Item 1. Business
Overview
Electronic Control Security Inc. (“ECSI” or the “Company” or “we” or “us”) designs, manufactures and supplies stand-alone and fully integrated state-of-the-art entry control and perimeter intrusion detection systems for the Department of Defense, Department of Energy, nuclear power stations, and various international customers. We offer U.S. Air Force certified technology and a comprehensive services portfolio that includes: site survey/risk assessment, design & engineering, systems manufacturing and integration, factory acceptance testing, installation supervision, commissioning, operations and maintenance training.
We work closely with architects, engineers, systems integrators, construction managers and owners in the development and design of security monitoring and control systems that will afford a normative but secure environment for management, staff and visitors. To support such efforts, ECSI’s team of key personnel are technically accomplished and fully familiar with advances in planning, programming and designing systems utilizing standard peripheral components, mini/micro architecture, user friendly software/firmware selection and application.
Strategic Positioning / Competitive Advantage
ECSI’s design experts are experienced in the various technologies (both mature and emerging) being applied to security challenges in the U.S. and world-wide because they have been intimately involved in developing “turnkey” security systems for U.S. Government facilities (Department of Defense (DoD), Department of Energy (DoE), and Nuclear Regulatory Commission-licensed nuclear facilities.
We believe that our company is strategically positioned to leverage our experience and expertise because of the following:
·37+ year track record with high customer retention rate;
·U.S. Air Force certified technology;
·Best industry warranty - 10 Years on select equipment;
·General Services Administration (GSA) contract valid through July 2014;
·SeaPort-e contract valid through July 2014;
·Competitive Small Business (SB) capable of taking advantage of government solicited Small Business Set-Aside contract opportunities;
·Strong teaming arrangements with large systems integrators to supply technology and offer design and engineering support services to on multiple current and pending contracts;
·Award by Space and Naval Warfare Systems Command (“SPAWAR”) on May 2, 2012 affords ECSI a five-year multi-million dollar contract vehicle for DoD project procurement; Separate award by SPAWAR on July 19, 2012, affords ECSI another five-year multi-million dollar contract vehicle for DoD project procurement;
·$146 million of proposals under evaluation as of June 30, 2012; and
·World-wide implementation and support through robust domestic and international marketing and distribution network with multiple direct and indirect distribution channels and strategic partnerships; and
We believe that our competitive advantages include the following:
·providing the highest level of perimeter protection;
·offering supporting technologies and systems to enable total systems integration;
·delivering systems that are easy to operate and maintain while providing superior life cycle cost performance;
·solid credentials in protecting high value targets;
·best industry warranty
·superior technologies --- technologies targeted to the specific protected environment, and
·Interoperability Device Management System (IDMS) offering situational awareness and total system management.
Corporate Mission:
We believe that we have built a solid reputation as a provider of leading-edge, high technology security solutions and services. Our view is shared and supported by the many international government sectors and commercial clients that engage our services and products on a continuing basis.
Our mission is to establish ourselves as a Small Business (SB) prime contractor to take advantage of the small business opportunities that exist today and in the forseeable future. According to published government reports, approximately $1.4 billion was spent last year for small business in the government market. We project that this market sector will continue to grow in the years ahead, and we plan to be an integral part of this program.
To achieve that end we have formed a team of both small and large corporation agreements to support our company in the pursuit of this market. We believe that our past performance and in depth experience as well as that of our teaming partners will place us in a lead position to capture a good share of this market.
Further, ECSI’s intent is to focus on its core products. We will dedicate the necessary resources for research and development and explore opportunities for our currently certified systems to be tested and certified by additional government sponsored agencies in order to open additional markets for these products. We will also explore opportunities for our other (non-certified) systems to be tested and certified by specific government sponsored agencies in order to open new markets for these particular products. ECSI has already begun this initiative. We are currently 9 months in to a 12 month test program and expect additional testing opportunities to begin during the early part of 2013.
Integration Support Services
ECSI has worked with system integrators on various high-threat projects including the World Trade Center in New York City after the first bombing in 1993, Rocky Flats, Golden, CO., Pantex, Amarillo, TX, naval facilities in Washingon, D.C. and Maryland, as well as UNECA’s facility in Addis Ababa, Ethopia. Each of these projects utilized different hardware and software platforms for the Central Alarm Station (CAS) and Secondary Alarm Station (SAS) including Livermore Argus System at the Pantex Facility.
It is imperative for a facility to have remote devices and subsystems integrated with the hardware and software at the CAS and SAS. The inherent design of an interoperable device management system (IDMS) lends itself to integrate with any of the remote devices and sub-systems that will be selected for a Perimeter Intrusion Detection and Assessment System (PIDAS). Based on our experience in system design, application, commissioning, training and operation, the integration of the various technologies proceeds in a seamless manner.
Consulting Support Services
The consulting support services we provide our dealers/installers and system integrators are an integral part of the security solution. Effective and efficient use of technology can be achieved only if properly utilized. Toward that end, we assist our customers in conducting risk assessment and vulnerability/criticality studies to ascertain their security requirements and develop a comprehensive risk management and mitigation program; and provide security system design support services.
Our support services generally represent the first steps in assisting the dealer/installer or systems integrator to develop a security solution. The risk assessment, threat, vulnerability and criticality analyses that the system integrator utilizes allows us to develop effective responses necessary to address and mitigate the threat.
Our design personnel are expert in their knowledge of the various technologies (mature and emerging) and their application to security challenges, both in the United States and abroad, because they continue to be intimately involved in developing security systems for government facilities in the United States and overseas.
Security Industry Overview
The Security Institute of America estimates that the worldwide market for security products and services in 2013 will exceed $9.5 billion. The industry encompasses a wide ranging, highly fragmented group of products and service providers which includes entities that market comprehensive security systems and offer security consulting services, such as dealers/installers, small single product companies, equipment manufacturers, and large systems integrators. We believe the security industry will continue to grow rapidly because:
·western nations have been the target of high profile terrorist attacks over the last several years that have squarely focused attention on security and threat issues;
·perimeter security for airports, maritime, chemical, transportation, energy and pharmaceutical facilities has been mandated by Homeland Security;
·newer, more effective and efficient security equipment incorporating advancements in security technology is replacing obsolete equipment;
DoD & DoE are upgrading their facilities to enhance security while reducing manpower;
·nuclear power stations both in the United States and overseas have increased the level of security based on recent NRDC security requirements; and
·private industry is operating in more remote geographic locations and higher risk environments.
Product Design
We design and develop new products based upon market requirements and as deemed necessary to meet clients' specific needs. We research and assess threat and vulnerability issues and design and engineer our products in-house, with outside consultants as needed, and in conjunction with joint venture partners to meet the requirements of clients based upon the results of such research. We investigate new and emerging technologies that have application in the security industry and seek to license these technologies which we may incorporate into our product line.
Products, Systems and Technologies
The services and technologies required to create a secure environment must address the entire range of security concerns that challenge government and commercial institutions, including the protection of personnel and physical assets.
Our Integrated Security Solutions are comprised of one or more subsystems and components that perform a variety of security functions for a facility with a single Command and Control Center and, in certain cases, a back up Command & Control Center that incorporates many of our systems integrated with legacy and Government or owner furnished technologies.
Product Focus
Automated Entry Control System (AECS) automated vehicle/personnel gate system consisting of Radio Frequency Identification (RFID) to read vehicle tags, license plate cameras (front & rear), personnel card readers (e.g., proximity, barcode) and keypad, intercom and camera, anti-tailgating sensors, electric gates. Integrated system interfaced with facility’s databases for rapid identification of vehicles/personnel for reasonable traffic flow.
Infrared Perimeter Intrusion Detection(IPIDÒ) U.S. Air Force Certified. Standard with Deparment of Energy and Nuclear Regulatory Commission power stations. System offers an undefeatable barrier of pulsed infrared beams to create multiple intrusion detection zones, each with a range of up to 330 feet. Modular design can be stacked to form an invisible wall that cannot be penetrated without detection.
Fiber Optic Intelligence Detection System FOIDSÒ Ò Standard with Department of Energy and several international oil & gas companies. Most advanced fiber optic sensor technology available for fence/wall line perimeter monitoring and intrusion detection. FOIDS® uses single mode fiber optic cable and highly sensitive interferometry technology for intrusion detection along fences and walls up to a zone length of 3.5 miles. The system detects climbing, cutting, and pulling along the fence/wall line. Technology does not use electronics in the field, has a range of over 60km, and uses single mode fiber optic cable.
PTZ Cameras The view of PTZ cameras can be adjusted a number of ways: Human manipulation, motion detection, door contact signals or automatically to a preset pattern. The use of PTZ cameras to automatically track an intruder based on an alarm from another technology provides the best solution.
Day/Night & Thermal Imaging Cameras Highest Rated, all weather environmental enclosures (-40°F to +149°F). High resolution sensor for clear, sharp imagery. Uniformity of picture (no white or dark borders found in other cameras). Smooth transition between extreme temperature differences. No “residue” trailing in picture when camera shifts positioning. Range up to 21Km (13 miles). Built-in video “trip-wire” intelligent motion detection. Full service support, including Maintenance and Repair
ECSI Long Range Day / Night CCTV ECSI’s Long Range Day/Night camera offers imaging systems for any security application where lighting is impractical, too expensive or where long-range performance is required. For border security, port security, and critical infrastructure applications, the system has proven vital to threat detection initiatives.
Vehicle Gate Automation ECSI’s smart gate consists of Radio Frequency Identification (RFID) equipment to read vehicle tags, personnel card readers (e.g., proximity cards, bar-coded information on identification cards and the Access Control Card (ACC), biometric validation, etc.), visual and acoustic devices supplying the Human-Machine Interface to alert the Security Force (SF) team to identification and threat assessment results, a computer-based access control system interfacing with the facility databases.
ECSI Long Range Radar Potential intruders entering oil fields, refineries, bases, or crossing borders can now be detected and monitored remotely using an innovative radar design. The radar systems, named “Area Intrusion Monitoring System” (AIMS) operate with uniquely low power and light weight solid state components.
Water Infrastructure Sensing Equipment (WISE®) Proprietary real-time, on-Line bio/chemical detection and reporting system. Continually monitors water flow for chemical and biological contaminants. Immediately reports out-of-parameter conditions (via e-mail or SCADA) to any number of recipients. Draws sample of contaminated water for further analysis. Offers capability of bypassing of shutting down flow of contaminated water. DoD/EPA tested.
Interoperable Device Management System (IDMS)
Comprehensive interoperability platform for total system management capability. IDMS delivers comprehensive integration of security systems (transparent to the end user); single view of events and incidents (via customized role-specific graphical user interfaces and dashboards); process-driven event management (via graphical workflow tools, response plans and customized alarm stack design); analysis, status and management information (built-in report designers to provide timely and effective reports and statistics on compliance to security policies). Open architecture allows integration of new and legacy systems - ability to monitor and control systems simultaneously through one easy-to-use interface (automated entry control systems, intrusion detection systems, day/night & thermal imaging cameras, etc.) This technology permits the Command Control Communication and Computer (CCC&C) center to operate as the custodial and security nerve center where officers in the center have the ability to perform the IDMS monitoring and control process on one new network.
