UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

Commission File Number:  1-7939

VICON INDUSTRIES, INC.

See Accompanying Notes to Condensed Consolidated Financial Statements.

See Accompanying Notes to Condensed Consolidated Financial Statements.

Accounts receivable is stated net of an allowance for uncollectible accounts of $1,001,000$1,008,000 and $1,025,000$982,000 as of June 30,December 31, 2010 and September 30, 2009,2010, respectively.

The Company's total comprehensive income (loss)loss for the three month and nine month periods ended June 30,December 31, 2010 and 2009 was as follows:

The accumulated other comprehensive loss balances at June 30,December 31, 2010 and September 30, 20092010 consisted of the following:

The Company maintains stock option plans that include both incentive and non-qualified options reserved for issuance to key employees, including officers and directors.  All options are issued at fair market value at the grant date and are exercisable in varying installments according to the plans.  The plans allow for the payment of option exercises through the surrender of previously owned mature shares based on the fair market value of such shares at the date of surrender.

The Company follows ASC 718 (SFAS No. 123(R), “Share-Based Payment”), which requires that all share based payments to employees, including stock options, be recognized as compensation expense in the consolidated financial statements based on their grant date fair values and over the requisite service period.  For the three-month periods ended June 30,December 31, 2010 and 2009, the Company recorded non-cash compensation expense of $70,305$77,968 and $78,912,$76,663, respectively, ($.02 and $.02 per basic and diluted share, respectively) relating to stock compensation.  For the nine-month periods ended June 30, 2010 and 2009, the Company recorded non-cash compensation expense of $224,529 and $224,127, respectively, ($.05 and $.05 per basic and diluted share, respectively) relating to stock compensation.

The Company is one of several defendants in a patent infringement suit commenced by Lectrolarm Custom Systems, Inc. in May 2003 in the United States District Court for the Western District of Tennessee.  The alleged infringement by the Company relates to its dome camera dome systems and system controller product lines, among other products that collectively represent significant sales to the Company.  Among other things, the suit seeks past anddamages, enhanced damages injunctive relief and attorney’s fees. The Company and its outside patent counsel believe that the complaint against the Company is without merit and is vigorously defending itself in a joint defense with certain other named defendants. In January 2006, the Company received the plaintiff’s claim for past damages through December 31, 2005 that approximated $11.7 million plus pre-judgmentpre-judg ment interest. The Company and its outside patent counsel believe thatSuch damages claim was based upon $233 million of alleged infringing product sales for the complaint against the Company is without merit.  The Company is vigorously defending itself and isperiod at a party to a joint defense with certain other named defendants.royalty rate of 5%.   

In January 2005, the Company petitioned the U.S. Patent and Trademark Office (USPTO) to reexamine the plaintiff’s patent, believing it to be invalid.  In April 2006, the USPTO issued a non-final office action rejecting all of the plaintiff’s patent claims asserted against the Company citing the existence of prior art of the Company and another defendant.  On June 30, 2006, the Federal District Court granted the defendants’ motion for continuance (delay) of the trial, pending the outcome of the USPTO’s reexamination proceedings.  In February 2007, the USPTO issued a Final Rejection of the six claims in the plaintiff’s patent asserted against the Company which was reaffirmedand in JuneMay 2007, after the plaintiff filed a response with the USPTO requesting reconsideration of its Final Rejection.  The plaintiff has appealed the examiner’s decision to the USPTO Board of Patent Appeals and Interferences (BPAI). On August 16, 2010, the BPAI issued its decision to affirm the USPTO examiner’s finding of invalidity of two of the asserted claims and reversed the examiner’s finding of invalidity of the other four claims. In August 2010, Federal District Court granted the plaintiff’s motion to reopen the case, which has an additional appeal availablebeen scheduled for trial in early 2012. The Company believes that it has substantial non-infringement and invalidity defenses to it thereafterthe plaintiff’s remaining claims and in November 2010, filed a petition with the Court of AppealsUSPTO to reexamine such claims based upon newly discovered prior art. In January 2011, the Company’s request for reexamination was granted by the Federal Circuit.USPTO.  

