UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

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

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

Commission file number: 001-32469

XENONICS HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

Nevada (State or other jurisdiction of incorporation or organization)		84-1433854 (I.R.S. Employer Identification No.)
3186 Lionshead Avenue Carlsbad, California (Address of principal executive offices)		92010 (Zip code)

(760) 477-8900
(Registrant’s telephone number, including area code)

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

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,“and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer o		Accelerated filer o		Non-accelerated filer o		Smaller Reporting Company þ

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

The registrant had 24,975,929 shares of common stock outstanding as of August 2, 2011.

 

 

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2011 (unaudited) and September 30, 2010			1
Condensed Consolidated Statements of Operations for the Three and Nine Months ended June 30, 2011 and 2010 (unaudited)			2
Condensed Consolidated Statements of Cash Flows for the Nine Months ended June 30, 2011 and 2010 (unaudited)			3
Notes to Unaudited Condensed Consolidated Financial Statements			4
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			10
Item 3. Quantitative and Qualitative Disclosures About Market Risk			13
Item 4. Controls and Procedures			13
PART II. OTHER INFORMATION
Item 6. Exhibits			14
SIGNATURES			15
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT

PART I. FINANCIAL INFORMATION

ITEM 1.		Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS

		June 30,				September 30,
		2011				2010
Rounded in thousands, except par value		(unaudited)
Assets
Current Assets:
Cash		$	739,000			$	705,000
Accounts receivable, net			679,000				956,000
Inventories, net			2,123,000				1,966,000
Other current assets			322,000				166,000
Total Current Assets			3,863,000				3,793,000
Equipment, furniture and fixtures at cost, less accumulated depreciation of $151,000 and $132,000			43,000				69,000
Goodwill			375,000				375,000
Other assets			141,000				216,000
Total Assets		$	4,422,000			$	4,453,000
Liabilities and Shareholders’ Equity
Current Liabilities:
Accounts payable		$	146,000			$	492,000
Accrued expenses			83,000				126,000
Accrued payroll and related taxes			132,000				110,000
Total Current Liabilities			361,000				728,000
Notes payable			438,000				376,000
Total Liabilities			799,000				1,104,000
Commitments and contingencies (Note 9)
Shareholders’ Equity:
Preferred shares, $0.001 par value, 5,000,000 shares authorized, 0 shares issued and outstanding			—				—
Common shares, $0.001 par value, 50,000,000 shares authorized as of June 30, 2011 and September 30, 2010; 24,976,000 shares issued and outstanding as of June 30, 2011 and 25,622,000 issued as of September 30, 2010; 25,509,000 shares outstanding as of September 30, 2010			25,000				25,000
Additional paid-in capital			26,652,000				26,954,000
Accumulated deficit			(23,054,000	)			(23,324,000	)
			3,623,000				3,655,000
Less treasury shares, at cost, 0 shares as of June 30, 2011 and 113,000 shares as of September 30, 2010			—				(306,000	)
Total Shareholders’ Equity			3,623,000				3,349,000
Total Liabilities and Shareholders’ Equity		$	4,422,000			$	4,453,000

See notes to unaudited condensed consolidated financial statements.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

		Three months ended								Nine months ended
		June 30,								June 30,
		2011				2010				2011				2010
Rounded in thousands, except per share amounts						(unaudited)								(unaudited)
Revenues		$	775,000			$	1,421,000			$	6,323,000			$	2,786,000
Cost of goods sold			537,000				692,000				3,463,000				1,433,000
Gross profit			238,000				729,000				2,860,000				1,353,000
Selling, general and administrative			601,000				709,000				1,878,000				2,198,000
Research and development			198,000				171,000				495,000				625,000
Income (loss) from operations			(561,000	)			(151,000	)			487,000				(1,470,000	)
Other income/(expense):
Gain on derivative revaluation			—				—				—				38,000
Interest income			2,000				1,000				5,000				3,000
Interest (expense)			(38,000	)			(38,000	)			(113,000	)			(113,000	)
Income (loss) before provision for income taxes			(597,000	)			(188,000	)			379,000				(1,542,000	)
Income tax provision			—				—				2,000				2,000
Net income (loss)		$	(597,000	)		$	(188,000	)		$	377,000			$	(1,544,000	)
Net income (loss) per share:
Basic		$	(0.02	)		$	(0.01	)		$	0.02			$	(0.07	)
Fully-diluted		$	(0.02	)		$	(0.01	)		$	0.02			$	(0.07	)
Weighted average shares outstanding:
Basic			25,088,000				24,719,000				25,107,000				22,247,000
Fully diluted			25,088,000				24,719,000				25,107,000				22,247,000