Emergency Response Stations:
The Emergency Response Stations provide the immediate response to potential security incursions. The surveillance system is monitored by sensor technology supplemented by CCTV cameras. The ERS is networked to the surveillance system and other sensor nodes through a redundant fiber optic network. The optical cameras provide immediate assessment of any potential target in the operational sector.
We believe that the technology we offer is qualitatively comparable to or more effective than those offered by our competitors because our products:
·provide low nuisance and false alarm rates;
·are reliable in virtually any environmental condition;
·in many cases can be user specified and adapted to their environment; and
·are subject to low installation and maintenance costs.
Markets for Our Products
We have identified a number of markets for our products and have developed programs to gain access to those target markets. The U.S. Government, along with many of its agencies and departments, represents a significant market for our products. We are now implementing a proactive marketing program to increase sales of our products to the following U.S. Government agencies, all of which have purchased our products in the past and will continue to be among our top customers. Further, in many instances, laws have been enacted and mandates decreed for compliance with some minimum-security standards. Airport security is a prime example. We target these entities as well as entities where we can demonstrate the need for security measures.
Primary markets that we target include:
·the U.S. Government, its agencies and departments, including the Department of Defense and the Department of Energy;
·large industrial facilities, including pharmaceutical companies and major office complexes;
·energy facilities, including nuclear power stations, utilities, chemical-petrochemical pipelines;
·foreign/export opportunities in all of the above-noted target markets.
Our open-ended contract with the General Services Administration (GSA), which has been extended through July 31, 2014, authorizes the U.S. Government and a network of eligible sources to purchase materials and services from us on negotiated and approved prices without having to undergo a full competitive bid. The Company is a technology supplier to the three large system integrators selected for the FPS2 program addressing United States Air Force Bases over the next four years.
Foreign/Export Opportunities. Government operations and private industries in foreign countries are all subject to the same security issues that challenge similar entities in the United States. We, along with our strategic teaming partners and international sales representatives, continue to seek penetration of these major market opportunities, i.e. Kingdom of Saudi Arabia, Qatar, Egypt, Uganda, Ethiopia and Chile.
Marketing
We have developed a multi-tiered marketing plan, allowing us to effectively market products to each of the separate government and industry segments identified as target markets both in the United States and internationally. Our marketing strategy highlights product and support service strengths as they apply to each particular industry.
The primary goals of our marketing strategy are to:
·Broaden the base of potential clients, domestically and internationally, and
·Demonstrate the efficacy of our products and support services.
We entered into strategic partnerships, teaming, and representative relationships with major multi-national corporations in each of the industries that comprise our target markets. These companies generally enjoy a strong market presence in their respective industries and we believe that our teaming agreements with these entities afford us added credibility. These entities frequently subcontract our services and purchase our products in connection with larger projects and, in turn, support the company on projects we are pursuing as the prime contractor. During fiscal 2011, we entered into teaming and marketing agreements with ITSI, SAIC, Fortis, Calnet, Honeywell, Culmen, ERIS, and Boeing.
During fiscal 2012, we submitted proposals on projects for Department of Defense facilities and certain nuclear power stations in the United States and Southeast Asia valued at approximately $146,550,000. We anticipate decisions relating to these proposals during fiscal 2013.
Members of our management team have many years of experience in the security industry. Each member is assigned a corporate account and thereby establishes relationships with government and commercial organizations in a specific market.
We are projecting our international business to develop through a network of independent sales representatives. Agreements are in place with various entities that allow us to maintain a presence in 11 countries worldwide. These agreements generally extend for a period of two years and provide the dealer/installer with price discounts from current price schedules as an incentive to market our products in their geographic area.
A presence is maintained at the major trade conferences that address our target markets and we advertise in the relevant conference publications.
Business Growth Strategy
Our mission is to establish ourselves as a Small Business (SB) prime contractor to take advantage of the small business set-aside opportunities that exist today and in the foreseeable future.
In order to achieve a sustainable and continuous growth rate, we believe that we must devote additional resources to marketing and product development. Specifically, we have or intend to:
·Dedicate the necessary resources for research and development and explore opportunities for our currently certified systems to be tested and certified by additional government sponsored agencies in order to open additional markets for these products. We will also explore opportunities for our other (non-certified) systems to be tested and certified by specific government sponsored agencies in order to open new markets for these particular products. ECSI has already begun this initiative. We are currently 9 months in to a 12 month test program and expect additional testing opportunities to begin during the early part of 2013.
·Expand our global presence. We entered into sales agreements with a number of multi-national companies to represent and support our products in Chile, Kingdom of Saudi Arabia, Africa, India, China, and other Middle East countries.
·Design and develop new systems. We will continue to develop new security systems to expand our portfolio of proprietary products. We believe that this will help us to open new markets and retain our position as a leading edge provider of technology based security equipment.
·License new and emerging technologies. We will continue to identify, analyze and acquire new and emerging technologies for application in the security industry. We will seek to acquire technologies that will enhance our existing systems and develop new products.
·Upgrade existing products. We have and will continue to upgrade existing products by taking advantage of technological advancements to ensure that they remain state-of-the-art.
Customers
We provide products and services to certain customers who maintain their own integration engineering and installation departments. During the past five years we have provided products to approximately 50 nuclear power stations, Department of Energy and other government agencies covering over 220 projects.
Under usual business conditions, given the nature of our customers, products, and support services, we receive relatively large orders for products and services from a relatively small number of customers during any one period. We are committed to expanding our business with each existing customer as well as broadening our customer base. During the fiscal year ended June 30, 2012, there were three customer groups which comprised a significant portion of our revenues. For Fiscal Year 2012, the Department of Defense accounted for 65% of our net revenues, nuclear power stations for 25% and Department of Energy for 5%. For Fiscal Year 2011, the Department of Defense accounted for 60% of our net revenues, nuclear power stations, 33%; and the Department of Energy 5 %.
Competition
Competition for U.S. government contracts is intense. We compete against a large number of established multi-national corporations as well as smaller, more specialized companies that concentrate their resources in particular areas. As a result of the diverse requirements of the U.S. Government and our commercial customers, we frequently collaborate with other companies to compete for large contracts and bid against these team members in other situations.
Competition is intense among a fragmented and wide ranging group of product and service providers, including security equipment manufacturers, providers of integrated security systems, systems integrators, consulting, engineering and design firms and others that provide individual elements of a system, in the future against existing or potential competitors.
We believe we are able to sustain our competitive position in the industry because:
·our principal officers, security analysts, design personnel and sales people have an aggregate of over 250 years of experience in the security industry;
·we have the ability to analyze security risks, design, engineer and manufacture products customized to a client's requirements;
·our products address a wide range of security requirements;
·our products are among the most technologically advanced and the highest quality available;
·our products are reliable, and relatively easy and inexpensive to install and maintain; and
·we have been successful in teaming with large multinational companies to market and incorporate our products into their product offerings, thereby contributing to the credibility and efficacy of our products.
Manufacturing
Manufacturing operations are maintained at our facility in Clifton, New Jersey. ECSI operates in a facility having Department of Defense Secret Clearance. The premises consist of 12,500 square feet, including 2,500 administrative and design & engineering, 2,000 inventory, and 8,000 for purchasing, configurable and custom manufacturing (both hardware and software), testing, and quality assurance. ECSI is registered to the ISO 9001:2008 Quality Management System, based on its scope of supply including design, development, commissioning, and servicing of physical security and data communications systems. Activities include the procurement of materials, product assembly and component integration, product assurance, quality control and final testing.
Individual components that we purchase comprise some of our products or we subcontract the manufacture of specific subsystems to third parties. We believe that we are not overly dependent on any one supplier for the components of our products. In the event of any disruption in supply or discontinuation of production by any of our present suppliers, we believe that the components used in our products are available from numerous sources at competitive prices. Various aspects of the software programming required in connection with our computer products are designed and written by in-house personnel or are subcontracted to third parties.
We have not entered into any long-term contracts for the purchase of components but rather rely on rolling forecasts to determine the number of units we will sell and the components required. We maintain an inventory of certain long-lead items required in the manufacture of our products, as reflected in our balance sheet. To date, we have been able to obtain supplies of these components and we believe that adequate quantities are available to meet our needs.
To date, compliance with environmental laws has not impacted our manufacturing or other operations, although there can be no assurance that this will continue to be the case.
Intellectual Property and Other Proprietary Rights
Proprietary protection for our technological expertise, products and product candidates are important to our business. Currently, we rely upon trade secrets, application experience and continuing technological innovation to develop and maintain our competitive position. We also rely on a combination of trade secret protection and non-disclosure agreements to establish and protect our proprietary rights.
Our success is dependent to a great extent on our proprietary knowledge, innovative skills, technical expertise and marketing ability. Our intention is not to rely primarily on patents or other intellectual property rights to protect or establish our market position.
We obtained trademarks in the United States, South Korea, United Kingdom and Saudi Arabia for “FOIDS®” (Fiber Optic Intelligent Detection System); “IPID®” (Infrared Perimeter Intrusion Detection); “RDIDS®” (Rapid Deployment Intrusion Detection System); “IDMS®” (Intrusion Detection & Monitoring System); “LanDataSecure®” (LAN and WAN Security Monitoring); “WISE®” (Water Infrastructure Sensing Equipment), “Vacusonic®” (a water purification process), and “Gamma Shark®” (a water radiation detection system). We have also filed for trademarks in other countries.
We require all employees, consultants and contractors to execute non-disclosure agreements as a condition of employment with or engagement by our company. We cannot be certain, however, that we can limit unauthorized or wrongful disclosures of unpatented trade secret information.
Although we continue to implement protective measures and intend to defend our proprietary rights, policing unauthorized use of our technology or products is difficult and we cannot be certain that these measures will be effective or successful.
Research and Development
The forces that drive the design and development of new products include the need to meet new security threats, incorporate newly developed technologies and satisfy a client's unique security requirements. We research and assess threat and vulnerability issues at selected facilities within our target markets and design and engineer products in-house with outside consultants as necessary and in conjunction with joint venture partners to meet the needs of clients based upon the results of such research. We investigate new and emerging technologies in the security industry and seek to license certain technologies which we then incorporate into our products.
During the years ended June 30, 2012 and 2011, we expended $139,322 and $129,722, respectively, on research and development activities.
Product Warranty
IPID® sensors are warranted for ten years, under normal use, against defects in workmanship and material from date of installation of the system on the customer's premises. All other components are warranted to the extent of the warranty given by the actual manufacturer. FOIDS® processors are warranted for a ten year period. For the years ended June 30, 2012 and 2011, net expenses attributable to warranties were well below the amounts accrued.
Technology Licensing Arrangements
As we endeavor to design and manufacture the most effective and efficient technology based security solutions, we review and investigate new and emerging technologies that have application in the security industry. Frequently, we seek to incorporate these technologies into our systems. We are party to agreements to use certain proprietary IT and security systems including Meridian Technologies Inc. (for fiber optic networking affording video voice and data over single fiber), You Tech (for day/night pan/tilt/zoom long range infrared/laser illumination with video motion detection capability from two to 20 kilometers), a magnetic fence and/or in-ground sensor system, and Vindicator/Honeywell for data acquisition.