The Company isbelieves that the plaintiff’s damages claims through 2005 are without merit and has not yet received their subsequent damages claims through the expiration of their patent in May 2009.  Due to the inherent uncertainty of a jury trial and technical nature of this matter, the Company has been unable to reasonably estimate a range of possible loss, if any, at this time. Although theThe Company has received favorable rulings fromheld settlement discussions with the USPTOplaintiff in the past with respectno result and may continue to do so in the reexamination proceedings,future. However, there is alwaysno assurance that any settlement can be reached.

Notwithstanding any of the possibility that the plaintiff’s patent claims could be upheld on appeal andforegoing, the matter would proceed to trial.  Should this occur and the Company receives an unfavorable outcome at trial, it could ultimately result in a liability that is material to the Company’s results of operations and financial position. The Company has been informed by its legal counsel that the estimated future cost of this litigation could approximate $1.6 million through trial, including legal and expert witness representation.

In the normal course of business, the Company is a party to certain other claims and litigation.  Management believes that the settlement of such claims and litigation, considered in the aggregate, will not have a material adverse effect on the Company’s financial position and results of operations.

In October 2009, the FASB issued Accounting Standards Update (ASU) 2009-13, “Revenue Recognition (Topic 605) — Multiple-Deliverable Revenue Arrangements” (ASU 2009-13) and ASU 2009-14, “Software (Topic 985) — Certain Revenue Arrangements That Include Software Elements” (ASU 2009-14).  ASU 2009-13 modifies the requirements that must be met for an entity to recognize revenue from the sale of a delivered item that is part of a multiple-element arrangement when other items have not yet been delivered.  ASU 2009-14 modifies the software revenue recognition guidance to exclude from its scope tangible products that contain both software and non-software components that function together to deliver a product’s essential functionality.  These new updates becomebecame effective on a prospective basis forin the Company’s fiscal year ended September 30, 2011, although early adoption is permitted.  The Company has not yet evaluated theDecember 31, 2010 quarter and had no material impact if any,upon its consolidated financial position, results of adopting these updates.operations or cash flows.

The Company recognizes potential accrued interest and penalties related to unrecognized tax benefits in income tax expense.  The Company files U.S. Federal and State income tax returns and foreign tax returns in the United Kingdom, Germany and Israel.  The Company is generally no longer subject to tax examinations in such jurisdictions for fiscal years prior to 2003 in the U.S., 2004 and 2005 in the U.K., 2005 in Germany and 2002 in Israel.

The majority of the Company’s non-financial assets and liabilities are not required to be carried at fair value on a recurring basis, but the Company is required on a non-recurring basis to use fair value measurements when analyzing asset impairment as it relates to long-lived assets.  The carrying amounts for trade accounts and other receivables, accounts payable and accrued expenses approximate fair value due to the short-term maturity of these instruments.  The fair value of the Company’s foreign currency forward exchange contracts is estimated by obtaining quoted market exchange rates for similar contracts (Level 2 inputs).  The contracted exchange rates on committed forward exchange contracts was approximately $113,769 more$9,880 less favorable than the market rates for similar term contracts at June 30,Decemb er 31, 2010.

Fair value estimates are made at a specific point in time based on relevant market information about the financial instrument.  These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision.  Changes in assumptions could significantly affect the estimates.

Management's Discussion and Analysis of Financial Condition and Results of Operations discusses the Company’s consolidated financial statements for the periods indicated, which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to revenue recognition, bad debts, product warranties, inventories, long lived assets, income taxes and conting encies and litigation. Management bases its estimates and judgments on historical experience and on various other factors including general market conditions that are believed to be reasonable under the circumstances.  Actual results may differ from these estimates under different assumptions or conditions.  Results for the periods reported herein are not necessarily indicative of results that may be expected in future periods.

The Company designs, engineers,manufactures, assembles and markets a wide range of video and access control systems and system components used for security, surveillance, safety and communication purposes by a broad group of end users worldwide. The Company’s product line consists of various elements of a video system, including digital video and network video recorders, video encoders, decoders, servers and related physical security information management software, analog, megapixel and IP fixed and robotic cameras, virtual and analogue matrix video switches, access control panels, video displaysswitchers and controls, and system peripherals.