See notes to unaudited condensed consolidated financial statements

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

		Nine months ended
		June 30,
		2011				2010
Rounded in thousands		(unaudited)
Cash flows from operating activities:
Net income (loss)		$	377,000			$	(1,544,000	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation			25,000				40,000
Provision for bad debts			(36,000	)			(80,000	)
Non-cash compensation to employees and directors			—				35,000
Non-cash compensation for warrants issued			4,000				103,000
Non-cash compensation to consultants			75,000				65,000
(Gain) loss on derivative revaluation			—				(38,000	)
Amortization of warrants for notes payable			62,000				63,000
Changes in operating assets and liabilities:
Accounts receivable			313,000				437,000
Inventories			(157,000	)			47,000
Other current assets			(156,000	)			26,000
Accounts payable			(346,000	)			(453,000	)
Accrued expenses			(43,000	)			(80,000	)
Accrued payroll and related taxes			22,000				(18,000	)
Accrued derivative liability			—				(161,000	)
Net cash provided by (used in) operating activities			140,000				(1,558,000	)
Cash flows from financing activities:
Proceeds from sale of common stock			—				1,928,000
Proceeds from exercise of stock options			—				6,000
Purchase of common stock			(106,000	)			—
Net cash provided by (used in) financing activities			(106,000	)			1,934,000
Net increase in cash			34,000				376,000
Cash, beginning of period			705,000				126,000
Cash, end of period		$	739,000			$	502,000
Supplemental cash flow information:
Cash paid during the period for income taxes		$	2,000			$	2,000
Cash paid during the period for interest		$	51,000			$	51,000
Supplemental schedule of non-cash financing activities:
The Company issued 25,000 shares of common stock for the exercise of stock options for cash of $6,000 plus consulting services		$	—			$	10,000
The Company issued 300,000 shares of common stock for a three-year financial advisory service agreement at $0.80 per share		$	—			$	240,000
The Company issued 300,000 shares of common stock for a one-year Extension of the financial advisory service agreement at $0.49 per share		$	—			$	147,000

See notes to unaudited condensed consolidated financial statements.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Rounded in thousands)

1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. These financial statements and notes thereto should be read in conjunction with the financial statements and notes thereto for the year ended September 30, 2010 included in the Xenonics Holdings, Inc. (“Holdings”) Form 10-K filing. The results for the interim period are not necessarily indicative of the results for the full fiscal year.

The condensed consolidated financial statements include the accounts of Holdings and its wholly-owned subsidiary, Xenonics, Inc. (“Xenonics”), collectively, the “Company”.

2. RECENTLY ADOPTED AND ISSUED ACCOUNTING PRONOUNCEMENTS

Recently Adopted:

On October 1, 2010, we adopted new FASB rules related to accounting for transfers of financial assets. These new rules were incorporated into the Accounting Standards Codification in December 2009 as discussed in FASB Accounting Standards Update (ASU) No. 2009-16, Transfers and Servicing (Topic 860): Accounting for Transfers of Financial Assets. The new rules amended various provisions related to accounting for transfers and servicing of financial assets and extinguishments of liabilities, by removing the concept of a qualifying special-purpose entity and removes the exception from applying FASB rules related to variable interest entities that are qualifying special-purpose entities; limits the circumstances in which a transferor derecognizes a portion or component of a financial asset; defines a participating interest; requires a transferor to recognize and initially measure at fair value all assets obtained and liabilities incurred as a result of a transfer accounted for as a sale; and requires enhanced disclosure; among others. The adoption of this standard did not have an impact on our consolidated financial statements.