Employees
As of June 30, 2012, we had 19 employees, of whom 18 were full-time employees.
We have relationships with 13 independent sales representative and/or dealer-installer organizations covering specific regions in the U.S.A., Central America, South America, United Kingdom, Africa, the Middle East, and Southeast Asia.
Based on our teaming agreements with large system integrators, we are able to address large projects by utilizing the technical expertise of these teaming partners in support our factory engineering and/or in-field personnel requirements on any given project.
None of our employees are covered by a collective bargaining agreement or represented by a labor union. We consider our relationship with our employees to be satisfactory.
Item 1A.
Item 1A. RISK FACTORS
Our business, financial condition and results of operations could be materially adversely affected by various risks, including, but not limited to the principal risks noted below.
Risks Relating to Our Business
We derive a substantial amount of our revenues from the sale of our solutions either directly or indirectly to U.S. government entities pursuant to government contracts, which differ materially from standard commercial contracts and may be subject to cancellation or delay without penalty, any of which may produce volatility in our revenues and earnings.
We derived approximately 70% and 65% of our revenues for each of the years ended June 30, 2012 and 2011, respectively, from government related contracts on which we serve as a subcontractor.
Government contracts frequently include provisions that are not standard in private commercial transactions, and are subject to laws and regulations that give the federal government rights and remedies not typically found in commercial contracts, including provisions permitting the federal government to:
terminate our existing contracts;
reduce potential future income from our existing contracts;
modify some of the terms and conditions in our existing contracts;
suspend or permanently prohibit us from doing business with the federal government or with any specific government agency;
impose fines and penalties;
subject us to criminal prosecution;
suspend work under existing multiple year contracts and related task orders if the necessary funds are not appropriated by Congress;
decline to exercise an option to extend an existing multiple year contract; and
claim rights in technologies and systems invented, developed or produced by us.
In addition, government contracts are frequently awarded only after formal competitive bidding processes, which have been and may continue to be protracted and typically impose provisions that permit cancellation in the event that necessary funds are unavailable to the public agency. Competitive procurements impose substantial costs and managerial time and effort in order to prepare bids and proposals for contracts that may not be awarded to us. In many cases, unsuccessful bidders for government agency contracts are provided the opportunity to formally protest certain contract awards through various agencies, administrative and judicial channels. The protest process may substantially delay a successful bidder's contract performance, result in cancellation of the contract award entirely and distract management. We may not be awarded contracts for which we bid, and substantial delays or cancellation of purchases may follow our successful bids as a result of such protests.
Because our sales tend to be concentrated among a small number of customers during any period, our operating results may be subject to substantial fluctuations. Accordingly, our revenues and operating results for any particular quarter may not be indicative of our performance in future quarters, making it difficult for investors to evaluate our future prospects based solely on the results of any one quarter.
Given the nature of our customers and products, we receive relatively large orders for products from a relatively small number of customers. Consequently, a single order from one customer may represent a substantial portion of our sales in any one period and significant orders by any customer during one period may not be followed by further orders from the same customer in subsequent periods. Our sales and operating results are subject to very substantial periodic variations. Since quarterly performance is likely to vary significantly, our results of operations for any quarter are not necessarily indicative of the results that we might achieve for any subsequent period. Accordingly, quarter-to-quarter comparisons of our operating results may not be meaningful.
We rely on rolling forecasts when ordering components and materials for the manufacture of our products which could cause us to overestimate or underestimate our actual requirements. This may result in an increase in our costs or prevent us from meeting customer demand.
We use rolling forecasts based on anticipated orders to determine component requirements. Lead times for materials and components vary significantly and depend on factors such as specific supplier requirements, contract terms and current market demand for such components. As a result, our component requirement forecasts may not be accurate. If management overestimates our component requirements, we may have excess inventory, which would increase our costs. If management underestimates component requirements, we may have inadequate inventory, which could interrupt manufacturing and delay delivery of product to customers. Any of these occurrences would negatively impact our business and results of operations.
Our product offerings involve a lengthy sales cycle, and management may not anticipate sales levels appropriately, which could impair profitability.
Our products and services are designed for medium to large commercial, industrial and government facilities, such as military installations, office buildings, nuclear power stations and other energy facilities, airports, correctional institutions and high technology companies desiring to protect valuable assets and/or prevent intrusion into high security facilities. Given the nature of our products and customers, sales cycles can be lengthy as customers conduct intensive investigations of specific competing technologies and providers. Moreover, orders received from governments may be subject to funding appropriations, which may not be approved. For these and other reasons, the sales cycle associated with our products is typically lengthy and subject to a number of significant risks over which we have little or no control.
During fiscal 2012, the Company submitted proposals on projects for Department of Defense and Department of Energy facilities and certain nuclear power stations in the United States and southeast Asia valued at approximately $146,550,000. We anticipate decisions relating to these proposals during fiscal 2013.
We anticipate that business from projects outside the United States will comprise an increasing part of our business and, accordingly, we are subject to risks associated with doing business outside the United States.
During the fiscal years ended June 30, 2012 and 2011, we generated approximately 7% and 0%, respectively, of our business from projects outside the United States. We anticipate that the revenue portion from overseas operations will increase significantly during Fiscal 2013 as a percentage of sales. Our international business operations are subject, generally, to the financial and operating risks of conducting business internationally, including, but not limited to:
·unexpected changes in or impositions of legislative or regulatory requirements;
·potential hostilities and changes in diplomatic and trade relationships; and
·political instability.
One or more of these or other factors not referenced herein or now known to us could materially impact our business and results of operations could suffer.
We depend on our relationships with strategic partners as a source of business and our business and results of operations could suffer if these relationships are terminated.
We have entered into strategic partnerships or teaming arrangements with several large multinational corporations that promote our products and services and incorporate our products into their projects. In the event that we are unable to maintain these strategic relationships for any reason, our business, operating results and financial condition could be adversely affected.
We compete against entities that have significantly greater name recognition and resources than we do, enabling them to respond more quickly to changes in customer requirements and allocate these resources to marketing efforts.
The security industry is highly competitive and continues to become increasingly so as security issues and concerns have become a primary consideration at both government and private facilities worldwide. Competition is intense among a wide ranging and fragmented group of product and service providers, including security equipment manufacturers, providers of integrated security systems, systems integrators, consulting firms, engineering and design firms and others that provide individual elements of a system, some of which are larger than we are and possess significantly greater name recognition, assets, personnel, sales and financial resources. These entities may be able to respond more quickly to changing market conditions by developing new products that meet customer requirements or are otherwise superior to our products and may be able to more effectively market their products than we can because of the financial and personnel resources. We cannot assure investors that we will be able to distinguish ourselves in a competitive market. To the extent that we are unable to successfully compete against existing and future competitors, our business, operating results and financial condition would be materially and adversely affected.
We rely on third parties for key components used in our products.
We rely on suppliers for several key components utilized in the manufacture of our products. Our reliance on suppliers involves certain risks, including a potential inability to obtain an adequate supply of required components, price increases, timely delivery and component quality. We cannot assure you that there will not be additional disruptions of our supplies in the future. Disruption or termination of the supply of components could delay shipments of products and could have a material adverse affect on our business, operating results and financial condition.
If our subcontractors fail to perform their contractual obligations, our prime contract performance and our ability to obtain future business could be materially and adversely impacted.
Some of our contracts involve subcontracts with other companies upon which we rely to perform a portion of the services that we must provide to our customers. There is a risk that we may have disputes with our subcontractors, including disputes regarding the quality and timeliness of work performed by the subcontractor. A failure by one or more of our subcontractors to satisfactorily perform the agreed-upon services may materially and adversely impact our ability to perform our obligations as the prime contractor. Subcontractor performance deficiencies could result in a customer terminating our contract for default. A default termination could expose us to liability and have a material adverse effect on our ability to compete for future contracts and orders.
Our services and reputation may be adversely affected by product defects or inadequate performance.
In the event our products do not perform to specifications or are defective in any way, our reputation may be adversely affected and we may suffer a loss of business and a corresponding loss in revenues.
If we are unable to retain key executives or hire new qualified personnel, our business will be adversely affected.
Our success greatly depends on our ability to retain existing management and attract key technical, sales, marketing, information systems, and financial and executive personnel. We are especially dependent on the continued services of our senior management team and our key marketing personnel. The loss of any of these people could have a materially detrimental effect on our business. We have not entered into employment agreements with any of these people. We do not maintain key person life insurance on any of our personnel. In addition, we are seeking to engage senior sales staff and if we fail to attract, hire or retain the necessary personnel, or if we lose the services of any member of our senior management team, our business could be adversely affected.
If we are unable to obtain additional funds when needed, we may not be able to fulfill large orders or take advantage of any unforeseen opportunities that may arise.
Management believes that our currently available cash resources, as well as anticipated revenue from firm purchase orders will allow us to meet our operating requirements through fiscal 2013. However, it is conceivable that we may raise additional funds to support strategic acquisitions and/or joint venture opportunities, and/or to satisfy any additional significant purchase orders that it may receive. If and or when additional capital is required there are no assurances that we will be successful in obtaining additional required capital on reasonable terms and conditions.
Risks Relating to Our Common Stock
We have outstanding two classes of preferred stock which have preference over the common stock as to dividends and liquidation distributions, among other preferential rights.
As of the date hereof, we have issued and outstanding 300,000 shares of Series A Convertible Preferred Stock (“Series A Preferred Stock”) and 645 shares of Series B Preferred Stock (which together with the Series A Preferred Stock is referred to as the “Preferred Stock”). The Preferred Stock affords holders a preference to assets upon liquidation, a cumulative annual dividend and is convertible into shares of common stock, all of which rights impact the outstanding shares of common stock. The Preferred Stock's right to annual dividends makes less likely the possibility that we will declare dividends on the common stock. In the event of a liquidation of the Company's assets, holders of Preferred Stock will have a right to receive as a liquidation payment any remaining assets of the Company prior to any distributions to holders of the common stock and the holders of the Preferred Stock may be able to block actions otherwise approved by the holders of the common stock if such action is adverse to their rights. In addition, holders of common stock will suffer dilution upon any conversion of the Preferred Stock which could reduce the market value of the common stock.
Our common stock price has fluctuated considerably and may not appreciate in value.
Prices for our common stock have in the past, and could continue to, fluctuate significantly and will be influenced by many factors, including the liquidity of the market for the common stock, investor perception of the industry in which we operate and our products, and general economic and market conditions. Factors which could cause fluctuation in the price of our common stock include:
·conditions or trends in the industry,
·failure to keep pace with changing technology,
·costs associated with developing new products and services,
·costs associated with marketing products and services may increase significantly,
·the timing of sales and the recognition of revenues from them,
·government regulations may be enacted which affect how we do business and the products which may be used at government facilities,
·downward pressure on prices due to increased competition,
·changes in our operating expenses,
·sales of common stock,
·actual or anticipated variations in quarterly results, and
·changes in financial estimates by securities analysts.