The Company sells itshigh-end video systems and system components in a highly competitive worldwide marketplace principally to authorized security dealers and system integrators. Such dealers and integrators typically resell the Company’s products directly to end users, among other services. The Company’s sales are principally project based and are largely dependent upon winning projects, construction activities and the timing of funding.  Sales will vary from period to period depending upon many factors including seasonal and geographic trends in construction activities and the timing of deliveries due to changes in project schedules and funding. The Company does not maintain a sizable backlog as its customer orders are typically deliverable within three months or often upon receipt of or der.order. The Company’s operatingope rating cost structure is principally fixed and therefore profitability is largely dependent upon sales levels. ThroughoutSince fiscal year 2009, and subsequent, the Company’s business hassales levels have been impacted by the worldwide economic downturn as capital spendingexpenditures for new construction and renovation projects have weakened.  InSuch sales declines have had an adverse impact on the first half of fiscal 2010, the Company experienced increasing weak market conditions that significantly reduced its sales levels and consequently adversely impacted itsCompany’s financial results.  In the current quarter ended June 30, 2010, the Company experienced an increase in its business levels over the previous two quarters, which was sufficient to generate a small profitresults for the period.these periods.

The Company competes in a market of rapid technology shifts which influence the performance capability of security systems.  As a result, the Company spends a significant amount on new product development. In the first nine months of fiscal 2010 and 2009, the Company incurred $4.2$5.5 million and $4.0$5.4 million of engineering and development expense or 12%11% and 9% of net sales, respectively. The Company’s expenditures for product development are substantially less in absolute levels than its larger competitors.  In recent years, the rapid pace of technology changes has placed increased burden on the Company’s development resources which may necessitatehas necessitated an increase in annual expense for product development.  Further, the Company’s sales effort requires a high level of custom ercustomer service and technical support for its products.  CustomerCus tomer support levels were maintained during the first nine months of fiscal 2010 despite a reduction in sales and such expenditure levels are expected to continue for the remainder of thein fiscal year.2011.  The Company will also consider anyhas considered various strategic initiativeinitiatives that may augment or supplement its present product offerings and technology platforms, among other benefits.

The Company has a foreign sales and distribution subsidiary in Europe that conducts business in British pounds and Euros that represented approximately 36%31% of the Company’s consolidated sales for fiscal 2009.2010. It also has an Israel based engineering and development subsidiary that incurs a majority of its operating expenses in Shekels that represented approximately 15%18% of the Company’s operating expenses for fiscal 2009.2010. During fiscal 2009, there were material changes in exchange rates between world currencies that affected the Company’s financial statements. In 2009, U.S. dollar gained on average 21% against the British pound, 10% against the Euro and 8% against the Shekel compared with 2008. This served to reduce the Company’s consolidated reported sales and costs in these currencies on a translation basis, increaseinc rease the cost of European subsidiaries U.S. dollar based sourced product costs and incur company-wide negative result impacts on the settlements of transactional balances between companies. In the first nine months ofDuring fiscal 2010, there were minimal financial statementsuch world currency exchange rate changes moderated, which significantly lessened the Company’s currency impacts of foreign currency transactions and translations as rate change volatility during this period had lessened compared with 2009. The Company has also historically secured selected forward currency exchange contracts to help stabilize the impact of changing exchange rates and will continue to do so for the remainder ofin fiscal 2010. Such contract settlements have served to further impact currency transactions for the periods presented.  The aggregate impacts of such complex currency exchange transactions on the reported periods’ results were not reasonably quantifiable.2011.

Net cash used inprovided by operating activities was $1.5 million$459,000 for the first nine monthsquarter of fiscal 2010, which included $971,0002011.  Cash generated from a $1.7 million reduction in accounts receivable due to lower sales was offset in part by $370,000 of losses net of non-cash charges.  Cash generated from reductions in inventoriesitems and accounts receivable of $1.2 million and $234,000, respectively, due to lower sales were more than offset by a $2.0 millionan $858,000 net reduction in other operating assets and liabilities.  Net cash used in investing activities was $5.3 million$240,000 for the first nine monthsquarter of fiscal 20102011 consisting of $5.0 million$79,000 of marketable securities purchases and $262,000$161,000 of general capital expenditures.  The marketable security purchases consisted of mutual fund investments principally in federal, state and local government debt securities.  Net cash used in financing activities was $785,000$53,000 for the first nine monthsquarter of fiscal 2010,2011, which included $835,000$75,000 of common stock repurchases offset in part by $50,000$22,000 of proceeds received from the exercise of stock options.  As a resul tresult of the foregoing, cash decreased(exclusive of marketable securities) increased by $7.6 million$98,000 for the first nine monthsquarter of fiscal 20102011 after the minimal effect of exchange rate changes on the cash position of the Company.

