SECUREALERT, INC. – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of Section 21E of the Exchange Act and Section 27A of the Securities Act. All statements contained in this Form 10-K other than statements of historical fact are forward-looking statements. When used in this report or elsewhere by management from time to time, the words "believe," "anticipate," "intend," "plan," "estimate," "expect," "may," "will," "should," "seeks" and similar expressions are forward-looking statements. Such forward-looking statements are based on current expectations, but the absence of these words does not necessarily mean that a statement is not forward-looking. Forward-looking statements are not guarantees of future performance and involve risks and uncertainties. Actual events or results may differ materially from those discussed in the forward-looking statements as a result of various factors. For a more detailed discussion of such forward-looking statements and the potential risks and uncertainties that may impact upon their accuracy, see Item 1A.,"Risk Factors" in Part I of this Form 10-K and the "Overview" and "Liquidity and Capital Resources" sections of this Item 7., Management's Discussion and Analysis of Financial Condition and Results of Operations. These forward-looking statements reflect our view only as of the date of this report. Except as required by law, we undertake no obligations to update any forward-looking statements. Accordingly, you should also carefully consider the factors set forth in other reports or documents that we file from time to time with the SEC.

The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help the reader better understand SecureAlert, our operations and our present business environment. Our fiscal year ends on September 30 of each year. Reference to fiscal year 2011 refers to the year ended September 30, 2011. This MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements for the fiscal years ended September 30, 2011 and 2010 and the accompanying notes thereto contained in this report. This introduction summarizes MD&A, which includes the following sections:

   · Overview - a general description of our business and the markets in which we     operate; our objectives; our areas of focus; and challenges and risks of our     business.      · Recent Developments - a brief description of business developments occurring     after the fiscal year ended September 30, 2011 and prior to the filing of this     report.      · Results of Operations - an analysis of our consolidated results of operations     for the last two fiscal years presented in our consolidated financial     statements.      · Liquidity and Capital Resources - an analysis of cash flows; off-balance sheet     arrangements and aggregate contractual obligations; an overview of financial     position including the Company's ability to continue as a going concern; and     the impact of inflation and changing prices.      · Critical Accounting Policies - a discussion of accounting policies that     require critical judgments and estimates.   

We intend for this discussion to provide the reader with information that will assist in understanding our financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our financial statements.

Overview

We market and deploy offender management programs, combining patented GPS tracking technologies, fulltime 24/7/365 intervention-based monitoring capabilities and case management services. Our vision is to be the global market leader for delivering the most reliable offender management solutions, which leverage superior intervention capabilities and integrated communication technologies. We believe that we currently deliver the only offender management technology, which effectively integrates GPS, RF and an interactive 3-way voice communication system into a single piece device, deployable worldwide. Through our patented electronic monitoring technologies and services, we empower law enforcement, corrections and rehabilitation professionals with offender, defendant, probationer and parolee programs, which grant convicted criminals and pre-trial suspects an accountable opportunity to be "free from prison". This provides for greater public safety at a lower cost compared to incarceration or traditional resource-intensive alternatives.

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Our ReliAlert™ and ReliAlert™ XC devices are manufactured in the United States and include a portfolio of products, e-Arrest Beacons and monitoring services designed to create "Jails without Walls", while re-socializing offender populations. The products and services are customizable by offender types (e.g., domestic abusers, sexual predators, gang members, pre-trial defendants, or juvenile offenders) and offer practical solutions and options for the reintegration and effective re-socialization of select offenders safely back into society. Additionally, our proprietary software and device firmware support the dynamic accommodation of agency-established monitoring protocols, victim protection imperatives, geographic boundaries, work environments, school attendance, rehabilitation programs and sanctioned home restrictions. Our technologies are designed for domestic or international, federal, state and local agencies to provide location tracking of designated individuals within the criminal justice system and throughout a restricted geography.