On October 1, 2010, we adopted new FASB rules which amended certain accounting for variable interest entities (VIE). These new rules were incorporated into the Accounting Standards Codification in December 2009 as discussed in FASB ASU No. 2009-17, Consolidation (Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities. The new rules require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a VIE; to require ongoing reassessments of whether an enterprise is the primary beneficiary of a VIE; to eliminate the quantitative approach previously required for determining the primary beneficiary of a VIE; to add an additional reconsideration event for determining whether an entity is a VIE when any changes in facts and circumstances occur such that holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that most significantly impact the entity’s economic performance; and to require enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in a VIE. The adoption of this standard did not have an impact on our consolidated financial statements.

On October 1, 2010, we adopted new FASB rules which amended the Accounting Standards Codification, Revenue Recognition (Topic 605): Multiple-Element Arrangements. The new rules amended accounting for revenue arrangements with multiple deliverables, to eliminate the requirement that all undelivered elements have Vendor-Specific Objective Evidence (VSOE) or Third-Party Evidence (TPE) before an entity can recognize the portion of an overall arrangement fee that is attributable to items that already have been delivered. In the absence of VSOE or TPE of the standalone selling price for one or more delivered or undelivered elements in a multiple-element arrangement, entities will be required to estimate the selling prices of those elements. The overall arrangement fee will be allocated to each element (both delivered and undelivered items) based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on the entity’s estimated selling price. Application of the “residual method” of allocating an overall arrangement fee between delivered and undelivered elements will no longer be permitted upon adoption. Additionally, the new guidance will require entities to disclose more information about their multiple-element revenue arrangements. The adoption of this standard did not have an impact on our consolidated financial statements.

Recently Issued:

In January 2010, FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures About Fair Value Measurements. The ASU requires new disclosures about transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements. It also clarifies existing fair value disclosures about the level of disaggregation of disclosed assets and liabilities, and about inputs and valuation techniques used to measure fair value for both recurring and nonrecurring fair value measurements that fall in either Level 2 or Level 3. The new disclosures and clarifications of existing disclosures were effective, and adopted, during the Company’s second quarter ended March 31, 2010, however the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 measurements, will be effective for the Company’s first quarter ending December 31, 2011. Other than requiring additional disclosures, the full adoption of this new guidance will not have an impact on our consolidated financial statements.

In December 2010, the FASB issued ASU No. 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations (“ASU 2010-29”), which addresses diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. The amendments in ASU 2010-29 specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments in ASU 2010-29 also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments in ASU 2010-29 are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The new rules become effective for the Company on October 1, 2011. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements.

3. EARNINGS (LOSS) PER SHARE

Earnings (loss) per share is computed by dividing the income available to common shareholders by the weighted average number of common shares outstanding. Diluted earnings per share is computed similarly to basic earnings per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential additional common shares that were dilutive had been issued. Common share equivalents are excluded from the computation if their effect is anti-dilutive. The Company’s common share equivalents consist of stock options and warrants.

The diluted earnings per share did not include the dilutive effect, if any, from the potential exercise of stock options and warrants outstanding using the treasury stock method, because the exercise prices for all of the stock options and warrants outstanding was less than the average stock price for the period. For the three and nine months ended June 30, 2011, the number of stock options and warrants excluded was 7,453,000. For the three and nine months ended June 30, 2010, the number of stock options and warrants excluded was 8,066,000 and 3,486,000, respectively.

4. INVENTORIES

Inventories were comprised of:

		June 30, 2011				September 30, 2010
		(unaudited)
Raw materials		$	1,189,000			$	1,285,000
Work in process			226,000				250,000
Finished goods			708,000				431,000
		$	2,123,000			$	1,966,000

5. USE OF ESTIMATES

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

6. STOCK BASED COMPENSATION

Stock Options — US GAAP requires that compensation cost relating to share-based payment arrangements be recognized in the financial statements. US GAAP requires measurement of compensation cost for all employee share-based awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of stock options is determined using the Black-Scholes valuation model. Such fair value is recognized as expense over the service period, net of estimated forfeitures.