The stock market in general has experienced extreme price and volume fluctuations. The market prices of shares of security-related companies experienced fluctuations that often have been unrelated or disproportionate to the operating results of these companies. Continued market fluctuations could result in extreme volatility in the price of our common stock, which could cause a decline in the value of our common stock. Price volatility might be worse if the trading volume of our common stock is low.
Our common stock is considered a “penny stock” and may be difficult to trade.
The SEC has adopted regulations that generally define “penny stock” as an equity security with a market or exercise price of less than $5.00 per share, subject to specific exemptions. The market price of our common stock is less than $5.00 per share, and therefore may be designated as a “penny stock” according to SEC rules. Under these rules, broker-dealers who recommend such securities to persons other than institutional accredited investors must:
·make a special written suitability determination for the purchaser,
·receive the purchaser's written agreement to a transaction prior to sale,
·provide the purchaser with risk disclosure documents which identify certain risks associated with investing in “penny stocks” and which describe the market for these “penny stocks” as well as a purchaser's legal remedies, and
·obtain a signed and dated acknowledgment from the purchaser demonstrating that the purchaser has actually received the required risk disclosure document before a transaction in a “penny stock” can be completed.
Under these rules, broker-dealers may find it difficult to effectuate customer transactions and trading activity in our securities may be adversely affected. As a result, the market price of our securities may be depressed, and it may be more difficult to sell our securities. In addition, you may find it difficult to obtain accurate quotations of our common stock and may experience a lack of buyers to purchase such stock or a lack of market makers to support the stock price.
Our common stock is traded over the counter, which may result in higher price volatility and less market liquidity for our common stock.
Our common stock is quoted on the OTC Bulletin Board. As such, our common stock may have fewer market makers, lower trading volume and a larger spread between bid and asked prices than securities listed on an exchange such as the New York Stock Exchange, the American Stock Exchange or the Nasdaq Stock Market. These factors may result in higher price volatility and less market liquidity for our common stock.
Our principal stockholders have significant voting power and may take actions that may not be in the best interest of other stockholders.
Our executive officers, directors and principal stockholders control approximately 29% of our currently outstanding shares of common stock. If these stockholders act together, they may be able to exert significant control over our management and affairs requiring stockholder approval, including approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control and might adversely affect the market price of our common stock. This concentration of ownership may not be in the best interests of all our stockholders.
We do not anticipate paying cash dividends on our common stock in the near future, and the lack of dividends may have a negative effect on our stock price.
We have never declared or paid any cash dividends or distributions on our capital stock. We currently intend to retain our future earnings to support operations and to finance expansion and therefore we do not anticipate paying any cash dividends on our common stock in the near future.
A significant number of our shares will be eligible for sale, and their sale could depress the market price of our common stock.
Sales of a significant number of shares of our common stock in the public market could harm the market price of our common stock.
There is an approximate aggregate of 11.8 million shares of our common stock outstanding, some or all of which may also be offered from time to time in the open market pursuant to Rule 144, and these sales may have a depressive effect on the market for our shares of common stock. In general, a non-affiliated person who has held restricted shares for a period of six months may, under Rule144, sell into the market shares of our common stock. Such sales may be repeated once every three months, and any of the restricted shares may be sold by a non-affiliate after they have been held for two years.
We could issue “blank check” preferred stock without stockholder approval with the effect of diluting then current stockholder interests and impairing their voting rights.
Our Certificate of Incorporation authorizes the issuance of up to approximately an additional 3,898,000 shares of “blank check” preferred stock with designations, rights and preferences as may be determined from time to time by our Board of Directors. Accordingly, our Board of Directors is empowered, without stockholder approval, to issue a series of preferred stock with dividends, liquidation, conversion, voting or other rights which could dilute the interest of, or impair the voting power of, our common stockholders. The issuance of a series of preferred stock could be used as a method of discouraging, delaying or preventing a change in control. For example, it would be possible for our Board of Directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to change control of our Company.
The liability of our directors is limited under State of New Jersey corporate law.
As permitted by the corporate laws of the State of New Jersey, our Certificate of Incorporation includes a provision that eliminates the personal liability of our directors for monetary damages for breach or alleged breach of their fiduciary duties as directors, subject to certain exceptions. In addition, our by-laws provide that we are required to indemnify our officers and directors under certain circumstances, including those circumstances in which indemnification would otherwise be discretionary, and we are required to advance expenses to our officers and directors as incurred in connection with proceedings against them for which they may be indemnified.
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2.
Item 2. Properties
Our corporate headquarters are located at 790 Bloomfield Avenue, Clifton, New Jersey where we lease approximately 12,200 square feet of space divided among administrative (2,600 square feet) and manufacturing (9,600 square feet) space. We have renewed our lease for this space through April 30, 2018 at a rent of $7,098 per month with an option to renew through April 30, 2028.
Item 3.
Item 3. Legal Proceedings
ECSI International, Inc. v. Lockheed Martin Global Training and Logistics. On March 7, 2012, we, through our wholly-owned subsidiary, ECSI International, Inc. filed a lawsuit in the United States District Court for the District of New Jersey against Lockheed Martin Global Training and Logistics (“Lockheed Martin”). The lawsuit, as detailed in the First Amended Complaint and Demand for Trial by Jury (the “Amended Complaint”) dated March 29, 2012, alleges breach of contract and tortious interference by Lockheed Martin and seeks actual damages of approximately $978,000, as well as punitive damages, costs and such further relief as the Court deems equitable and proper. In addition, the Amended Complaint seeks payment under Lockheed Martin’s payment bonds required by the United States Navy Facilities Engineering Command. Lockheed Martin has indicated that it may file counterclaim against ECSI International, Inc. seeking reimbursement of approximately $200,000 in costs alleged to have been incurred by Lockheed Martin on the project related to the above amount due to us. We are aggressively pursuing our claim against Lockheed Martin and defending against a counterclaim if one is asserted. Discovery has been proceeding.
We are not involved in any other legal proceedings that we anticipate would result in a material adverse effect on our business or operations.
Item 4.
Item 4. Mine Safety Disclosures
Not Applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Common Stock of the Company trades on the OTC Bulletin Board under the trading symbol EKCS. Although trading in our Common Stock has occurred on a relatively consistent basis, the volume of shares traded has been sporadic. There can be no assurance that an established trading market will develop, that the current market will be maintained or that a liquid market for our Common Stock will be available in the future. Investors should not rely on historical stock price performance as an indication of future price performance.
The following table shows the quarterly high and low bid prices for our Common Stock over the last two completed fiscal years as quoted on the OTC Bulletin Board. The prices represent quotations by dealers without adjustments for retail mark-ups, mark-downs or commission and may not represent actual transactions. The closing price of our Common Stock on October 3, 2012, was $.05 per share.
As of October 3, 2012, ECSI had 196 holders of record of common stock. This number of holders of record does not include beneficial owners of the Company's common stock whose shares are held in the names of various security holders, dealers, and clearing agencies.
Dividend Policy
The Company has not paid any cash dividends on its common stock and does not anticipate paying cash dividends in the foreseeable future. The Company intends to retain any earnings to finance the growth of its business. There can be no assurance that the Company will ever pay cash dividends.
Issuer Purchases of Equity Securities
We do not have a stock repurchase program for our common stock.
Item 6.
Item 6. Selected Financial Data
Not applicable.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
We design, develop, manufacture and market stand-alone and fully integrated state-of-the-art entry control and perimeter intrusion detection systems for Department of Defense, Department of Energy, nuclear power stations, and various international customers. We offer U.S. Air Force certified technology and a comprehensive services portfolio that includes: site survey/risk assessment, design & engineering, systems manufacturing and integration, factory acceptance testing, installation supervision, commissioning, operations and maintenance training.
We work closely with architects, engineers, systems integrators, construction managers and owners in the development and design of security monitoring and control systems that will afford a normative but secure environment for management, staff and visitors. To support such efforts, ECSI’s team of key personnel are technically accomplished and fully familiar with advances in planning, programming and designing systems utilizing standard peripheral components, mini/micro architecture, user friendly software/firmware selection and application.
Our mission is to establish ourselves as a Small Business (SB) prime contractor to take advantage of the small business opportunities that exist today and in the forseeable future. To achieve that end we have formed a team of both small and large corporation agreements to support our company in the pursuit of this market. We believe that our past performance and in depth experience as well as that of our teaming partners will place us in a lead position to capture a good share of this market.
We entered into strategic partnerships, teaming, and representative relationships with major multi-national corporations in each of the industries that comprise our target markets. These companies generally enjoy a strong market presence in their respective industries and we believe that our teaming agreements with these entities afford us added credibility. These entities frequently subcontract our services and purchase our products in connection with larger projects and, in turn, support the company on projects we are pursuing as the prime contractor. During fiscal 2011, we entered into teaming and marketing agreements with ITSI, SAIC, Fortis, Calnet, Honeywell, Culmen, ERIS, and Boeing.
During fiscal 2012, we submitted proposals on projects for Department of Defense facilities and certain nuclear power stations in the United States and Southeast Asia valued at approximately $146,550,000. We anticipate decisions relating to these proposals during fiscal 2013.
Recent Developments
Our revenues and results from operations for the year ended June 30, 2012 were negatively impacted by the ongoing delays by agencies of the U.S. Government in proceeding with approved projects, funding projects already awarded, and in awarding new contracts. We have invested significant time and personnel resources in fiscal 2012 in providing proposals on future projects, both as a prime contractor (Small Business) and as a subcontractor. We are awaiting the results of the bidding process. Our cash flow and liquidity was also severely impacted with the refusal by Lockheed Martin to pay us for the accounts receivable due from them totaling almost $1 million. These amounts are the subject of litigation, as described in Item 3 of this Annual Report on Form 10-K.
Critical Accounting Policies
We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, management evaluates its estimates, including those related to inventory reserves, allowance for doubtful accounts and deferred taxes. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies and the related judgments and estimates affect the preparation of our financial statements.
Inventory Valuation - Inventories are valued at lower of cost or market. We routinely evaluate the composition of our inventory to identify obsolete or otherwise impaired inventories. Inventories identified as impaired are evaluated to determine if reserves are required.
Allowance for Doubtful Accounts - The allowance for doubtful accounts is comprised of two parts, a specific account analysis and a general reserve. Accounts where specific information indicates a potential loss may exist are reviewed and a specific reserve against amounts due is recorded. As additional information becomes available such specific account reserves are updated. Additionally, a general reserve is applied to the aging categories based on historical collection and write-off experience.
Accounting for Income Taxes - We record a valuation allowance to our deferred tax assets to the amount that is more likely than not to be realized. While we consider historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event that we determine that we would be able to realize deferred tax assets in the future in excess of the net amount recorded, an adjustment to the deferred tax asset would increase income in the period such determination has been made. Likewise, should we determine that we would not be able to realize all or part of the net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged against income in the period such determination was made. A valuation allowance in the amount of $2,055,821 has been recorded against our deferred tax assets at June 30, 2012.