Our GPS devices are securely attached around the offender's ankle with a tamper resistant strap (steel cabling with optic fiber) that can be adjusted or removed without detection only by a supervising officer, and which is activated through services provided by our SecureAlert Monitoring Center (or other agency-based monitoring centers). During fiscal year 2011, we also deployed an upgraded, patented, dual-steel banded SecureCuff™ strap for "at-risk" offenders who have qualified for electronic monitoring supervision, but who require an incremental level of security and supervision, provided through both hardware and monitoring services. Our monitoring and intervention centers act as an important link between the offender and the supervising officer, as intervention specialists persistently track and monitor the offender, initiating contact at the direction of the supervising agency and/or when the offender is in violation of any established restrictions or protocols. The ReliAlert™ and ReliAlert™ XC units are intelligent devices with integrated computer circuitry and constructed from case-hardened plastics designed to promptly notify the intervention centers of any attempt made to breach applicable protocols, or to remove or otherwise tamper with the device or optical strap housing.

Recent Developments

The Company evaluated subsequent events through the date the accompanying consolidated financial statements were issued. Subsequent to September 30, 2011, the following events occurred:

   1) 5,376,499 shares of common stock were issued for 4th quarter Series D      Preferred stock dividends, valued at $541,797.      2) 600,000 shares of common stock were issued to Mr. Klinkhammer, a director, in      lieu of non-employee director expenses accrued for the fiscal year 2011,      valued at $51,000.      3) Warrants to purchase 1,200,000 shares of common stock at an exercise price of      $0.0833 per share were issued to Messrs. David Hanlon, Robert Childers and      Larry Schafran, directors, in lieu of non-employee director expenses accrued      for the fiscal year 2011, valued at $67,476 for each director.      4) Mr. Hastings, the Chief Executive Officer of the Company, loaned the Company      $50,000 at 15% per annum. The Company agreed to re-price outstanding warrants      and options granted to Mr. Hastings to an exercise price of $0.075 per share,      valued at $15,237. Additionally, the Company paid an origination fee of      $5,000 in cash. As of the date of this report, this note has been paid in      full.      5) Mr. Olsen, the Chief Financial Officer of the Company, loaned the Company      $250,000 at 15% per annum. The Company agreed to re-price outstanding      warrants and options granted to him and other individuals to an exercise      price of $0.075 per share, valued at $24,723. Additionally, the Company paid      an origination fee of $15,000 in cash. As of the date of this report, this      note has been paid in full.      6) The Company received $4,000,000 from an international customer to pay for      services. As of September 30, 2011, $1,995,804 was outstanding accounts      receivable, and of the remaining $2,004,196 portion of the $4,000,000 not      included in accounts receivable, $1,452,472 will be recognized as revenue in      future periods and $551,724 will be due in value-added taxes in the      customer's country.      7) 172,704 shares of common stock were issued to pay $14,386 of royalty expense      due in connection with a royalty agreement.      8) 100,000 warrants to purchase common stock with an exercise price of $0.0833      per share were issued to Mr. Bernardi, a former member of the Board of      Directors, for services rendered while in office.      9) The Company borrowed $1,000,000 with an interest rate of 15% per annum.      Subsequently, the Company paid $1,018,082 to pay off this note.      10) The Company settled an outstanding lawsuit from Aculis, Inc. whereby both       parties agreed to dismiss their respective suits with prejudice.      11) The shareholders at the Annual Shareholders meeting, held on December 21,       2011, approved to increase the total authorized shares of common stock from       600,000,000 to 1,250,000,000. Additionally, five new members were added to       the Board of Directors.      12) 4,008 shares of Series D Preferred stock were issued for $2,004,000 in cash,       or $500 per share.                                            19

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Results of Operations

Fiscal Year 2011 compared to Fiscal Year 2010

During the fiscal year ended September 30, 2011, we had net revenues of $17,961,803 compared to net revenues of $12,450,971 for the fiscal year ended September 30, 2010, an increase of $5,510,832, or approximately 44 percent. Revenues from monitoring services for the fiscal year ended September 30, 2011, totaled $16,410,292, compared to $12,079,757 for the same period ended 2010, resulting in an increase of $4,330,535 or approximately 36 percent. These revenues increased as a result of our expansion into the global market which contributed an additional $3,438,467 to monitoring revenues for the fiscal year ended September 30, 2011. Additionally, domestic revenues increased by $2,072,365, or 17 percent, from the fiscal year ended September 30, 2010. Revenues from product sales for the fiscal year ended September 30, 2011 were $1,551,511, compared to $371,214 for the prior year, an increase of $1,180,297. This increase is primarily due to a one-time sale and installation of an onsite monitoring product. This type of sale is rare for the Company. For the years ended September 30, 2011 and 2010, revenues from one-piece activated GPS tracking devices supported entirely about a single limb of the monitored person totaled $6,505,056 and $5,635,198, respectively.