The Company believes that it will have sufficient cash to meet its anticipated operating costs and capital expenditure requirements for at least the next twelve months.

The Company does not have any off-balance sheet transactions, arrangements or obligations (including contingent obligations) that have, or are reasonably likely to have, a material effect on the Company’s financial condition, results of operations, liquidity, capital expenditures or capital resources.

The Company is one of several defendants in a patent infringement suit commenced by Lectrolarm Custom Systems, Inc. in May 2003 in the United States District Court for the Western District of Tennessee.  The alleged infringement by the Company relates to its dome camera dome systems and system controller product lines, among other products that collectively represent significant sales to the Company.  Among other things, the suit seeks past anddamages, enhanced damages injunctive relief and attorney’s fees. The Company and its outside patent counsel believe that the complaint against the Company is without merit and is vigorously defending itself in a joint defense with certain other named defendants. In January 2006, the Company received the plaintiff’s claim for past damages through December 31, 2005 that approximated $11.7 million plus pre-judgmentpre-judg ment interest. The Company and its outside patent counsel believe thatSuch damages claim was based upon $233 million of alleged infringing product sales for the complaint against the Company is without merit.  The Company is vigorously defending itself and isperiod at a party to a joint defense with certain other named defendants.royalty rate of 5%.   

In January 2005, the Company petitioned the U.S. Patent and Trademark Office (USPTO) to reexamine the plaintiff’s patent, believing it to be invalid.  In April 2006, the USPTO issued a non-final office action rejecting all of the plaintiff’s patent claims asserted against the Company citing the existence of prior art of the Company and another defendant.  On June 30, 2006, the Federal District Court granted the defendants’ motion for continuance (delay) of the trial, pending the outcome of the USPTO’s reexamination proceedings.  In February 2007, the USPTO issued a Final Rejection of the six claims in the plaintiff’s patent asserted against the Company which was reaffirmedand in JuneMay 2007, after the plaintiff filed a response with the USPTO requesting reconsideration of its Final Rejection.  The plaintiff has appealed the examiner’s decision to the USPTO Board of Patent Appeals and Interferences (BPAI). On August 16, 2010, the BPAI issued its decision to affirm the USPTO examiner’s finding of invalidity of two of the asserted claims and reversed the examiner’s finding of invalidity of the other four claims. In August 2010, Federal District Court granted the plaintiff’s motion to reopen the case, which has an additional appeal availablebeen scheduled for trial in early 2012. The Company believes that it has substantial non-infringement and invalidity defenses to it thereafterthe plaintiff’s remaining claims and in November 2010, filed a petition with the Court of AppealsUSPTO to reexamine such claims based upon newly discovered prior art. In January 2011, the Company’s request for reexamination was granted by the Federal Circuit.USPTO.  

The Company isbelieves that the plaintiff’s damages claims through 2005 are without merit and has not yet received their subsequent damages claims through the expiration of their patent in May 2009.  Due to the inherent uncertainty of a jury trial and technical nature of this matter, the Company has been unable to reasonably estimate a range of possible loss, if any, at this time. Although theThe Company has received favorable rulings fromheld settlement discussions with the USPTOplaintiff in the past with respectno result and may continue to do so in the reexamination proceedings,future. However, there is alwaysno assurance that any settlement can be reached.

Notwithstanding any of the possibility that the plaintiff’s patent claims could be upheld on appeal andforegoing, the matter would proceed to trial.  Should this occur and the Company receives an unfavorable outcome at trial, it could ultimately result in a liability that is material to the Company’s results of operations and financial position. The Company has been informed by its legal counsel that the estimated future cost of this litigation could approximate $1.6 million through trial, including legal and expert witness representation.