We account for stock-based compensation in accordance accounting guidance now codified as Financial Accounting Standards Board (FAS) Accounting Standards Codification (ASC) Topic 718, “Compensation - Stock Compensation.” Under the fair value recognition provision of FAS ASC Topic 718, stock-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period of the individual equity. We use the Black-Scholes option-pricing model to estimate the fair value of options. In order to calculate the fair value of the options, assumptions are made for certain components of the model, including risk-free interest rate, volatility, expected dividend yield rate and expected option life. Although we use available resources and information when setting these assumptions, changes to the assumptions could cause significant adjustments to the valuation.
Results of Operations
Year Ended June 30, 2012 (“Fiscal 2012 Period”) Compared to Year Ended June 30, 2011 (“Fiscal 2011 Period”)
Revenues. We had net revenues of $2,216,082 for the Fiscal 2012 Period, as compared to revenues of $3,958,941 for the Fiscal 2011 Period, representing a decrease of approximately 44%. Of the revenues reported in the Fiscal 2012 period, approximately 93% are attributable to domestic projects and 7% are attributable to international projects. The decrease in revenues in the Fiscal 2012 Period is attributable to the delays encountered by the Government related contract awards, Requests for Proposals (“RFP’s”) and task order awards. The Government has delayed the review and approval process which has had a further negative impact on sales for Fiscal 2012.
Gross Margins. Gross margins for the Fiscal 2012 Period were 9% of revenue as compared to 50% of revenue for the Fiscal 2011 Period. The decrease in gross margins is primarily attributable to the reduction in the revenues in the Fiscal 2012 Period and to a change in the order mix of equipment sales and support services. We incurred an increase in material cost as a percentage of revenues due to the change in the mix of sales and support services. We experienced an increase in proposal, design and engineering support service costs as a percentage of revenues due primarily to the lower revenues in the Fiscal 2012 Period.
Research and Development. Research and development expenses were $139,322 in the Fiscal 2012 Period as compared to $129,722 in the Fiscal 2011 Period. Research and development expenses were maintained at previous levels for continued new product development during this period.
Selling, General and Administrative (SG&A). Selling, general and administrative expenses increased in the Fiscal 2012 Period to $1,525,988 from $1,413,240 in the Fiscal 2011 Period primarily because the Fiscal 2012 Period included an allowance for doubtful accounts in the amount of $200,000, partially offset by a decrease in other selling, general and administrative expenses of 6%.
Stock Based Compensation. In the Fiscal 2012 Period, we granted stock options to directors and employees that were valued at $96,815 and granted restricted stock to employees valued at $24,850. In the 2011 Period, we did not issue stock options to our directors or employees. The value of options is amortized over the vesting period of the underlying award. Stock-based compensation is non-cash and, therefore, has no impact on cash flow or liquidity.
Interest Expense. Interest expense in the Fiscal 2012 Period was $72,998 as compared to $1,078 for the Fiscal 2011 Period. Included in interest expense for fiscal 2012 is the interest on the line of credit.
Income Tax Benefit. We recognized a net $130,000 deferred income tax benefit in fiscal 2012 and a $128,000 deferred tax benefit Fiscal 2011. The deferred income tax benefits were recorded based on expectations of that we will utilize a portion of our existing net operating loss carryforwards with future operating earnings. The company and its subsidiaries have net operating loss carryforwards for federal income tax purposes of about $5.7 million expiring in 2023 - 2032 and about $4.3 million for state income tax purposes expiring in 2013 - 2032.
Net Profit/Loss. Net loss before dividends for the Fiscal 2012 period was $(1,531,773) as compared to a net profit of $530,130 in Fiscal 2011.
Dividends Related to 10% Series B Convertible Preferred Stock.
We recorded dividends totaling $149,506 on our Series B Convertible Preferred Stock in Fiscal 2012 and $148,564 in Fiscal 2011. In lieu of a cash payment, we have elected, under the terms of the agreement whereby these securities were sold, to add this amount to the stated value of the Series B Convertible Preferred Stock. In the second half of Fiscal 2012, holders of 146 shares, 18% of the number outstanding, converted their preferred shares into common shares.
These dividends are non-cash and, therefore, have no impact on our net worth or cash flow.
Liquidity and Capital Resources
Our cash flow has been adversely impacted by the refusal of Lockheed Martin to forward to us proceeds ot accounts receivables payable to us. This matter is currently the subject matter of litigation initiated by us and discussed further above in Item 3 of this Annual Report in From 10-K. Nonetheless, we believe that cash on hand, together with anticipated collection of accounts receivable during the short term, will be sufficient to provide for our working capital needs for the next twelve months. However, we may need to raise funds in order to allow for shortfalls in anticipated revenue or to expand existing capacities and/or to satisfy any additional significant purchase order that we may receive. At the present time, we have no commitments or assurances of additional revenue beyond the firm purchase orders we have received. We have held discussions with various parties in order to raise additional funds through debt or equity issuance; to date we have not entered into any agreements.
At June 30, 2012, we had working capital of about $501,000 compared to $1.8 million at June 30, 2011. Net cash used by operating activities for Fiscal 2012 was $520,125 as compared to net cash provided by operating activities of $33,480 for Fiscal 2011.
Inventory increased by $16,991 in Fiscal 2012. However, we anticipate a decrease during the first half of Fiscal 2013 for shipments on committed projects that have been or are being released.
Day's sales outstanding (DSO) were approximately 144 days at June 30, 2012 as compared with 97 DSO at June 30, 2011. This increase is due to amounts not yet collected on the receivable from Lockheed Martin, which is subject to legal proceedings described further below.
At June 30, 2012, we had a line of credit with a bank in the amount of $475,000 which we had fully utilized. Due to the net loss in fiscal 2012, we did not meet a covenant of the loan agreement which requires that we have a Minimum Debt Service Coverage Ratio, as defined in the agreement, of 1.1. The bank has provided a waiver of an event of default related to this loan covenant.
Accounts payable and accrued expenses have increased by $647,272 in the Fiscal 2012 Period. This increase is accounts payable and accrued expenses is directly related to the timing of payments due to the delays in collecting the receivable from Lockheed Martin.
Investing activities for Fiscal 2012 were reduced to $24,800 from $357,515 in Fiscal 2011 in order to conserve cash. We do not have any material commitments for capital expenditures going forward.
In Fiscal 2008, the Company financed the purchase of equipment from a vendor in the amount of $101,762, evidenced by a bearing interest at the rate of 8% per annum. As the Company purchases product from the vendor a portion of each invoice will be charged to reduce the note balance. Management expects that the note will be repaid within the next 12 months. The balances at June 30, 2012 and 2011 were $2,639 and $14,237, respectively.
In September 2011, $94,000 of loans due to officers was converted into common stock. In February 2012, $15,000 of accrued compensation due to an officer was converted into common stock. The amounts due to officers and directors from interest-bearing advances increased in the Fiscal 2012 Period by $104,351 and the accrued compensation and other costs due to officers increased by $225,034. The increases in the amounts due to officers and the conversion of a portion into common stock resulted in additional funds provided to the Company totaling about $438,385.
Discussion of Results, Business Outlook and Identifiable Industry Trends
Spending in the security industry has decreased over the last year as the U.S. Congress has continued to reduce funding homeland security initiatives, including Department of Energy and Department of Defense programs. We expect this trend will continue for the foreseeable future. The Company has pursued more Small Business and international opportunities to offset this reduction. As a result, the level of new proposals continues and our committed backlog, including awards for the U.S. Navy, U.S. Air Force, nuclear power stations, and international projects is one of the largest in our history. We cannot, however, assure you that we will complete any or all of the orders comprising our backlog within the anticipated time frame. Our experience has taught us that all of these anticipated releases and new contracts are subject to cancellation or delay, thus we cannot be certain of the total realized revenue amount of our backlog and do not reference the total dollar amount of our present backlog or submitted proposals.
Our sales dependency has continued to shift from our President and Chief Executive Officer, Arthur Barchenko, to marketing and sales representatives, program and project managers to meet our revenue objectives. During the last year, we continued to mitigate the concentration of sales efforts by (i) engaging independent sales representatives to market our products and generate sales opportunities and (ii) expanding sales efforts through dealer-installers and system integrators in geographic regions on which we have not focused our resources in years past such as Latin America, Egypt and the Middle East, China and Africa, where we are developing projects that management believes will result in ongoing revenue.
During the Fiscal 2012 period, we submitted bids on 38 new projects for work to be performed at our Clifton, New Jersey facilities. We cannot be certain that we will be successful in winning any of the bids tendered. Even if we do receive orders, contracts are subject to cancellation by customers upon short notice with little or no penalty, as is typical in our industry.
We are committed to offering our customers comprehensive, integrated security system solutions that employ the latest technologies and address the most critical security requirements. The security industry continues to evolve rapidly as new technologies are developed specifically to meet security challenges and existing technologies are being adapted for new uses. In addition, the public and private sectors continue to analyze and distinguish new security risks and industry participants seek to develop technologies and products to fill these newly discerned requirements. We remain committed to pursuing teaming and OEM agreements that may add to our revenues and enhance both our product line and, ultimately, our ability to compete in our industry.
Business Outlook
As global economic prospects changed during 2012, proposals and commitments increased due to the need for improved security levels while reducing manpower and maintenance costs. Currently, proposals for new orders continue to grow. However, our historical results have taught us that the release of funds that support proposals may never be forthcoming. Furthermore, as is customary in the security industry, our contracts are subject to cancellation or delay at any time with little notice or penalty. Government based purchase orders which are subject to legislative appropriations are particularly sensitive to economic and political conditions. Thus, we cannot be certain of the total realized value and revenue which we will generate from proposals and committed orders. We expect to receive releases and task orders for a significant portion of our contract commitments within the next twelve months, although we cannot be certain that we will complete any or all of such orders within the anticipated time frame.
The security industry as a whole has changed. The security market historically has been a product oriented opportunity for manufacturers, both within the United States and internationally. The difficulty the industry traditionally faced has been the ability to develop a standard security platform that would permit systems integrators to design a seamless interface between the multiple products and subsystems required to address threats in high-security environments. The Company has developed a platform that addresses seamless integration of multiple technologies including legacy and government-furnished equipment. We expect this trend to continue for the foreseeable future, since the demand for integrated platforms has become a necessity.
Business Approach
Over the last several years we have tried to develop contacts and relationships through our marketing programs and staff with clearly defined and targeted potential strategic partners. The strategic relationship framework provides a comprehensive and thorough mechanism for developing and implementing corporate strategy. Our advisory board determined early in our existence that, given our size and the criticality of our business situation, the strategic relationship framework would provide us with a non-resource exhaustive and more expedient and efficient means of entering new markets. This approach has met with considerable success and we continue to seek strategic alliances.
Recently Issued Accounting Pronouncements
In December 2010, the FASB amended ASC 350, “Intangibles - Goodwill and Other,” with Accounting Standards Update (“ASU”) 2010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” This update requires that step 2 of the goodwill impairment test (i.e., measurement and recognition of an impairment loss) be performed if a reporting unit has a carrying value equal to or less than zero and qualitative factors indicate that it is more likely than not that a goodwill impairment exists. The provisions of this update are effective for annual reporting periods beginning after December 15, 2010. Management does not expect these new standards to significantly impact its consolidated financial statements.
