Critical Accounting Policies

"Management's Discussion and Analysis of Financial Condition and Results of Operations" discusses our consolidated financial statements that have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. On an on-going basis, we evaluate our estimates and judgments, including those related to revenue recognition, valuation allowances for inventory and receivables, estimated fair value of stock based compensation, warranty reserves, impairment of long-lived and intangible assets, realizability of deferred tax assets and estimating potential liabilities relating to ongoing litigation. We base our estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. The result of these estimates and judgments form the basis for making conclusions about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates under different assumptions or conditions.

The SEC suggests that all registrants list their most "critical accounting policies" in Management's Discussion and Analysis. A critical accounting policy is one which is both important to the portrayal of the Company's financial condition and results and requires management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Management has identified the critical accounting policies presented below as those accounting policies that affect its more significant judgments and estimates in the preparation of its consolidated financial statements. The Company's Audit Committee has reviewed and approved the critical accounting policies identified.

Results of Operations

In accordance with accounting principles generally accepted in the United States of America, the Company is reporting consolidated revenues for fiscal years ended June 30, 2009 and 2008 from its RFID Technology segment and Wireless Asset Management segment. The Data Storage segment, reported as an operating segment in prior years, is reported as discontinued operations for fiscal years 2009 and 2008.

The following table is a summary of the results of operations and other financial information by major segment:

                                        Wireless
                                         Asset                 RFID
                                       Management           Technology             Corporate             Total
Fiscal year 2009
Sales                              $     13,633,600   $           5,468,400  $                  -  $    19,102,000
   Cost of Goods Sold                     9,686,100               3,540,200                     -       13,226,300
Gross Profit                              3,947,500               1,928,200                     -        5,875,700
   Selling, General &
   Administrative                         5,671,300               1,630,000               916,500        8,217,800
   Stock based compensation expense         319,500                  58,900             1,092,900        1,471,300
Operating Income (Loss)            $    (2,043,300)   $             239,300  $        (2,009,400)  $   (3,813,400)
Gross Margin                                  29.0%                   35.3%                                  30.8%

Accounts Receivable, net           $      1,484,600   $             736,900  $             81,500  $     2,303,000  (1)
Inventory, net                     $      1,354,800   $             980,000  $                  -  $     2,334,800
Total Assets                       $     17,977,300   $           7,390,000  $            707,200  $    26,074,500
Capital Expenditures               $        234,200   $              89,600  $              1,500  $       325,300
Research & Development             $        300,000   $             400,000  $                  -  $       700,000
Depreciation & Amortization        $        499,600   $              84,400  $                800  $       584,800

Fiscal year 2008
Sales                              $     11,838,900   $           1,639,400  $                  -  $    13,478,300
   Cost of Goods Sold                     8,319,800               1,408,000                     -        9,727,800
Gross Profit                              3,519,100                 231,400                     -        3,750,500
   Selling, General &
   Administrative                         6,064,900               2,166,400             1,253,400        9,484,700
   Stock based compensation expense         236,700                  16,800               169,700          423,200
Operating Loss                     $    (2,782,500)   $         (1,951,800)  $        (1,423,100)  $   (6,157,400)
Gross Margin                                  29.7%                   14.1%                                  27.8%

Accounts Receivable, net           $      1,783,700   $             910,600  $             96,300  $     2,790,600 (1)
Inventory, net                     $      2,024,100   $           1,963,500  $                  -  $     3,987,600
Total Assets                       $     18,701,600   $           8,117,100  $          1,394,900  $    28,213,600
Capital Expenditures               $        145,600   $              15,500  $              1,000  $       162,100
Research & Development             $        250,000   $             400,000  $                  -  $       650,000
Depreciation & Amortization        $        455,600   $             143,400  $              1,000  $       600,000

Sales

Consolidated net sales for fiscal year 2009 were $19,102,000, a 41.7% increase when compared to $13,478,300 reported for fiscal year 2008. The increase in sales resulted from increases for both the RFID Technology segment and the Wireless Asset Management segments.