US GAAP requires that equity instruments issued to non-employees in exchange for services be valued at the more accurate of the fair value of the services provided or the fair value of the equity instruments issued. For equity instruments issued that are subject to a required service period the expense associated with the equity instruments is recorded as the instruments vest or the services are provided. The Company has granted options and warrants to non-employees and recorded the fair value of these equity instruments on the date of issuance using the Black-Scholes valuation model. The Company has granted stock to non-employees for services and values the stock at the more reliable of the market value on the date of issuance or the value of the services provided. For grants subject to vesting or service requirements, expenses are deferred and recognized over the more appropriate of the vesting period, or as services are provided.

In July 2003, the Company’s board of directors adopted a stock option plan. Under the 2003 option plan, options to purchase up to 1,500,000 shares of common stock are available for employees, directors, and outside consultants.

In December 2004, the Company’s board of directors adopted a 2004 stock incentive plan. The Company may issue up to 1,500,000 shares of common stock under the 2004 plan and no person may be granted awards during any twelve-month period that cover more than 300,000 shares of common stock.

The fair value of each option award is estimated on the date of grant using the Black-Scholes valuation model. The following assumptions were used for options granted in the nine months ended June 30, 2011 and 2010:

		For the Nine Months
		Ended June 30,
		2011				2010
Risk-free interest rate			—				1.76	%
Expected life (in years)			—				4
Dividend yield			—				0.0	%
Expected volatility			—				103	%
Weighted-average volatility			—				103	%

Expected volatility is determined based on historical volatility. Expected life is determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards and vesting schedules. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. Share-based compensation expense recognized is based on the options ultimately expected to vest. US GAAP requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimated. Forfeitures were estimated based on the Company’s historical experiences.

A summary of the Company’s stock option activity as of June 30, 2011, and changes during the nine months then ended is presented below:

										Weighted
						Weighted				Average
		Stock				Average				Contractual				Aggregate
		Options				Exercise Price				Term (Years)				Intrinsic Value *
Outstanding at October 1, 2010			1,813,000			$	0.76				4.05
Granted			—				—
Exercised			—				—
Forfeited, Expired or Cancelled			(108,000	)		$	1.79
Outstanding at June 30, 2011			1,705,000			$	0.69				3.41			$	—
Exercisable at June 30, 2011			805,000			$	0.73				2.55			$	—	*

A summary of the status of the Company’s non-vested stock options as of June 30, 2011, and changes during the nine months ended June 30, 2011, is presented below:

						Weighted Average
						Grant-Date
		Stock Options				Fair Value
Non-vested at October 1, 2010			900,000			$	0.20
Granted			—				—
Forfeited or Expired			—				—
Vested			—				—
Non-vested at June 30, 2011			900,000			$	0.20

In September 2010, the Company granted a total of 900,000 new stock options. These options will vest only if certain revenue and profitability milestones are achieved for the fiscal year ended September 30, 2011. As of June 30, 2011, there was $178,000 of total unrecognized compensation costs related to these non-vested stock options. No expense was recorded at this time because the probability of achieving the milestones is not deemed certain as of June 30, 2011.

There was no compensation expense related to outstanding options for the three months ended June 30, 2011 and 2010. There was no compensation expense related to outstanding options for the nine months ended June 30, 2011. Total compensation expense related to outstanding options for the nine months ended June 30, 2010 was $35,000. Such amounts are included in selling, general and administrative expenses in the accompanying Condensed Consolidated Statements of Operations.

Stock warrants — The Company recognizes the value of stock warrants issued based upon an option-pricing model at their fair value as an expense over the period in which the grants vest from the measurement date, which is the date when the number of warrants, their exercise price and other terms became certain.

At June 30, 2011 and 2010, 6,648,000 and 7,148,000 warrants were outstanding and 5,962,000 and 2,212,000 warrants were vested, respectively.

There was no compensation expense related to outstanding warrants for the three months ended June 30, 2011. Total compensation expense related to outstanding warrants for the three months ended June 30, 2010 was $18,000. For the nine months ended June 30, 2011 and 2010 total compensation expense was $4,000 and $103,000, respectively.