In May 2011, the FASB issued ASU Topic No. 2011-04, Fair Value Measurement (Topic 820)-Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, which expands the disclosure requirements for fair value measurements. More quantitative and qualitative disclosures will be required for fair value measurements using level 3 inputs. ASU No. 2011-04 is effective for interim and annual periods beginning after December 15, 2011. Management does not expect these new standards to significantly impact its consolidated financial statements.
In June 2011, the FASB issued ASU Topic No. 2011-05, Comprehensive Income (Topic 220)-Presentation of Comprehensive Income, which updates the presentation requirements related to comprehensive income. The total of comprehensive income, the components of net income, and the components of other comprehensive income may be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU No. 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The update is effective for interim and annual periods beginning after December 15, 2011. Management does not expect these new standards to significantly impact its consolidated financial statements.
In September 2011, the FASB amended ASC 350, “Intangibles - Goodwill and Other,” with Accounting Standards Update (“ASU”) 2011-08, “Testing Goodwill for Impairment”. This update simplifies how entities test goodwill for impairment. It permits an entity to first assess qualitative factors to determine whether it is more likely that not that the fair value of a reporting unit is less than its carrying value as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. The provisions of this update are effective for annual impairment tests performed for fiscal years beginning after December 15, 2011. Management does not expect these new standards to significantly impact its consolidated financial statements.
In December 2011, the FASB amended ASC 220, “Comprehensive Income,” with ASU 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05”. This update defers the effective date pertaining to reclassification adjustments out of accumulated other comprehensive income in ASU 2011-05. The provisions of this update are effective for fiscal years beginning after December 15, 2011. Management does not expect these new standards to significantly impact its consolidated financial statements.
In July 2012, the FASB amended ASC 350, “Intangibles - Goodwill and Other,” with ASU 2011-08, “Testing Goodwill for Impairment”. This update reduces the cost and complexity of performing an impairment test for indefinite-lived intangible assets by simplifying how an entity tests those assets for impairment and to improve consistency in impairment testing guidance among long-lived asset categories. The provisions of this update are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Management does not expect these new standards to significantly impact its consolidated financial statements.
Management does not believe that any other recently issued, but not yet effective, accounting standard if currently adopted would have a material effect on the accompanying financial statements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Not applicable.
Item 8.
Item 8. Financial Statements
The information called for by this Item 8 is included following the “Index to Financial Statements” contained in this Annual Report on Form 10-K.
Item 9.
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A
Item 9A Controls and Procedures.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to management, including our President and Chief Executive Officer and our Chief Financial Officer (our principal financial and accounting officer) to allow timely decisions regarding required disclosure based closely on the definition of "disclosure controls and procedures" in Rule 13a-15(e).
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with participation of management, including our President and Chief Executive Officer (who also serves as our principal executive officer) and our Chief Financial Officer (our principal financial and accounting officer), of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our President and Chief Executive Officer and Chief Financial officer have concluded that our disclosure controls and procedures were effective.
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States. Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements.
The Company’s management, including our principal executive officer and our principal financial and accounting officer, does not expect that our disclosure controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Our management, including our principal executive officer and our principal financial and accounting officer, conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the evaluation under the framework in Internal Control - Integrated Framework , our management concluded that our internal control over financial reporting was effective as of June 30, 2012.
This annual report does not include an attestation report of the Company's registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company's registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this Annual Report.
Changes in Internal Control over Financial Reporting
During the fourth quarter ended June 30, 2012, there were no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information.
On July 5, 2012, we appointed Daryl K. Holcomb as our Chief Financial Officer. Prior to his appointment as our Chief Financial Officer, Mr. Holcomb, age 61, was employed by RCLC, Inc. (formerly known as Ronson Corporation) from September 1988 through October 2011. Mr. Holcomb served as Vice President and Chief Financial Officer of Ronson from 1995 through 2011. From 1988 through 1995, Mr. Holcomb was the Corporate Controller of Ronson. Ronson was a publicly-held company that, during Mr. Holcomb’s employment, manufactured and distributed consumer products, provided aircraft services as a fixed-base operator, and manufactured hydraulic and pneumatic components for the aircraft industry. From October 2011 through June 2012, Mr. Holcomb was self-employed, providing accounting services to several organizations, including to us. There are currently no compensation arrangements between the Company and Mr. Holcomb.
PART III
The information called for by Items 10, 11, 12, 13 and 14 will be contained in the Company's definitive proxy statement which the Company intends to file within 120 days after the end of the Company's fiscal year ended June 30, 2012 and such information is incorporated herein by reference.
Item 15.
Item 15. Exhibits
Exhibit No.
Description
Location
Reference
3.1
Certificate of Incorporation of Electronic Control Security Inc.
3.2
Certificate of Amendment to Certificate of Incorporation of Electronic Control Security Inc.
3.3
Certificate of Amendment to Certificate of Incorporation
3.4
By-Laws of Electronic Control Security Inc.
3.5
Certificate of Incorporation of SEM Consultants III, Inc.
3.6
By-Laws of SEM Consultants III, Inc.
3.7
Certificate of Incorporation of ECSI International, Inc.
3.8
By-Laws of ECSI International, Inc.
3.9
Certificate of Incorporation of ECSI FOIDS, Inc.
3.10
By-Laws of ECSI FOIDS, Inc.
3.11
Certificate of Incorporation of ECSI-DSA, Inc.
3.12
By-Laws of ECSI-DSA, Inc.
3.13
Memorandum of Association of ECSI Security Communications, Inc., a Middle East Corporation
3.14
Articles of Association of ECSI Security Communications, Inc., a Middle East Corporation
4.1
Form of Common Stock Purchase Warrant issued June 30, 2004
4.2
Form of Common Stock Purchase Warrant issued January 13, 2006
4.3
Form of Senior Secured Convertible Debenture due January 11, 2009.
4.4
Registration Rights Agreement dated as of January 11, 2006, by and among
Electronic Control Security Inc. and the investors specified therein.
10.1
Lease Agreement with 580 Brighton Road Associates for space in Clifton, New Jersey.
10.2
Securities Purchase Agreement dated June 30, 2004.
10.3
Registration Rights Agreement dated June 30, 2004.
10.4
Securities Purchase Agreement dated as of January 11, 2006, by and among
Electronic Control Security Inc. and the purchasers named therein.
10.5
Security Agreement, dated January 11, 2006, by and among Electronic Control
Security Inc. and the investors specified therein.
10.6
Drawdown Equity Financing Agreement, dated as of February 8, 2011 by and between Electronic Control Security Inc. Inc. and Auctus Private Equity Fund, LLC.
10.7
Registration Rights Agreement, dated as of February 8, 2011 by and between Electronic Control Security Inc. Inc. and Auctus Private Equity Fund, LLC.
10.8
Business Loan Agreement dated as of March 15, 2011 between ECSI International, Inc. and Atlantic Stewardship Bank
10.9
Commercial Security Agreement dated as of March 15, 2011 between ECSI International, Inc. and Atlantic Stewardship Bank
10.10
Letter Agreement dated as of June 30, 2010 between Eigerhawk, Ltd. and Electronic Control Security Inc.
14.1
Code of Ethics and Business Conduct
23.1
Consent of Demetrius & Company, L.L.C.
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
32.1
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* * * *
1. Incorporated by reference to such exhibit filed with Electronic Control Security Inc.'s Registration Statement on Form 10-SB filed with the Commission on February 16, 2001.
2. Incorporated by reference to such exhibit filed with Electronic Control Security Inc.'s Registration Statement on Form SB-2 filed with the Commission on June 6, 2002.
3. Incorporated by reference to such exhibit filed with Electronic Control Security Inc.'s Current Report on Form 8-K filed with the Commission on July 1, 2004.
4. Incorporated by reference to such exhibit filed with Electronic Control Security Inc.'s Current Report on Form 8-K filed with the Commission on January 18, 2006
5. Incorporated by reference to such exhibit filed with Electronic Control Security Inc.'s Quarterly Report on Form 10-Q filed with the Commission on February 10, 2011.
Incorporated by reference to such exhibit filed with Electronic Control Security Inc.'s Quarterly Report on Form 10-Q filed with the Commission on May 3, 2011.
7. Incorporated by reference to such exhibit filed with Electronic Control Security Inc.'s Annual Report on Form 10-K filed with the Commission on September 27, 2011.
8. Filed as an Exhibit hereto.
SIGNATURES
Pursuant to the requirements of The Exchange Act of 1934 as amended, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ELECTRONIC CONTROL SECURITY INC.
(Registrant)
By: /s/ Arthur Barchenko
By: /s/ Daryl K. Holcomb
Arthur Barchenko
Daryl K. Holcomb
Chief Executive Officer
(Principal Executive Officer)
Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: October 15, 2012
Date: October 15, 2012
Person
Capacity
Date
/s/ Arthur Barchenko
Arthur Barchenko
President, Chief Executive Officer
and Director
October 15, 2012
/s/ Natalie Barchenko
Natalie Barchenko
Treasurer and Director
October 15, 2012
/s/ Daryl K. Holcomb
Chief Financial Officer
October 15, 2012
/s/ Edward Snow
Edward Snow
Director
October 15,
/s/ Stephen Rossetti
Stephen Rossetti
Director
October 15, 2012
/s/ Gordon E. Fornell
Gordon E. Fornell
Director
October 15, 2012
/s/ Ronald Thomas
Ronald Thomas
Director
October 15, 2012
/s/ Norman Barta
Norman Barta
Director
October 15, 2012
ELECTRONIC CONTROL SECURITY INC.
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
With Report of Independent Registered Public Accounting Firm
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Electronic Control Security Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Electronic Control Security, Inc. and Subsidiaries as of June 30, 2012 and 2011, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the two years in the period ended June 30, 2012. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Electronic Control Security, Inc. and Subsidiaries as of June 30, 2012 and 2011, and the consolidated results of their operations and cash flows for each of the two years in the period ended June 30, 2012, in conformity with accounting principles generally accepted in the United States of America.
DEMETRIUS & COMPANY, L.L.C.
Wayne, New Jersey
October 12, 2012
Electronic Control Security Inc.
Consolidated Balance Sheets
See Notes to Consolidated Financial Statements.
Electronic Control Security Inc.
Consolidated Statements of Operations
See Notes to Consolidated Financial Statements.
Electronic Control Security Inc.
Consolidated Statements of Cash Flows
See Notes to Consolidated Financial Statements.
Electronic Control Security Inc.
Consolidated Statements of Changes in Shareholders Equity
See Notes to Consolidated Financial Statements.
Note 1 - Nature of Operations
Electronic Control Security, Inc. (the “Company”) is engaged in the design, development, manufacture and marketing of technology-based integrated security solutions. The Company also performs support services consisting of risk assessment and vulnerability studies to ascertain a customer's security requirements in developing a comprehensive risk management and mitigation program as well as product design and engineering services in support of the systems integrators and dealers/installers providing these services to a client.
The Company’s office and manufacturing facilities are located in Clifton, New Jersey. Products and services are marketed domestically and internationally to national and local government entities, chemical and petrochemical facilities, energy facilities, commercial transportation centers, border security, and water and agricultural resources.