Cost of Revenues

During the fiscal year ended September 30, 2011, cost of revenues, excluding impairment of equipment and parts, totaled $9,565,959, compared to cost of revenues during the fiscal year ended September 30, 2010 of $6,978,974, an increase of $2,586,985. Cost of revenues, as a percentage of net revenues, decreased 3%, from 56 percent in 2010 to 53 percent in 2011, primarily due to a decrease in communication costs of $509,615. The increase in cost of revenues of $2,586,985 in 2011 resulted primarily from increases of $1,365,488 in international costs, $784,393 in other monitoring costs, $292,474 in amortization expense, and $265,614 in monitoring center costs necessary for the organic growth in revenues.

Although there were increases in the cost of goods sold, as stated above, we reduced our communication costs by $509,615 in 2011. Communication costs for the fiscal years ended September 30, 2011 and 2010 were $650,230 and $1,159,845, respectively. These costs primarily involve the costs associated with Subscriber Identity Modules ("SIM") which are embedded in each TrackerPAL™ and ReliAlert™ device. The SIM enables the device to transfer voice and data information to a monitoring center. We incur a monthly charge for each SIM, regardless of whether or not the associated device generates revenue because the SIM cards are ordered and inserted into devices before the devices are sold or leased.

Impairment costs for the fiscal years ended September 30, 2011 and 2010 were $464,295 and $590,801, respectively. These costs resulted from disposals of obsolete inventory, monitoring equipment and parts.

Amortization for the fiscal years ended September 30, 2011 and 2010 totaled $1,160,920 and $875,312, respectively. Amortization costs are based on a three-year useful life for TrackerPAL™ and ReliAlert™ devices. Devices that are leased or retained by us for future deployment or sale are amortized over three years. We believe this three-year life is appropriate due to rapid changes in electronic monitoring technology and the corresponding potential for obsolescence. Management periodically assesses the useful life of the devices for appropriateness.

We expect the cost of revenues as a percentage of revenues to decrease in the foreseeable future due to (a) economies of scale realized through projected increases in revenues, and (b) further development of our proprietary software, enabling each operator to monitor more devices resulting in lower monitoring center costs.

Gross Profit and Margin

During the fiscal year ended September 30, 2011, gross profit totaled $7,931,549, or 44 percent of net revenues, compared to $4,881,196, or 39 percent of net revenues during the fiscal year ended September 30, 2010, an improvement of $3,050,353. Included in cost of revenues are costs attributable to impairment of inventory and monitoring equipment of $464,295 and $590,801 for the fiscal years ended September 30, 2011 and 2010, respectively. These impairment costs from disposal and reduction in value of obsolete monitoring equipment are expenses not expected in future periods. Excluding impairment costs, adjusted gross profit for the fiscal year ended September 30, 2011 was $8,395,844 or 47 percent of net revenues, compared to $5,471,997 or 44 percent of net revenues for the same period in 2010, an improvement of $2,923,847.

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Research and Development Expenses

During the fiscal year ended September 30, 2011, we incurred research and development expenses of $1,453,994 compared to similar expenses recognized during fiscal year 2010 totaling $1,483,385. This decrease of $29,391 is due primarily to management's decision during the fiscal year ended September 30, 2011 to improve efficiency in the software and device engineering departments.