The Company's significant accounting policies are fully described in Note 1 to the Company's consolidated financial statements included in its September 30, 20092010 Annual Report on Form 10-K.  Management believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable, and collectibility of the resulting receivable is reasonably assured.  As it relates to product sales, revenueRevenue is generally recognized when products are sold and title is passed to the customer.  Shipping and handling costs are included in cost of sales.  Advance service billings under equipment maintenance agreements are deferred and recognized as revenues on a pro rata basis over the term of the service agreements.  Theagreement.  Pursuant to the adoption of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 605-25-05 (EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables”), the Company evaluates multiple-element revenue arrangements for separate units of accounting, pursuant to ASC 605-25-05 (EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables”) and follows appropriate revenue recognition policies for each separate unit.  Elements are considered separate units of accounting provided that (i) the delivered item has stand-alone value to the customer, (ii) there is objective and reliable evidence of the fair value of the undelivered item, and (iii) if a general right of return exists relative to the delivered item, delivery or performance of the undelivered item is considered probable and substantially within the control of the Company.  As applied to the Company, under arrangements involving the sale of product and the provision of services, product sales are recognized as revenue when the products are sold and title is passed to the customer, and service revenue is recognized as services are performed.

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments.  If the financial condition of its customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

The Company provides for the estimated cost of product warranties at the time revenue is recognized.  While the Company engages in product quality programs and processes, including monitoring and evaluating the quality of its component suppliers, its warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure.  Should actual product failure rates, material usage or service delivery costs differ from its estimates, revisions to the estimated warranty liability may be required.

The Company writes down its inventory for estimated obsolescence and slow moving inventory equal to the difference between the cost of inventory and the estimated net realizable market value based upon assumptions about future demand and market conditions.  Technology changes and market conditions may render some of the Company's products obsolete and additional inventory write-downs may be required.  If actual future demand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

The Company assesses the recoverability of the carrying value of its long-lived assets, including identifiable intangible assets with finite useful lives, whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company evaluates the recoverability of such assets based upon the expectations of undiscounted cash flows from such assets.  If the sum of the expected future undiscounted cash flows were less than the carrying amount of the asset, a loss would be recognized for the difference between the fair value and the carrying amount.

The Company’s ability to recover the reported amounts of deferred income tax assets is dependent upon its ability to generate sufficient taxable income during the periods over which net temporary tax differences become deductible.

The Company is subject to proceedings, lawsuits and other claims related to labor, product and other matters.  The Company assesses the likelihood of an adverse judgment or outcomes for these matters, as well as the range of potential losses.  A determination of the reserves required, if any, is made after careful analysis.  The required reserves may change in the future due to new developments.

Statements in this Report on Form 10-Q and other statements made by the Company or its representatives that are not strictly historical facts including, without limitation, statements included herein under the  Management’s Discussion and Analysis captions “Overview”, "Results of Operations", "Liquidity and Capital Resources" and “Critical Accounting Policies” are "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995 that should be considered as subject to the many risks and uncertainties that exist in the Company's operations and business environment.  The forward-looking statements are based on current expectations and involve a number of known and unknown risks and uncertainties that could cause the actual results, performance and/or achievements of the Company to differ materially from any future results, performance or achievements, express or implied, by the forward-looking statements.  Readers are cautioned not to place undue reliance on these forward-looking statements, and that in light of the significant uncertainties inherent in forward-looking statements, the inclusion of such statements should not be regarded as a representation by the Company or any other person that the objectives or plans of the Company will be achieved.  The Company also assumes no obligation to update its forward-looking statements or to advise of changes in the assumptions and factors on which they are based.

The Company is exposed to various market risks, including changes in foreign currency exchange rates and interest rates. The Company has a policy that prohibits the use of currency derivatives or other financial instruments for trading or speculative purposes.

The Company enters into forward exchange contracts to hedge certain foreign currency exposures and minimize the effect of such fluctuations on reported earnings and cash flow (see Note 6 “Derivative Instruments” to the accompanying condensed consolidated financial statements).  The Company’s ongoing foreign currency exchange risks include intercompany sales of product and services between subsidiary companies operating in differing functional currencies.

 
 

The Company’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as required by Exchange Act Rule 13a-15.  Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms and such information is accumulated and commu nicated to management as appropriate to allow timely decisions regarding required disclosures.

The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting.  The Company's internal control over financial reporting is a process designed under the supervision of its Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company's financial statements for external reporting in accordance with accounting principles generally accepted in the United States of America.  Management evaluates the effectiveness of the Company's internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework. Management, under the supervisio n and with the participation of the Company's Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Company's internal control over financial reporting as of June 30,December 31, 2010 and concluded that it is effective.