The Company's Wireless Asset Management segment reported a sales increase of $1,794,700, or 15.2%, to $13,633,600 compared to prior year sales of $11,838,900. The sales increase resulted from increased product demand in the refrigerated truck/trailer market. Although revenues on a quarter to quarter comparison may fluctuate, management believes that increases in hardware sales and monitoring revenues will continue to increase in fiscal year ended 2010 through new product introductions and increased market penetration.

Sales for the RFID Technology segment increased by $3,829,000, or 234%, when compared to the prior fiscal year. The improvement in the RFID Technology segment sales reflects momentum in customer acceptance of the TSI PRSIM tracking and monitoring technology and reflects the completion of the long sales cycles required for customers to understand the advantages of the TSI PRISM technology and then secure budget approval for an acquisition This sales improvement has been achieved while maintaining the pricing structure it has utilized over the past few years.

The sales process for the TSI PRISM products is protracted because it generally involves four separate phases: 1) product presentation to a state director of corrections, 2) obtaining the state director of correction's agreement to position the product among the top priorities of his budget, 3) competing with other state projects for funding and 4) publishing the RFP (request for proposal) and awarding the contract. RFID segment customers are currently at various phases in the procurement process, and we believe that although TSI PRISM revenues may fluctuate on a quarter to quarter comparison basis, management believes that sales will continue to increase in fiscal year 2010 as the funding phase is completed and contracts are awarded.

As further evidence of improved market penetration by the TSI PRISM technology, the Company announced during the year that TSI PRISM had been selected as subcontractor for tracking and monitoring technology required for nineteen (19) federal immigration detention facilities under a three year, $44 million contract awarded to Northrop Grumman Corporation ("Northrop"). The Department of Homeland Security awarded Northrop a task order to provide infrastructure and an integrated system that will locate and track detainees, reserve bed space among various facilities and manage detainee transportation requirements. The facilities, housing in excess of 20,000 alien detainees, are operated by the U.S. Immigration and Custom Enforcement-Detention and Removal Operations (ICE-DRO), an agency of the Department of Homeland Security (DHS).

If the Data Storage segment had been included in consolidated operating results, consolidated sales for the year ended June 30, 2009 would have been increased to $21,259,100 (a $4,048,100 increase), a 23.5% increase, compared to $17,211,000 that would have been reported for the same period of the prior year.

Gross Profit

The Company reported gross profit for fiscal year 2009 of $5,875,700 (30.8% of sales), an increase of $2,125,300 or 56.7%, when compared to $3,750,400 (27.8% of sales) for the prior year. The improvement in gross margin resulted from improved gross profit in both the RFID Technology segment and the Wireless Asset Management segment.

Fiscal year 2009 gross profits for the Wireless Asset Management segment increased to $3,947,500 (29.0% of sales), an increase of $428,400 or 12.2% compared to $3,519,100 (29.7% of sales) in gross profit reported for fiscal year ended June 30, 2008. The increase in gross profit resulted from additional hardware sales and data services revenue compared to the prior year. The margins in fiscal 2009 continued to be negatively effected by additional costs (estimated at approximately $800,000) required to convert current customers from control channel to GSM products, and special inventory obsolescence reserve adjustments of approximately $150,000 recorded due to the changeover to the new RT6000 product line.

The RFID Technology segment reported gross profit of $1,928,200 (35.3% of sales), a 733% increase compared to the $231,300 (14.1% of sales) reported for the prior fiscal year. The increase resulted primarily from increased sales as discussed above. In addition, gross margin for the RFID Technology segment in fiscal year 2008 was negatively affected by a strategic decision to install a system at a low margin that provided a significant opportunity to test certain design concepts with an objective of developing a lower cost RFID system designed for a new market and not due to other changes in pricing strategy. We believe that reported gross margin for fiscal years 2009 is more reflective of expected gross margin under higher sales levels.

If the Data Storage segment had been included in consolidated operating results, consolidated gross profit for the year ended June 30, 2009 would have increased to $6,461,200 (30.4% of sales), an increases of $1,712,600, or 36.1%, compared to $4,748,600 that would have been reported for the same period of the prior year.

Selling, General & Administrative Expense

Fiscal year 2009 Selling, general and administrative (SGA) expense, excluding amortization of stock based compensation, decreased to $8,217,800, a decreases of $1,267,100, or 13.4%, when compared to $9,484,900 reported for fiscal year 2008. The reduction in SGA expense was achieved in all areas of the Company.