Common stock — On October 10, 2009 the Company issued 300,000 shares of unregistered common stock to an independent firm for investor relations, financial public relations and marketing services for a period of three years. The total value of the common stock issued was $240,000, of which $80,000 was recorded in Other current assets and $142,000 was recorded in Other assets. On April 28, 2010 the Company issued 300,000 shares to the same independent firm for an additional year for investor relations, financial public relations and marketing services. The total value of the common stock issued was $147,000, of which $43,000 was recorded in Other current assets and $104,000 was recorded in Other assets. For the three and nine months ended June 30, 2011, $25,000 and $74,000, respectively, was recorded as selling, general and administrative expense compared to $28,000 and $65,000 for the three and nine months ended June 30, 2010.

On December 6, 2010, in connection with the resignation of a director, the Company purchased and retired all 534,000 of its common shares owned by the director for a total price of $106,000 or $0.20 per share.

During the quarter ended March 31, 2011 the Company retired 113,000 of its common shares that had previously been designated as treasury shares.

7. INCOME TAXES

The Company made a comprehensive review of its portfolio of uncertain tax positions in accordance with recognition standards established for certain tax positions. In this regard, an uncertain tax position represents the Company’s expected treatment of a tax position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes. As of June 30, 2011 and September 30, 2010, the Company does not have a liability for unrecognized tax benefits. The Company concluded that at this time there are no uncertain tax positions. As of June 30, 2011, the Company does not expect any material changes to unrecognized tax positions within the next twelve months.

The Company recognizes the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences could materially impact our financial position or our results of operations. For the nine months ended June 30, 2011, deferred income tax assets and the corresponding valuation allowance increased by $67,000.

The Company’s 2011 provision for income taxes primarily relates to state taxes. The difference between the Company’s 2011 effective rate and statutory rate is primarily due to the use of federal net operating losses to offset taxable income. The difference between the Company’s 2010 effective rate and statutory rate is primarily due to the utilization of net operating losses.

8. FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company’s cash and cash equivalents are measured at fair value in the Company’s condensed consolidated financial statements and are valued using unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 inputs under ASC 820). The carrying amount of our accounts receivable, accounts payable and accrued expenses reported in the consolidated balance sheets approximates fair value because of the short maturity of those instruments. The fair value of the notes payable is estimated based on current rates offered to the Company for similar debt of the same remaining maturities.

9. COMMITMENTS AND CONTINGENCIES

Litigation — The Company received notice in February 2006 regarding a breach of contract action filed in the Delaware Superior Court by Steven M. Mizel against Xenonics, Inc. (“Xenonics”), a 98.6% owned subsidiary of the Company. Plaintiff, a former holder of warrants of Xenonics, alleged that prior to the effective date of a transaction on or about July 23, 2003 between Digital Home Theatre Systems, Inc. (“DHTS”) and Xenonics, plaintiff was not allowed to exercise his warrants and that Xenonics wrongfully refused to permit him to purchase the Company’s shares at the exercise price in his warrants for Xenonics shares. Effective December 10, 2008 the Company agreed to repurchase the minority interest pursuant to an Exchange Agreement between the Company and Mr. Mizel (the “Exchange Agreement”), whereby Mr. Mizel transferred to the Company 125,000 shares of common stock of Xenonics in exchange for 275,000 shares of common stock of the Company with a guaranteed market value (taking into account shares of common stock sold by Mr. Mizel before December 10, 2009) of at least $375,000 on December 10, 2009. In connection with this exchange, Mr. Mizel dismissed with prejudice the action in the Delaware Superior Court.

The Company is occasionally subject to legal proceedings and claims that arise in the ordinary course of business. It is impossible to predict with any certainty the outcome of pending disputes, and management cannot predict whether any liability arising from pending claims and litigation will be material in relation to the Company’s consolidated financial position or results of operations.

10. GOODWILL

The $375,000 recorded as goodwill represents the excess of the purchase price over the recorded minority interest of the Xenonics common stock repurchased as discussed in Note 9 above. The Company does not amortize goodwill. Instead, the Company evaluates goodwill annually in the fourth quarter and whenever events or changes in circumstances indicate that it is more likely than not that an impairment loss has been incurred. As of June 30, 2011, the Company determined that no such impairment indicators exist.

