
Liabilities





On March
4, 2005, the Company, through its wholly owned subsidiary, Clarion Sensing
Systems Acquisition Corp.(the "Subsidiary"), entered into a series of agreements
with Clarion Sensing Systems, Inc., an Indiana corporation ("Clarion"), and its
stockholders (the "Clarion Stockholders") to acquire all of Clarion's assets
(the "Clarion Assets") and assume certain of its liabilities. In addition to the
initial cost of the acquisition, the Company agreed to assume $438,959 of
certain liabilities of Clarion on a contingent basis. The Subsidiary will be
obligated to pay the Contingent Liabilities, if at all, only if the Subsidiary
achieves (A) sales in excess of $3,000,000 ("$3,000,000 in Sales") and/or (B)
net earnings before taxes in excess of  $600,000 ("$600,000 in Net
Earnings") in one of its fiscal years beginning within three (3) years of March
4, 2005. In the event $3,000,000 in Sales are achieved but $600,000 in Net
Earnings are not achieved, then 10% of the Subsidiary's net earnings before
taxes earned during such fiscal year shall be utilized to pay the Contingent
Liabilities. In the event $600,000 in Net Earnings are achieved (whether or not
$3,000,000 in Sales are achieved), then (I) all net earnings before taxes in
excess of $600,000 earned during such fiscal year plus (II) 10% of the
Subsidiary's net earnings before taxes earned during such fiscal year, shall be
utilized to pay the Contingent Liabilities. If the Contingent Liabilities are
not paid in full and $3,000,000 in sales or $600,000 in net earnings occurs in
one or more subsequent fiscal years, then net earnings before taxes with respect
to such fiscal years shall be utilized to pay the Contingent Liabilities in the
manner set forth in the preceding two sentences until such time, if ever, the
Contingent Liabilities are paid in full. Any amounts shall be payable in cash or
shares of common stock (valued as of the closing ask price on the date of
issuance) as the recipient shall direct.




F-18




ELECTRONIC
CONTROL SECURITY, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


The
Company anticipates the contingent payments made, if any, will be treated as
additional purchase price and included as an addition to the identifiable
intangible assets. As of June 30, 2009, the Company is not liable for any
contingent payments and, therefore, has not accrued any at this time. The
Company will continue to asses its liability under the contingent payment
arrangement in each successive quarter, and will record additional purchase
price through an increase to intangible assets, if and when a liability is
realized.





Loss
Contingencies





Loss
contingencies, including claims and legal actions arising in the ordinary course
of business, are recorded as liabilities when the likelihood of loss is probable
and an amount or range of loss can be reasonably estimated. Management does not
believe there now are such matters that will have a material effect on the
financial statements





Contract
costs, including indirect costs, are subject to audit by agencies of the United
States Government. Contract costs incurred through June 30, 2008 are currently
being audited. Management believes future adjustments, if any, from government
cost audits will not have a material effect on the financial
statements.





Note
14 – Geographic Data





The
Company currently operates in the United States and the Middle East. The
following is a summary of local operations by geographic area:





U.S.
                        
                        
                        % of total
                        
                        
                        Middle East
                        
                        
                        % of totalFor
      the year endedJune
      30, 2009Revenue
                        
                        $
                        3,472,696
                        
                        
                        
                        100.00
                        %
                        
                        $
                        —
                        
                        
                        
                        —Operating
      loss
                        
                        
                        (535,487
                        )
                        
                        
                        92.44
                        %
                        
                        
                        (43,816
                        )
                        
                        
                        7.56
                        %Identifiable
      assets
                        
                        
                        5,243,791
                        
                        
                        
                        94.85
                        %
                        
                        
                        284,647
                        
                        
                        
                        5.15
                        %For
      the year endedJune
      30, 2008Revenue
                        
                        $
                        2,916,410
                        
                        
                        
                        100.00
                        %
                        
                        $
                        —
                        
                        
                        
                        —Operating
      loss
                        
                        
                        (413,509
                        )
                        
                        
                        99.91
                        %
                        
                        
                        (386
                        )
                        
                        
                        .09
                        %Identifiable
      assets
                        
                        
                        6,618,698
                        
                        
                        
                        94.82
                        %
                        
                        
                        361,943
                        
                        
                        
                        5.18
                        %





Note
15 – Related Party Transactions





The
Company made non-interest bearing advances that are due on demand to a former
officer and director of the Company. The balances outstanding at June 30, 2009
and 2008 was $50,250.




F-19