Note 2 - Summary of Significant Accounting Policies
Principles of Consolidation
The financial statements include the accounts of the Company, its wholly owned subsidiaries, and its majority owned subsidiary. All significant inter-company accounts and transactions have been eliminated.
Accounts Receivable
Trade accounts receivable are recorded net of an allowance for expected losses. The allowance is estimated from historical performance and projections of trends.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market. A reserve for potentially obsolete or slow-moving inventory is provided based on management’s analysis of inventory aging, inventory levels and future sales forecasts. The Company reserved for $80,000 of finished goods inventory at June 30, 2012 and 2011.
Property and Equipment and Depreciation
Depreciation is provided for by straight-line and accelerated methods over the estimated useful lives of the assets, which vary from three to ten years. Cost of repairs and maintenance are charged to operations in the period incurred.
Software Development Costs
Software development costs are expensed as incurred until technological feasibility is established. Software development costs incurred subsequent to establishing technological feasibility are capitalized and amortized. Amortization is provided based on the greater of the ratios that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product, or the straight-line method over the estimated useful life of the product. The estimated useful life for the straight-line method is determined to be five years. There were no software development costs capitalized in the year ended June 30, 2012.
Earnings per Share
Basic earnings per share is computed based on the weighted-average number of shares of the Company's common stock outstanding. Diluted earnings per share are computed based on the weighted-average number of shares of the Company's common stock, including common stock equivalents outstanding.
Certain common shares consisting of stock options and convertible preferred stock that would have an anti-dilutive effect were not included in the diluted earnings per share attributable to common stockholders for the years ended June 30, 2012 and 2011.
The following is a reconciliation of the denominators of the basic and diluted earnings per share computations:
For the year ended June 30, 2012, there were outstanding potential common equivalent shares of 3,957,153 compared to 4,577,107 for the year ended June 30, 2011, which were excluded from the computation of diluted earnings per share because the effect would have been anti-dilutive. These potential dilutive common equivalent shares may be dilutive to future diluted earnings per share.
Foreign Currency Translation
The functional currency of the Company's foreign subsidiaries is the local currency. Accordingly, the Company translates all assets and liabilities into U.S. dollars at current rates. Revenues, costs, and expenses are translated at average rates during each reporting period. Gains and losses resulting from the translation of the consolidated financial statements are excluded from results of operations and are reflected as a translation adjustment and a separate component of stockholders' equity.
Gains and losses resulting from foreign currency transactions are recognized in the consolidated statement of operations in the period they occur.
Cash and Cash Equivalents
The Company considers all deposits with an original maturity of three months or less to be cash equivalents.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Long-lived assets
The Company records impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets.
Revenue Recognition
The Company recognizes product revenue at the time of shipment. Revenues from consulting and design services are recognized at the time the services are rendered. Revenue under contracts with periods of performance of greater than one year is recognized utilizing the percentage of completion method. The Company had no contracts at June 30, 2012, with durations of more than one year.
The Company also provides professional and technical services under specific contracts, based on a time and material plus fixed profit basis. Revenue on these contracts are recognized to the extent of costs incurred plus a proportionate amount of profit earned. Contract costs including indirect costs are subject to audit by agencies of the United States Government. Management believes future adjustments, if any, from government cost audits will not have a material effect on the financial statements.
Warranty Reserve
All of the Company’s products carry a warranty and the Company maintains a reserve for warranty work based on historical experience and anticipation of possible warranty work. IPID® sensors are warranted for ten years, under normal use, against defects in workmanship and material from date of installation of the system on the customer's premises. All other components are warranted to the extent of the warranty given by the actual manufacturer. FOIDS® processors are warranted for a ten year period. For the years ended June 30, 2012 and 2011, net expenses attributable to warranties were well below the amounts accrued.
Research and Development
Research and development expenditures are expensed as incurred. Research and development costs for the years ended June 30, 2012 and 2011 amounted to $139,322 and $129,722, respectively.
Income Taxes
The Company accounts for income taxes in accordance with accounting guidance now codified as Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 740, “Income Taxes,” which requires that the Company recognize deferred tax liabilities and assets based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities, using enacted tax rates in effect in the years the differences are expected to reverse. Deferred income tax benefit (expense) results from the change in net deferred tax assets or deferred tax liabilities. A valuation allowance is recorded when it is more likely than not that some or all deferred tax assets will not be realized.
Effective July 1, 2007, the Company adopted the provisions of FASB ASC 740-10-05, “Accounting for Uncertainties in Income Taxes.” The ASC clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. The ASC prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The ASC provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
The Company is no longer subject to federal or state and local income tax examinations by tax authorities for years before 2007.
Intangible Assets
The cost of licenses, patents, and trademarks are being amortized on the straight-line method over their useful lives, ranging from five to 20 years.
Advertising Costs
Advertising costs are reported in selling, general and administrative expenses, and include advertising, marketing and promotional programs. These costs are charged to expense in the year in which they are incurred. The Company incurred $4,800 in advertising costs for the year ended June 30, 2012, and did not incur advertising costs for the year ended June 30, 2011.
Shipping and Handling
Shipping and handling costs are recorded as costs of revenues and are approximately $25,700 and $21,400 for the years ended June 30, 2012 and 2011, respectively
Stock Based Compensation
The Company accounts for stock-based compensation in accordance with accounting guidance now codified as FASB ASC Topic 718, “Compensation - Stock Compensation.” Under the fair value recognition provision of FASB ASC Topic 718, stock-based compensation cost is estimated at the grant date based on the fair value of the award. The Company estimates the fair value of stock options granted using the Black-Scholes-Merton option pricing model.
Fair Value of Financial Instruments
Substantially all of the Company's financial instruments, consisting primarily of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, and other current liabilities, are carried at, or approximate, fair value because of their short-term nature or because they carry market rates of interest.
Recent Pronouncements
In December 2010, the FASB amended ASC 350, “Intangibles - Goodwill and Other,” with Accounting Standards Update (“ASU”) 2010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” This update requires that step 2 of the goodwill impairment test (i.e., measurement and recognition of an impairment loss) be performed if a reporting unit has a carrying value equal to or less than zero and qualitative factors indicate that it is more likely than not that a goodwill impairment exists. The provisions of this update are effective for annual reporting periods beginning after December 15, 2010. Management does not expect these new standards to significantly impact its consolidated financial statements.
In May 2011, the FASB issued ASU Topic No. 2011-04, Fair Value Measurement (Topic 820)-Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, which expands the disclosure requirements for fair value measurements. More quantitative and qualitative disclosures will be required for fair value measurements using level 3 inputs. ASU No. 2011-04 is effective for interim and annual periods beginning after December 15, 2011. Management does not expect these new standards to significantly impact its consolidated financial statements.
In June 2011, the FASB issued ASU Topic No. 2011-05, Comprehensive Income (Topic 220)-Presentation of Comprehensive Income, which updates the presentation requirements related to comprehensive income. The total of comprehensive income, the components of net income, and the components of other comprehensive income may be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU No. 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The update is effective for interim and annual periods beginning after December 15, 2011. Management does not expect these new standards to significantly impact its consolidated financial statements.
In September 2011, the FASB amended ASC 350, “Intangibles - Goodwill and Other,” with Accounting Standards Update (“ASU”) 2011-08, “Testing Goodwill for Impairment”. This update simplifies how entities test goodwill for impairment. It permits an entity to first assess qualitative factors to determine whether it is more likely that not that the fair value of a reporting unit is less than its carrying value as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350.
The provisions of this update are effective for annual impairment tests performed for fiscal years beginning after December 15, 2011. Management does not expect these new standards to significantly impact its consolidated financial statements.
In December 2011, the FASB amended ASC 220, “Comprehensive Income,” with ASU 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05”. This update defers the effective date pertaining to reclassification adjustments out of accumulated other comprehensive income in ASU 2011-05. The provisions of this update are effective for fiscal years beginning after December 15, 2011. Management does not expect these new standards to significantly impact its consolidated financial statements.
In July 2012, the FASB amended ASC 350, “Intangibles - Goodwill and Other,” with ASU 2011-08, “Testing Goodwill for Impairment”. This update reduces the cost and complexity of performing an impairment test for indefinite-lived intangible assets by simplifying how an entity tests those assets for impairment and to improve consistency in impairment testing guidance among long-lived asset categories. The provisions of this update are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Management does not expect these new standards to significantly impact its consolidated financial statements.
Management does not believe that any other recently issued, but not yet effective, accounting standard if currently adopted would have a material effect on the accompanying financial statements.
Reclassifications
Certain items in prior year’s information have been reclassified to conform to the current year’s presentation.
Note 3 - Inventories
Inventories at June 30, 2012 and 2011 consisted of the following:
Note 4 - Property, Equipment and Software Development Costs
Property, equipment and software development costs at June 30, 2012 and 2011 consisted of the following:
Depreciation and amortization expense was $117,204 and $111,811 for the years ended June 30, 2012 and 2011, respectively.
Note 5 - Intangibles
Amortization expense charged to operations was $75,735 and $81,468 for the years ended June 30, 2012 and 2011, respectively. Future annual amortization expense for the licenses and other intangible assets is expected to be approximately $75,700 each year for the patents and trademarks through 2022, their estimated remaining useful lives.
In January 2009, the Company agreed to release the minority shareholders of its Middle East subsidiary of all claims, including amounts receivable from them in the amount of $149,962 in exchange for their shares in the subsidiary. The Company recorded this additional investment in the subsidiary to Goodwill.
Note 6 - Short-Term Debt
On March 15, 2011, the Company, through its wholly owned subsidiary, ECSI International Inc. (the “Subsidiary”), entered into a revolving line of credit agreement with a financial institution (“Bank”) which allows for borrowings up to $475,000. The line bears interest at a rate of New York prime plus .25%, floating with a floor of 4.5%. The interest rate that the line was subject to at June 30, 2012 was 4.5% per annum. The line of credit requires an annual cleanup and matures on November 15, 2012, at which time the outstanding balance plus any accrued and unpaid interest is due and payable. The outstanding balance was $475,000 at June 30, 2012. Due to the net loss in fiscal 2012, we did not meet a covenant of the loan agreement which requires that we have a Minimum Debt Service Coverage Ratio, as defined in the agreement, of 1.1. The bank has provided a waiver of an event of default related to this loan covenant.
The above credit line is collateralized by Subsidiary’s accounts receivable, inventories and general intangibles and is subject to various financial and non-financial covenants that are measured on a consolidated basis. The Company is the sole guarantor of the line of credit.
On June 21, 2012, the Subsidiary entered into a loan agreement with the Bank for a loan of $62,500 due on July 5, 2012. The loan bore interest at the rate of 5.5%. It was repaid in July 2012.
Note 7 - Long-Term Debt
In fiscal 2008, the Company financed the purchase of equipment from a vendor in the amount of $101,762, evidenced by a note bearing interest at the rate of 8%. As the Company purchases product from the vendor a portion of each invoice will be charged to reduce the note balance. Management expects that the note will be repaid over the next 12 months. Collateral for the note is the underlying equipment. The balance on the note at June 30, 2012 and 2011 was $2,639 and $14,237, respectively.