11. DERIVATIVE LIABILITY

In connection with the repurchase of the Company’s minority interest as discussed in Note 9, the Company issued 275,000 shares of common stock with a guaranteed market value of at least $375,000 as of December 10, 2009. A derivative liability of $161,000 was initially recorded as the difference between the stock price on December 10, 2008 and the guaranteed market value of $375,000. Accordingly, any gains or losses resulting from the change in fair value of the common stock are reported as other income or expense in the accompanying consolidated financial statements. On December 11, 2009 the Company was notified that the final liability for this obligation would be $161,000. On January 8, 2010 the final obligation was paid in full.

12. SUBSEQUENT EVENTS

Management evaluated all activity through the date that the consolidated financial statements were issued, and concluded that no subsequent events have occurred that would require recognition in the condensed consolidated financial statements or disclosure in the notes to the condensed consolidated financial statements.

ITEM 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations (rounded in thousands)

The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and accompanying notes filed as part of this report.

Forward-Looking Statements

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations, as well as information contained elsewhere in this report, contain statements that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. These statements include statements regarding the intent, belief or current expectations of us, our directors or our officers with respect to, among other things: anticipated financial or operating results, financial projections, business prospects, future product performance and other matters that are not historical facts. The success of our business operations is dependent on factors such as the impact of competitive products, product development, commercialization and technology difficulties, the results of financing efforts and the effectiveness of our marketing strategies, general competitive and economic conditions. Forward-looking statements are not guarantees of future performance and involve risks and uncertainties. Actual results may differ materially from those projected in the forward-looking statements as a result of various factors, including as a result of the factors described in the “Risk Factors” section of our most recent Annual Report on Form 10-K. We do not undertake any obligation to update or revise any forward-looking statements contained in this report, whether as a result of new information, future events or otherwise.

Results of Operations

Three-months ended June 30, 2011 compared to the three-months ended June 30, 2010

We operate in the security lighting systems and night vision industries, and the majority of our revenues are derived from sales of our illumination products and our SuperVision night vision product to various customers.

Revenues: Revenues for the quarter ended June 30, 2011 were $775,000 compared to revenues of $1,421,000 for the quarter ended June 30, 2010. In the quarter ended June 30, 2011, 94% of revenues were from sales of our NightHunter products to the military (U.S. Army, U.S. Marines and military distributors). In the quarter ended June 30, 2010, 92% of revenues were from sales of our NightHunter products to the military.

Cost of Goods and Gross Profit: Cost of goods consist of the cost of manufacturing our NightHunter One and SuperVision products and the price that we pay to Excelitas Technologies (formerly PerkinElmer) for NightHunter 3 products that Excelitas Technologies manufactures for us.

The gross profit percentages were 31% and 51% for the quarters ended June 30, 2011 and 2010, respectively. The gross profit percentage for the quarter ended June 30, 2011 was lower because sales during this quarter were primarily NightHunter 3’s without shield mounts. Normal gross profit percentages for the complete NightHunter 3 package with shield mounts is 48%. Normal gross profit percentages for our NightHunter One and SuperVision products, which we manufacture, are approximately 50%.

Selling, General and Administrative: Selling, general and administrative expenses decreased by $108,000 to $601,000 for the quarter ended June 30, 2011 as compared to $709,000 for the quarter ended June 30, 2010. The decrease is primarily attributed to the reduction in consulting services of $51,000, legal expenses of $60,000 and non-cash compensation expenses for stock warrants of $21,000 offset by an increase in board of director fees of $29,000 (a former consultant to the Company became a member of the Board of Directors).

Research & Development: Research and development expenses increased by $27,000 to $198,000 for the quarter ended June 30, 2011 compared to $171,000 for the quarter ended June 30, 2010. This year when the Company had lower sales in the quarter, production staff personnel were used for the further development of the Company’s product lines.

Other Income (Expense): For the quarter ended June 30, 2011 interest expense was $38,000 compared to $38,000 of interest expense for the quarter ended June 30, 2010.

Net Income (Loss): Lower revenues in the quarter ended June 30, 2011 account for net loss of $597,000 compared to a net loss of $188,000 for the quarter ended June 30, 2010.