There were no changes in the Company's internal control over financial reporting identified in connection with the evaluation referred to above that occurred during the quarter ended June 30,December 31, 2010 that have materially affected, or are reasonably likely to materially affect, the registrant's internal control over financial reporting.

The Company believes that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all controls issues and instances of fraud, if any, within a Company have been detected.  The Company's disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives and the Company's Chief Executive Officer and Chief Financial Officer have concluded that such controls and procedures are effective at the "reasonable assurance" level.

The Company is one of several defendants in a patent infringement suit commenced by Lectrolarm Custom Systems, Inc. in May 2003 in the United States District Court for the Western District of Tennessee.  The alleged infringement by the Company relates to its dome camera dome systems and system controller product lines, among other products that collectively represent significant sales to the Company.  Among other things, the suit seeks past anddamages, enhanced damages injunctive relief and attorney’s fees. The Company and its outside patent counsel believe that the complaint against the Company is without merit and is vigorously defending itself in a joint defense with certain other named defendants. In January 2006, the Company received the plaintiff’s claim for past damages through December 31, 2005 that approximated $11.7 million plus pre-judgmentpre-judg ment interest. The Company and its outside patent counsel believe thatSuch damages claim was based upon $233 million of alleged infringing product sales for the complaint against the Company is without merit.  The Company is vigorously defending itself and isperiod at a party to a joint defense with certain other named defendants.royalty rate of 5%.   

In January 2005, the Company petitioned the U.S. Patent and Trademark Office (USPTO) to reexamine the plaintiff’s patent, believing it to be invalid.  In April 2006, the USPTO issued a non-final office action rejecting all of the plaintiff’s patent claims asserted against the Company citing the existence of prior art of the Company and another defendant.  On June 30, 2006, the Federal District Court granted the defendants’ motion for continuance (delay) of the trial, pending the outcome of the USPTO’s reexamination proceedings.  In February 2007, the USPTO issued a Final Rejection of the six claims in the plaintiff’s patent asserted against the Company which was reaffirmedand in JuneMay 2007, after the plaintiff filed a response with the USPTO requesting reconsideration of its Final Rejection.  The plaintiff has appealed the examiner’s decision to the USPTO Board of Patent Appeals and Interferences (BPAI). On August 16, 2010, the BPAI issued its decision to affirm the USPTO examiner’s finding of invalidity of two of the asserted claims and reversed the examiner’s finding of invalidity of the other four claims. In August 2010, Federal District Court granted the plaintiff’s motion to reopen the case, which has an additional appeal availablebeen scheduled for trial in early 2012. The Company believes that it has substantial non-infringement and invalidity defenses to it thereafterthe plaintiff’s remaining claims and in November 2010, filed a petition with the Court of AppealsUSPTO to reexamine such claims based upon newly discovered prior art. In January 2011, the Company’s request for reexamination was granted by the Federal Circuit.USPTO.  

The Company isbelieves that the plaintiff’s damages claims through 2005 are without merit and has not yet received their subsequent damages claims through the expiration of their patent in May 2009.  Due to the inherent uncertainty of a jury trial and technical nature of this matter, the Company has been unable to reasonably estimate a range of possible loss, if any, at this time. Although theThe Company has received favorable rulings fromheld settlement discussions with the USPTOplaintiff in the past with respectno result and may continue to do so in the reexamination proceedings,future. However, there is alwaysno assurance that any settlement can be reached.

Notwithstanding any of the possibility that the plaintiff’s patent claims could be upheld on appeal andforegoing, the matter would proceed to trial.  Should this occur and the Company receives an unfavorable outcome at trial, it could ultimately result in a liability that is material to the Company’s results of operations and financial position. The Company has been informed by its legal counsel that the estimated future cost of this litigation could approximate $1.6 million through trial, including legal and expert witness representation.

There have been no material changes with respect to the risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended September 30, 2009.2010.

In December 2008, the Company’s Board of Directors authorized the purchase of up to $1 million worth of shares of the Company’s outstanding common stock. OnIn December 3, 2009, the Company’s Board of Directors authorized the repurchasepurchase of an additional $1.5 million worth of shares of the Company’s outstanding common stock.

The following table summarizes the Company’s purchases of common stock in open market transactions or otherwise for the three month period ended June 30,December 31, 2010:

None

None

        Exhibit