Selling, General and Administrative Expenses

During the fiscal year ended September 30, 2011, our selling, general and administrative expenses totaled $15,652,303, compared to $12,126,413 for the fiscal year ended September 30, 2010. The increase of $3,525,890 is the result of increases in the following expenses: payroll and related taxes ($1,212,331), consulting ($770,155), bad debt ($803,300), taxes ($83,168), travel expenses ($160,559), insurance ($117,771), automobile ($98,866), and other expenses net of improvements ($279,740). Payroll and related tax expenses for the fiscal year ended September 30, 2011 were $6,162,058 compared to $4,949,727 for the fiscal year ended September 30, 2010, an increase of $1,212,331. The increase in payroll related expenses resulted primarily due to staffing requirements to fulfill international expansion initiatives. Increase in bad debt expense of $803,300 reflects the results from the conversion of a subsidiary from cash basis to accrual basis accounting. The Company has focused on requiring customers to prepay for services and improving protocols and processes to violate for late payment for direct offender pay programs in order to mitigate bad debt expense in future periods.

Other Income and Expense

For the fiscal year ended September 30, 2011, interest expense was $712,840, compared to $4,146,459 for the fiscal year ended September 30, 2010. This amount includes non-cash interest expense of approximately $42,351 related to amortization of deferred financing costs associated with warrants, shares of common stock issued for interest, and a beneficial conversion feature expense. This decrease of $3,433,619 is primarily related to the conversion of $16,910,384 in debt, accrued liabilities and interest into 17,174 shares of Series D Preferred stock which resulted in the elimination of the majority of interest that would have been recognized during the fiscal year ended September 30, 2011.

Net Loss

We had a net loss for the fiscal year ended September 30, 2011 totaling $9,858,824, compared to a net loss of $13,919,609 for the fiscal year ended September 30, 2010. This decrease of $4,060,785 is due primarily to increases in sales and the reduction of the cost of goods sold as a percentage of sales due to increased sales in areas with a much lower cost to deliver monitoring services and sales.

Liquidity and Capital Resources

We have not historically financed operations entirely from cash flows from operating activities. During the fiscal year ended September 30, 2011, we funded our operating and investing activities through sales of equity securities. See the accompanying Notes (14) to the Consolidated Financial Statements included in this report. The cash provided by these transactions was used by us to (i) pay operating expenses, including the costs associated with our monitoring center, (ii) purchase TrackerPAL™and ReliAlert™ devices, (iii) pay down debt and accounts payable, including amounts owed on a line of credit and bank debt, and (iv) pay general and administrative expenses, including the salaries of our employees, officers, and consultants and other expenses as described below.

As of September 30, 2011, we had unrestricted cash of $949,749, compared to unrestricted cash of $1,126,232 as of September 30, 2010. As of September 30, 2011, we had a working capital deficit of $1,201,955, compared to a working capital deficit of $3,394,932 as of September 30, 2010. The increase in working capital in fiscal year 2011 primarily resulted from increases in accounts receivable, inventory, prepaid and other current assets, and reductions in current portions of long-term debt and line-of-credit, offset by increases in accounts payable, accrued liabilities and deferred revenues during the fiscal year ended September 30, 2011.

During fiscal year 2011, our operating activities used cash of $6,809,513, compared to $5,779,984 used during fiscal year 2010. This increase in cash used from operating activities of $1,029,529 resulted primarily from decreases in net loss which was driven by an improvement in gross profit of $3,050,353, the amortization of a debt discount of $2,898,908, and an increase in the change in accounts payable of $1,322,469.

Investing activities during the fiscal year ended September 30, 2011, used cash of $3,716,554, compared to $2,228,803 during the fiscal year ended September 30, 2010. The increase in cash used by investing activities during fiscal year 2011 resulted primarily from an increase in purchases of additional monitoring equipment. We purchased $3,066,026 and $1,834,173 of monitoring equipment during the fiscal years ended September 30, 2011 and 2010, respectively.

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Financing activities during the fiscal year ended September 30, 2011, provided $10,349,584 of net cash compared to $8,532,698 during the fiscal year ended September 30, 2010.

During the year ended September 30, 2011, we made net payments of $635,657 on notes payable and $188,634 on a related-party line of credit. During the fiscal year 2011, we had net proceeds of $10,344,603 from the issuance of Series D Convertible Preferred stock and net proceeds of $829,272 from related-party notes payable.