Nine months ended June 30, 2011 compared to the nine months ended June 30, 2010

Revenues: Revenues for the nine months ended June 30, 2011 were $6,323,000 compared to revenues of $2,786,000 for the nine months ended June 30, 2010. For the nine months ended June 30, 2011, 95% of revenues were from sales of our NightHunter products to the military (U.S. Army, U.S. Marines and military distributors). This compares to 86% of revenues to the military market for the nine months ended June 30, 2010.

Cost of Goods and Gross Profit: Cost of goods consist of the cost of manufacturing our NightHunter One and SuperVision products and the price that we pay to Excelitas Technologies (formerly PerkinElmer) for NightHunter 3 products that Excelitas Technologies manufactures for us.

The gross profit percentages were 45% and 49% for the nine months ended June 30, 2011 and 2010, respectively. The gross profit percentage for the first nine months ended June 30, 2011 was impacted by the lower margin sales in the three months ended June 30, 2011.

Selling, General and Administrative: Selling, general and administrative expenses decreased by $320,000 to $1,878,000 for the nine months ended June 30, 2011 as compared to $2,198,000 for the nine months ended June 30, 2010. The decrease is primarily attributable to decreases in non-cash compensation expenses for stock options and warrants of $124,000, consulting expenses of $189,000 and legal expenses of $46,000 offset by an increase in board of director fees of $73,000 (a former consultant to the Company became a member of the Board of Directors).

Research & Development: Research and development expenses were $495,000 for the nine months ended June 30, 2011 compared to $625,000 for the nine months ended June 30, 2010. Last year when the Company had lower sales for the nine month period, production staff personnel were used for the further development of the Company’s product lines. This year the Company also incurred lower costs for outside engineering services.

Net Income (Loss): Significantly higher revenues for the nine month period ended June 30, 2011 accounted for net income of $377,000 compared to a net loss of $1,544,000 for the nine-months ended June 30, 2010.

In connection with the repurchase of the Company’s minority interest in December 2008, the Company issued 275,000 shares of common stock with a guaranteed market value of at least $375,000 as of December 10, 2009. The Company recorded a derivative of $161,000 at the time of the transaction. During the quarter ended December 31, 2009, the fair value of the common stock increased in value and the Company recorded the mark to market adjustment of $38,000 as a gain on derivative revaluation. The repurchase was completed in January 2010 for $161,000 and there was no mark to market adjustment for the nine months ended June 30, 2011.

Liquidity and Capital Resources

As of June 30, 2011, the Company had working capital of $3,502,000 and a current ratio of 10.7 to 1 as compared to working capital of $3,065,000 and a current ratio of 5.2 to 1 as of September 30, 2010.

Our net income of $377,000 for the nine months ended June 30, 2011 positively impacted cash. Significant sources of cash from operating activities during the first nine months of the current year included a decrease in accounts receivable of $313,000 offset by increases in inventories of $157,000 and other current assets of $156,000, which includes cash deposits for inventory to be delivered and a decrease in accounts payable of $346,000. Cash provided by operating activities totaled $140,000 for the nine months ended June 30, 2011.

Based on the amount of working capital that we had on hand on June 30, 2011 and the amount of unfilled and potential orders we have pending, we are optimistic about our ability to obtain sales orders and/or additional equity or debt financing to continue to support planned operations and satisfy obligations. However, due to the nature of our business, there is no assurance that we will receive new orders during the quarters that we expect them and although management believes it can obtain additional financing, there is no certainty that it can.

ITEM 3.		Quantitative and Qualitative Disclosures about Market Risk

Not applicable

ITEM 4.		Controls and Procedures

The Company’s management conducted an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness as of the end of the period covered by this quarterly report of the Company’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”). Disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (the “SEC”) and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2011, which is the end of the period covered by this quarterly report.

Based upon our evaluation, we also concluded that there was no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 6.		Exhibits

Exhibit Number				Description
	31.1			Certification of the Chairman of the Board and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
	31.2			Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
	32.1			Certification pursuant to Section 906 of the Sarbanes-Oxley Act
	32.2			Certification pursuant to Section 906 of the Sarbanes-Oxley Act

SIGNATURES

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