The Wireless Asset Management segment's SGA expenses decreased $393,600, or 6.5%, to $5,671,300, compared to $6,064,900 reported for fiscal year ended June 30, 2008 due primarily to reductions of sales commissions related to a large contract completed in fiscal 2008. RFID Technology segment reduced SGA expense to $1,630,000, a reduction of $536,400, or 24.8% compared to $2,166,400 reported in the prior year. The decrease was due to the capitalization of approximately $400,000 of engineering expense related to software development and the allocation of certain SGA costs to current contracts. Corporate SGA expense decreased to $916,500 in fiscal 2009, from $1,253,400 reported in fiscal year 2008, a decrease of $336,900, or 26.9%, due to a reduction in legal expense resulting from the TSIN litigation settlement that allowed the Company to write-off certain recorded liabilities as a recovery of legal fees.

If the Data Storage segment had been included in consolidated operating results, consolidated SGA for the year ended June 30, 2009 would have been $7,176,200, a decrease of $2,340,800, or 24.6% when compared to $9,517,000 reported for the fiscal year 2008.

Stock based compensation expense increased substantially to $1,471,300 in the fiscal year ended June 30, 2009, a 248% increase compared to $423,000 reported in fiscal year 2008. The $1,048,300 increase resulted from the Company's decision to change amortization assumptions of approximately $135,000, changes in vesting for company directors and officers of approximately $700,000, and additional expense related to repricing certain employee stock options during the fiscal year ended June 30, 2009 of approximately $166,900.

Operating Loss

The loss from operations for fiscal year ended June 30, 2009 was ($3,813,400), a $2,344,000, or 38.1%, improvement when compared to the operating loss for the prior fiscal year of ($6,157,300). The Wireless Asset Management segment reduced its operating loss by $739,200, reporting an operating loss of ($2,043,300) in fiscal year 2009 compared to ($2,782,500) in the prior fiscal year. The RFID Technology segment reported an operating profit of $239,300, compared to an operating loss to ($1,951,800) reported in fiscal year ended June 30, 2008.

If the Data Storage segment had been included in consolidated operating results, consolidated operating loss for the year ended June 30, 2009 would have been ($4,204,900), an improvement of $2,409,400, or 36.4% when compared to the fiscal year 2008 operating loss of ($6,614,300).

The Company reported Other Expense of ($342,900) for the year ended June 30, 2009, compared to Other Income of $80,500 reported for the comparable period of the prior fiscal year. Other income for fiscal 2008 related to the final liquidation of Fry Guy assets. The current fiscal year Other Expense was due primarily to a $345,100 charge during the current fiscal year to reduce the estimated value of the Company's 8.9% investment in TSIN.

The operations of ATSI were acquired in May of 2002 by the issuance of 2.4 million (post October 16, 2006 reverse split) shares of the Company's Class A Common Stock and the assumptions of certain specific liabilities. In anticipation of the transaction, the Company had acquired approximately 8.9% of the then outstanding shares of TSIN. TSIN had stated it was its intent to liquidate enough shares of the Alanco stock to pay off all TSIN liabilities and to distribute the remaining Alanco shares to the TSIN stockholders. To reflect the 8.9% investment in TSIN subsequent to the acquisition, the Company estimated that approximately 2.25 million shares would be remaining after payment of all TSIN liabilities and that an 8.9% ownership would receive approximately 200,000 shares upon distribution. Therefore, the Company recorded 200,000 treasury shares valued at market price on the transaction date.

On January 30, 2003, a shareholder of TSIN filed suit naming as defendants the Company and its wholly owned subsidiary, ATSI. The complaint set forth various allegations and sought damages arising out of the Company's acquisition of substantially all of the assets of TSIN. Eventually, the lawsuit was transferred to TSIN who became the plaintiff and continued the legal process until September 2007 when the parties to the lawsuit entered into a Settlement Agreement more fully explained in Note 8 - TSIN Litigation Settlement of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K. From 2003 through September 2007, TSIN incurred significant legal expenses associated with the lawsuit, forcing TSIN to sell a significant portion of the Alanco share held, thereby reducing the number of Alanco shares available to TSIN shareholders upon distribution. To reflect that reduction in investment value of the Company's 8.9% ownership in TSIN, the Company, during fiscal year ended June 30, 2009, reduced the estimated number of treasury shares to be received upon distribution from 200,000 shares to 16,000 shares and recorded a charge to other expenses of $345,100.