During fiscal year 2010, we made net payments of $949,544 on notes payable, $729,009 on a related-party line of credit, $100,000 on notes payables related to acquisitions, $50,000 on related-party notes, and $25,000 on Series A 15% debentures. During the fiscal year 2010, we had net proceeds of $9,638,851 from the issuance of Series D Convertible Preferred stock, $747,400 from bank line of credit borrowings.

During fiscal year ended September 30, 2011, we incurred a net loss of $9,858,824 and negative cash flows from operating activities of $6,809,513, compared to a net loss of $13,919,609 and negative cash flows from operating activities of $5,779,984 for the fiscal year ended September 30, 2010. As of September 30, 2011, our working capital deficit was $1,201,955, stockholders' equity was $13,615,308, and accumulated deficit totaled $229,055,519.

Going Concern

Notwithstanding the improvement in gross profit, operating loss and net loss achieved in the two fiscal years ended September 30, 2011, the factors described above, as well as the risk factors set out elsewhere in this report raise substantial doubt about our ability to continue as a going concern. The financial statements included in this report do not include any adjustments that might result from the outcome of this uncertainty. Our plan with respect to this uncertainty includes raising additional capital from the issuance of preferred stock or other securities, and expanding the market for our ReliAlert™ portfolio of products. There can be no assurance that revenues will increase rapidly enough to offset operating losses and repay debts. Likewise, there can be no assurance that our efforts to raise additional capital through debt or equity offerings will be successful. If we are unable to increase cash flows from operating activities or obtain additional financing, we will be unable to continue the development of our products and would likely cease operations.

Inflation

We do not believe that inflation has had a material impact on our historical operations or profitability.

Critical Accounting Policies

In Note (2) to the audited Consolidated Financial Statements for the fiscal year ended September 30, 2011 included in this report, we discussed those accounting policies that are considered to be significant in determining the results of operations and our financial position.

The preparation of financial statements requires management to make significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty. On an on-going basis, we evaluate our estimates, including those related to bad debts, inventories, intangible assets, warranty obligations, product liability, revenue, and income taxes. We base our estimates on historical experience and other facts and circumstances that are believed to be reasonable, and the results form the basis for making judgments about the carrying value of assets and liabilities. The actual results may differ from these estimates under different assumptions or conditions.

With respect to inventory reserves, revenue recognition, impairment of long-lived assets and allowance for doubtful accounts receivables, we apply critical accounting policies discussed below in the preparation of our financial statements.

Inventory Reserves

The nature of our business requires maintenance of sufficient inventory on hand at all times to meet the requirements of our customers. We record inventory and raw materials at the lower of cost, or market, which approximates actual cost. General inventory reserves are maintained for the possible impairment of the inventory. Impairment may be a result of slow moving or excess inventory, product obsolescence or changes in the valuation of the inventory. In determining the adequacy of reserves, management analyzes the following, among other things:

                       · Current inventory quantities on hand;                         · Product acceptance in the marketplace;                                    · Customer demand;                                   · Historical sales;                                    · Forecast sales;                               · Product obsolescence; and                               · Technological innovations.   

Any modifications to these estimates of reserves are reflected in cost of revenues within the statement of operations during the period in which such modifications are determined necessary by management.

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Revenue Recognition

Our revenue in fiscal year 2011 derived from two sources: (i) monitoring services; (ii) product sales.

Monitoring Services

Monitoring services include two components: (a) lease contracts in which the Company provides monitoring services and leases devices to distributors or end users and the Company retains ownership of the leased device; and (b) monitoring services purchased by distributors or end users who have previously purchased monitoring devices and opt to use our monitoring services.

We typically lease devices under one-year contracts with customers that opt to use our monitoring services. However, these contracts may be cancelled by either party at anytime with 30 days notice. Under our standard leasing contract, the leased device becomes billable on the date of activation or 7 to 21 days from the date the device is assigned to the lessee, and remains billable until the device is returned to us. We recognize revenue on leased devices at the end of each month that monitoring services have been provided. In those circumstances in which we receive payment in advance, we record these payments as deferred revenue.