Note 8 - Financing Agreement
On February 8, 2011, the Company executed a drawdown equity financing agreement and registration rights agreement (collectively, the “Agreements”) with Auctus Private Equity Fund, LLC (“Auctus”) pursuant to which, Auctus has committed, subject to certain conditions, to purchase up to $10 million of the Company’s common stock, over a term of up to five years commencing from the effective date of a registration statement covering the resale of the shares by Auctus. The registration statement was declared effective in July 2011. The Company did not use the equity financing and, accordingly, no shares were issued to Auctus. On December 13, 2011, the Company terminated the agreement with Auctus, as the Company determined that it would no longer be in its best interest to continue with the equity line.
Note 9 - Due to Officers and Shareholders
These amounts are composed of the following at June 30, 2012 and 2011:	
Note 10 - Income Taxes
The provision for taxes for the year ended June 30, 2012 and 2011 includes the following components:
The components of the deferred tax accounts as of June 30, 2012 and 2011 are as follows:
The valuation allowance at June 30, 2010 was $1,933,527.
The reconciliation of estimated income taxes attributed to operations at the statutory tax rates to the reported income tax benefit is as follows:
At June 30, 2012, and 2011, the Company had net operating loss carryforwards for federal and state income tax purposes of $5,658,385 and $4,290,709 respectively, expiring through 2032. The Company has foreign net operating loss carryforwards of $608,268 with no expiration date.
At June 30, 2012 and 2011, the Company had no material unrecognized tax benefits and no adjustments to liabilities or operations were required. The Company does not expect that its unrecognized tax benefits will materially increase within the next twelve months. The Company did not recognize any interest or penalties related to uncertain tax positions at June 30, 2012 and 2011.
The Company files U.S. and state income tax returns in jurisdictions with varying statutes of limitations. The 2007 through 2012 tax years generally remain subject to examination by federal and most state tax authorities.
Note 11 - Shareholders’ Equity
Series A Convertible Preferred Stock
In January to March 2002, the Company realized gross proceeds of $2,000,000 from the private placement of 40 Units, each Unit consisting of 25,000 shares of Series A Convertible Preferred Stock (“Series A Preferred”) and 12,500 common stock purchase Warrants. The Series A Preferred provides for an annual dividend of $.20 per share, payable quarterly, (payable in cash or shares of common stock valued at $2.00 per share), when, as and if declared by the Board of Directors. Dividends will be paid on a cumulative basis. Each Series A Preferred share was initially convertible at the option of the holder into one common share, commencing 120 days after closing. The conversion ratio is subject to certain adjustments, as defined and has since been adjusted to .88 Series A Preferred shares for one common share. The Series A Preferred shares have a liquidation preference in the amount of $2.00 per share and the Company may redeem them if the common shares have traded at or above $4.00 for a period of twenty consecutive trading days. All of the Warrants issued in connection with this offering have since expired unexercised.
As of June 30, 2012, 700,000 shares of Series A Preferred were converted into a like amount of common stock.
Cumulative but undeclared dividends at June 30, 2012 total approximately $615,000.
Series B Convertible Preferred Stock
On June 30, 2004, the Company completed a private placement of 2,000 shares of its 10% Series B Convertible Preferred Stock (“Series B Preferred”) and warrants to purchase up to 2,000,000 shares of common stock for an aggregate purchase price of $2,000,000. The Preferred Stock provides for a dividend at the rate of 10% per annum, payable quarterly, (payable in cash or by adding the dollar amount of such dividends to the Stated Value), dividends will be paid on a cumulative basis. The preferred shares have a liquidation preference in the amount of $1,000 per share and have preference to any payments to the Preferred A shareholders. Each preferred share is convertible at the option of the holder into 1,000 shares of common stock. The conversion price is subject to anti-dilution adjustments, including, among other things, in the event that the Company sells common stock during the next three years for a price of less than one dollar per share. The Company may require the conversion of all (but not less than all) of the then outstanding shares of Series B Preferred Stock, if at any time the volume weighted average trading price per share of common stock for each of 20 consecutive trading days prior to a conversion notice is greater than $2.50 (subject to adjustment), and the daily trading volume of the common stock is at least 100,000 shares. In addition all shares of common stock underlying the Series B Preferred Stock must be covered by an effective registration statement.
The Warrants are exercisable for a period of four years from the date of issuance at an exercise price per share of $1.00 per share and have similar anti-dilution privileges as the Series B Preferred Stock. All of the Warrants issued in connection with this offering have since expired unexercised.
In May 2006, in connection with the reset of the conversion and exercise price of the Debentures and Warrants discussed in Note 8 above, the conversion and exercise prices of the Series B Preferred and the accompanying warrants were reduced to $.75.
Stock Option Plans
Incentive Stock Option Plan
In 1986, the Company adopted an Incentive Stock Option Plan, which was renewed in 1996 for a second ten-year term. The Company initially had reserved 1,000,000 shares of common stock for issuance under the Incentive Stock Option Plan, which was increased to 2,000,000 shares upon the approval of the stockholders at the 2005 annual meeting. The board of directors administers the Incentive Stock Option Plan but may delegate such administration to a committee of three persons, one of whom must be a member of the board. The board or the committee has the authority to determine the number of stock options to be granted, when the stock options may be exercised and the exercise price of the stock options, provided that the exercise price may never be less than the fair market value of the shares of the common stock on the date the stock option is granted (110% in the case of any employee who owns more than 10% of the combined voting power or value of all classes of stock). Stock options may be granted for terms not exceeding ten years from the date of the grant, except for stock options granted to any person holding in excess of 5% of our common stock, in which case the stock options may not be granted for a term not to exceed five years from the date of the grant. The Incentive Stock Option Plan expired in September 2006.
Equity Incentive Plan
In October 2006, the Board adopted the Equity Incentive Plan, which was approved by the shareholders at the annual meeting of shareholders held in December 2006. The Equity Incentive Plan is intended to succeed the Incentive plan, which expired in September 2006. 2,000,000 shares were reserved for issuance under the Equity Incentive Plan. In December 2010, the Shareholders voted to increase the number of shares issuable thereunder to 4,000,000. The Equity Incentive Plan is administered by the Board of Directors or, at the discretion of the Board, by a committee consisting of at least two directors. The administrating body, whether it be the Board of Directors or a committee of the type described above, is sometimes referred to as the "Committee." The Committee is authorized from time to time to select and to grant awards under the Equity Incentive Plan to such key employees, non-employee directors, and consultants of the Company and its subsidiaries as the Compensation Committee, in its discretion, selects. The Compensation Committee is authorized to delegate any of its authority under the Equity Incentive Plan (including the authority to grant awards) to such executive officers of the Company as it thinks appropriate and is permitted by Rule 16B-3 of the Exchange Act and Section 162(m) of the Code. The Equity Incentive Plan allows for the grant of a number of different types of awards, including incentive and non-statutory stock options, stock appreciation rights, restricted stock grants, performance units, cash payments and other stock-based awards.
Non-Statutory Stock Option Plan.
The Company also adopted a Non-Statutory Stock Option Plan and have reserved 250,000 shares of common stock for issuance to directors, employees and non-employees. Stock options granted pursuant to this plan will be non-transferable and expire, if not exercised within five years from the date of the grant. Stock options will be granted in such amounts and at such exercise prices as our board of directors may determine.
Option activity for 2012 and 2011 is summarized as follows:
The aggregate intrinsic value on this table was calculated based on the positive difference between the closing market price of the Company’s common stock and the exercise price of the underlying options. No options were exercised in fiscal 2012 and 200,000 options were exercised in fiscal 2011.
The following table summarizes information about stock options outstanding at June 30, 2012.
The fair value of each option grant is estimate on the date of grant using the Black-Scholes option-pricing model. The Company uses historical data to estimate expected volatility, the period of time that option grants are expected to be outstanding, as well as employee termination behavior. The risk-free rate is based on the U.S. Treasury yield in effect at the time of grant for the estimated life of the option. The following weighted-average assumptions were used to estimate the fair value of options granted during the fiscal years ended June 30, 2012 and 2011, using the Black-Scholes option-pricing:
As of June 30, 2012, there was no unrecognized compensation cost related to nonvested options granted as all options have vested.
Note 12 - Concentrations and Economic Dependency
The Company had three customers that accounted for 63%, 7%, and 6% of net revenues for the year ended June 30, 2012, and one customer that accounted for approximately 50% of net revenues for the year ended June 30, 2011. One customer accounted for approximately 85% of the accounts receivable as of June 30, 2012. At June 30, 2012 approximately no accounts receivable were from foreign customers. The Company performs ongoing credit evaluations of its customers’ financial condition and generally requires no collateral from its customers.
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash in financial institutions. At June 30, 2012 and 2011, substantially all of the Company's cash was in two banks. The amount that is federally insured is subject to FDIC's limit of $250,000 per depositor per insured bank. Under the Dodd-Frank Act, beginning December 31, 2010 through December 31, 2012, all non-interest truncation accounts are fully insured, regardless of the balances of the account and the ownership capacity of the funds. The Company did not have balances that exceeded FDIC limits at June 30, 2012 and 2011.
Note 13 - Commitments and Contingencies
Lease Agreements
Future minimum annual rental payments required under non-cancelable operating leases for years after June 30, 2012 are as follows:
Rent expense under all operating leases was $91,213 and $69,864 for the years ended June 30, 2012 and 2011, respectively.
License Agreement
The Company has acquired intellectual property, equipment and a tooling license from Mason & Hanger National, Inc. and a patent license from Lucent Technologies, Inc. for the Fiber Optic Intelligence Detection Systems (FOIDSâ). In conjunction with these two license agreements whereby royalties totaling 5.4% are due on revenues from the Fiber Optic Intelligence Detection System (FOIDSâ).
Legal Proceeding
On March 7, 2012, the Company, through its wholly-owned subsidiary, ECSI International, Inc. filed a lawsuit in the United States District Court for the District of New Jersey against Lockheed Martin Global Training and Logistics (“Lockheed Martin”). The lawsuit, as detailed in the First Amended Complaint and Demand for Trial by Jury (the “Amended Complaint”) dated March 29, 2012, alleges breach of contract and tortious interference by Lockheed Martin and seeks actual damages of approximately $978,000, as well as punitive damages, costs and such further relief as the Court deems equitable and proper. In addition, the Amended Complaint seeks payment under Lockheed Martin’s payment bonds required by the United States Navy Facilities Engineering Command. At June 30, 2012, the Company has included in its accounts receivable (prior to allowances) the amount of the actual damages claimed. Lockheed Martin has indicated that it may file counterclaim against ECSI International, Inc. seeking reimbursement of approximately $200,000 in costs alleged to have been incurred by Lockheed Martin on the project related to the above amount due to us. We are aggressively pursuing our claim against Lockheed Martin and defending against a counterclaim if one is asserted. Discovery has been proceeding.
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements.
Note 14 - Geographic Data
The Company currently operates in the United States and the Middle East. The following is a summary of local operations by geographic area:
Note 15 - Related Party Transactions
The Company made non-interest bearing advances, due on demand, to a former officer and director of the Company. The balances outstanding at June 30, 2012 and 2011 were $49,765. Refer to Note 10 above for information regarding amounts due to officers and directors of the Company.