Loss From Discontinued Operations

The loss from discontinued operations represents the loss from the Data Storage segment which has been classified as an Asset Held for Sale at June 30, 2009 and 2008. For the fiscal year ended June 30, 2009 the loss from discontinued operations was ($391,500), an improvement of $47,800 when compared to a loss of ($439,300) for fiscal year 2008.

EBITDA

The Company believes that (loss) earnings before net interest income, income taxes, depreciation and amortization of intangible assets (EBITDA), is an important measure used by management to measure performance. EBITDA may also be used by certain investors to compare and analyze our operating results between accounting periods. However, EBITDA should not be considered in isolation or as a substitute for net income, cash flows or other financial statement data prepared in accordance with GAAP, or as a measure of our performance or liquidity. EBITDA for Alanco's fiscal year 2009 represents a loss of ($3,571,500) compared to a loss of ($5,476,900) for the same period of the prior year. EBITDA before stock-based compensation decreased to ($2,100,200) compared to ($5,053,900) reported in the prior period an improvement of $2,953,700 or 58.4%. Reconciliation between EBITDA and Loss From Continuing Operations is presented below:

               EBITDA RECONCILIATION TO LOSS FROM CONTINUING OPERATIONS
                                                             Fiscal Years Ended
                                                          June 30,       June 30,
                                                            2009           2008
   EBITDA before Stock-based compensation              $ (2,100,200)  $ (5,053,900)
       Stock-based compensation                          (1,471,300)      (423,000)
   EBITDA                                                (3,571,500)    (5,476,900)
       Net interest expense                                (900,700)      (792,900)
       Depreciation and amortization                       (584,800)      (600,000)
   LOSS FROM CONTINUING OPERATIONS                     $ (5,057,000)  $ (6,869,800)

Dividends

Preferred Stock dividends expensed during fiscal year 2009 amounted to $478,200, including preferred stock dividends of $149,500 paid in-kind, $97,200 paid in Class A Common Stock, $125,000 paid in cash and $106,500 accrued but unpaid at June 30, 2009. The $478,200 in preferred dividends expense was a significant decrease compared to Preferred Stock dividends of $2,439,500 paid in the prior year. The decrease is primarily due to the conversion of all Series A Preferred Stock into Class A Common Stock at June 20, 2008 and therefore the elimination of associated dividends. See Note 14 - Shareholders' Equity of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for additional discussion of Preferred Stock transactions.

Net Loss Attributable to Common Stockholders

Consolidated net loss attributable to Common stockholders for fiscal year ended June 30, 2009 was ($5,926,700), or ($.19) per share, a decrease of 39.2% when compared to a net loss attributable to Common stockholder of ($9,748,600), or ($.42) per share, for the prior year.

Net cash used in operating activities for the fiscal year ended June 30, 2009 was ($1,476,500) compared with net cash used in operating activities for the prior fiscal year of ($6,619,200). The reduction of $5,142,700, resulted primarily from a reduction in loss from continuing operations compared to the prior year and a reduction in both accounts receivable and inventory. Accounts receivable and inventory decreased by approximately $2.4 million in the current fiscal year compared to an increase of approximately $1.5 million in the prior year. See "Liquidity and Capital Resources" below for management's discussion of major items affecting the Consolidated Statement of Cash Flow contained in Item 8 of this Form 10-K.

Any new Statements of the Financial Accounting Standards affecting the Company are disclosed in the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.

Liquidity and Capital Resources

The Company's current liabilities exceeded its current assets by $277,800 at June 30, 2009, representing a current ratio of .96 to 1. At June 30, 2008 the Company's current assets exceeded current liabilities by $698,400 and reflected a current ratio of 1.1 to 1. The slight deterioration in current ratio at June 30, 2009 versus June 30, 2008 resulted primarily from Operating Losses during the twelve-month period.