Product Sales

We may sell our monitoring devices to customers in certain situations to its customers. In addition, we may sell equipment in connection with the building out and setting up a monitoring center on behalf of our customers. We recognize product sales revenue when persuasive evidence of an arrangement with the customer exists, title passes to the customer and the customer cannot return the devices or equipment, prices are fixed or determinable (including sales not being made outside the normal payment terms) and collection is reasonably assured. When purchasing products (such as TrackerPAL™ and ReliAlert™ devices) from us, customers may, but are not required to, enter into monitoring service contracts with us. We recognize revenue on monitoring services for customers that have previously purchased devices at the end of each month that monitoring services have been provided.

We sell and install standalone tracking systems that do not require ongoing monitoring by us. We have experience in component installation costs and direct labor hours related to this type of sale and can typically reasonably estimate costs, therefore we recognize revenue over the period in which the installation services are performed using the percentage-of-completion method of accounting for material installations. We typically uses labor hours or costs incurred to date as a percentage of the total estimated labor hours or costs to fulfill the contract as the most reliable and meaningful measure that is available for determining a project's progress toward completion. We evaluate our estimated labor hours and costs and determine the estimated gross profit or loss on each installation for each reporting period. If it is determined that total cost estimates are likely to exceed revenues, we accrue the estimated losses immediately.

Multiple Element Arrangements

The majority of our revenue transactions do not have multiple elements. However, on occasion, we enter into revenue transactions that have multiple elements. These may include different combinations of products or monitoring services that are included in a single billable rate. These products or monitoring services are delivered over time as the customer utilizes our services. For revenue arrangements that have multiple elements, we consider whether the delivered devices have standalone value to the customer, there is objective and reliable evidence of the fair value of the undelivered monitoring services, which is generally determined by surveying the price of competitors' comparable monitoring services, and the customer does not have a general right of return. Based on these criteria, we recognize revenue from the sale of devices separately from the monitoring services provided to the customer as the products or monitoring services are delivered.

Other Matters

We consider an arrangement with payment terms longer than our normal terms not to be fixed or determinable, and revenue is recognized when the fee becomes due. Normal payment terms for the sale of monitoring services and products are due upon receipt to 30 days. We sell our devices and services directly to end users and to distributors. Distributors do not have general rights of return. Also, distributors have no price protection or stock protection rights with respect to devices sold to them by the Company. Generally, title and risk of loss pass to the buyer upon delivery of the devices.

We estimate our product returns based on historical experience and maintain an allowance for estimated returns, which is recorded as a reduction to accounts receivable and revenue.

Shipping and handling fees charged to customers are included as part of net revenues. The related freight costs and supplies directly associated with shipping products to customers are included as a component of cost of revenues.

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Impairment of Long-lived Assets

We review our long-lived assets for impairment when events or changes in circumstances indicate that the book value of an asset may not be recoverable and in the case of goodwill, at least annually. We evaluate whether events and circumstances have occurred which indicate possible impairment as of each balance sheet date. We use an equity method of the related asset or group of assets in measuring whether the assets are recoverable. If the carrying amount of an asset exceeds its market value, an impairment charge is recognized for the amount by which the carrying amount exceeds the estimated fair value of the asset. Impairment of long-lived assets is assessed at the lowest levels for which there is an identifiable fair market value that is independent of other groups of assets. As of September 30, 2010, we impaired goodwill from Court Programs, Inc. by $204,735. No other impairments were necessary during the fiscal years ended September 30, 2010 and 2011.

Allowance for Doubtful Accounts

We must make estimates of the collectability of accounts receivable. In doing so, we analyze accounts receivable and historical bad debts, customer credit-worthiness, current economic trends and changes in customer payment patterns when evaluating the adequacy of the allowance for doubtful accounts.

Recent Accounting Pronouncements

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (FASB) or other standard setting bodies, which are adopted by us as of the specified effective date. Unless otherwise discussed, we believe that the impact of recently issued standards that are not yet effective will not have a material impact on its financial position or results of operations upon adoption.

Accounting for Stock-Based Compensation

We recognize compensation expense for stock-based awards expected to vest on a straight-line basis over the requisite service period of the award based on their grant date fair value. We estimate the fair value of stock options using a Black-Scholes option pricing model which requires us to make estimates for certain assumptions regarding risk-free interest rate, expected life of options, expected volatility of stock and expected dividend yield of stock.