Consolidated accounts receivable at June 30, 2009 of $2,303,000, forty days' sales in receivables, reflects a decrease of $487,600, or 17.5%, compared to the $2,790,600, fifty-nine days' sales in receivables, reported at the end of fiscal year 2008. The decrease in days' sales was reported in both the Wireless Asset Management and the RFID segments.

The Wireless Asset Management segment reported an Accounts Receivable balance at June 30, 2009 of $1,484,600, or 64.5% of the current fiscal year end consolidated balance, compared to 63.9% of the consolidated balance at the prior fiscal year end. The $1,484,600 June 30, 2009 balance for the Wireless Asset Management segment represented forty days' sales compared to an accounts receivable balance at June 30, 2008 of $1,783,700, representing fifty-five days' sales. The decrease in days' sales resulted from improved sales over the prior fiscal year as well as the segment's efforts to improve collections.

Receivables for the Data Storage segment increased by $2,800, or 3.6%, and RFID Technology segment decreased by $173,700, or 19.1%. The Data Storage segment accounts receivable balance at June 30, 2009 of $81,500 represented fourteen days' sales in receivables compared to $78,700 or eight days, at fiscal year end 2008. Days' sales in receivables for the Data Storage segment may be significantly affected by the percentage of credit card sales in a particular period versus a comparable period and therefore a change in days' sales in receivables is not considered a trend towards faster or slower receivable collection. Days' sales for the RFID Technology segment, forty-nine days at June 30, 2009 is a significant improvement as compared to two hundred and three days at June 30, 2008. The change is primarily due to the increased sales volume in fiscal year 2009 as compared to 2008, approximately $5.4M versus $1.6M respectively.

Consolidated inventories at June 30, 2009, excluding inventory presented as "Assets Held for Sale," amounted to $2,334,800, a decrease of $1,652,800, or 41.4%, when compared to $3,987,600 at June 30, 2008. $983,500 or 59.5% of the current year decrease was reported by the RFID Technology segment, reporting inventories of $980,000 at June 30, 2009, a decrease of $983,500, or 50.1%, from $1,963,500 at fiscal year end 2008. The decrease in inventories was due to delivery of material purchase in fiscal year 2008 for projects which were delivered largely in the first quarter of fiscal year 2009. Inventory turns for the fiscal year ended June 30, 2009 was 3.6 as compared to .72 for fiscal year 2008. The improvement is primarily due to the significant improvement in sales during fiscal year 2009. The Wireless Asset Management segment inventory accounted for $1,354,800, or 58% of the consolidated balances, representing an inventory turn of 7 as compared to 4.1 for the prior year. The Wireless Asset Management segment inventory levels decreased due improved sales volume during the fiscal year 2009 as compared to fiscal year 2008, approximately $13.6 million and $11.8 million respectively.

Net cash used in investing activities during the current year was ($325,500), compared to net cash used in investing activities in fiscal 2008 of ($90,500), a 235,000 increase. The current year increase was due to leasehold improvements, equipment and furniture and fixtures purchased for the new StarTrak office/production facilities in Morris Plains, NJ.

Net cash provided by financing activities during fiscal year ended June 30, 2009 amounted to $1,488,600, a reduction of $5,332,200 compared to $6,820,800 for the fiscal year ended June 30, 2008. During fiscal year 2008, the Company had raised over $5 million through the sale of common stock, a reduction of $4,883,000 compared to approximate $208,000 in net proceeds from the sale of common stock in the fiscal year ended June 30, 2009. In addition, during fiscal 2008 the Company raised $2.7 million from the sale of preferred stock compared to approximately $1.8 million raised from the sale of preferred stock in the current year.

At June 30, 2009, the Company had a $3,250,000 line of credit balance under a $3.25 million line of credit agreement with a private trust that was last amended in January of 2009. Under the amended agreement, which expires on July 1, 2010, the Company must maintain a minimum outstanding balance under the line of $2.50 million and pay interest at prime plus 3% (6.25% at June 30, 2009) on the outstanding balance up to $2 million and 12% on any balance in excess of $2 million. In addition, $1,000,000 of the outstanding balance is convertible into Class A Common Shares of the Company at a price of $1.25 per share. Interest payments made under the Agreement amount to $220,800 and $170,500 in . . .