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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the transition period from __________ to _________
Commission File Number: 000-31026
ELECTRONIC CONTROL SECURITY INC.
(Exact name of registrant as specified in its charter)
790 BLOOMFIELD AVENUE, CLIFTON, NEW JERSEY 07012
(Address of principal executive offices)
(Issuer's telephone number)
Indicate by checkmark whether the registrant has (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of May 10, 2012, Electronic Control Security Inc. had outstanding 11,512,146 shares of common stock, par value $0.001 per share.
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.
Notes to the Consolidated Financial Statements
Note 1 – Basis of Presentation
The accompanying unaudited consolidated financial statements of Electronic Control Security Inc. and its subsidiaries (collectively "the Company") have been prepared in accordance with generally accepted accounting principles for interim financial information and Article 8.03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended March 31, 2012 are not necessarily indicative of the results that may be expected for the year ending June 30, 2012. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in the Company's Form 10-K for the year ended June 30, 2011, as filed with the Securities and Exchange Commission.
Note 2 - 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 is computed based on the weighted-average number of shares of the Company’s common stock, including common stock equivalents outstanding. Certain common stock equivalents consisting of stock options, warrants, convertible debentures 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 three and nine month periods ended March 31, 2012 and 2011.
The following is a reconciliation of the denominators of the basic and diluted earnings per share computations:
For the nine months ended March 31, 2012 and 2011, there were outstanding potential common stock equivalent shares of 4,179,710 and 4,485,874, respectively, which were excluded from the computation of diluted earnings per share because the effect would have been anti-dilutive. These potential dilutive common stock equivalent shares may be dilutive to future diluted earnings per share.
Note 3 - Inventories
Inventories consist of the following:
Note 4 - Due to Officers and Shareholders
In September 2011, 522,221 shares of common stock were issued to officers in consideration of the conversion of certain amounts due to them in the aggregate amount of $94,000. In February 2012, 150,000 shares of common stock were issued to an officer in consideration of a reduction in the amount of $15,000 of accrued compensation due to such officer.
Note 5 – New Authoritative Pronouncements
The Company has considered all new accounting pronouncements and has concluded that there are no new pronouncements that may have a material impact on results of operations, financial condition, or cash flows, based on current information.
Note 6 – Financing Agreements
On March 27, 2012, the Company, through its wholly owned subsidiary, ECSI International Inc., and Atlantic Stewardship Bank (the “Bank”) entered an agreement pursuant to which the maturity date for the amounts outstanding under the credit line established in March 2011 has been extended to November 15, 2012. The principal amount outstanding is currently $475,000. All other terms of the agreements were unchanged.
On February 8, 2011, the Company entered into an equity financing and registration rights agreement with Auctus Private Equity Fund, LLC (“Auctus”) pursuant to which Auctus committed, subject to certain conditions, to purchase up to $10 million of 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. An S-1 registration statement in respect of the resale by Auctus of any shares of the Company’s common stock that would have been issuable under the Agreement was declared effective in July 2011. The Company did not utilize the equity financing facility 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 not be in its best interest to continue with the equity line.
Note 7 – 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 March 31, 2012, the Company has included the amount of the actual damages claimed in its accounts receivable (prior to allowances).
The following discussion should be read in conjunction with our financial statements and the notes related to those statements. Some of our discussion is forward-looking and involves risks and uncertainties. For information regarding risk factors that could have a material adverse effect on our business, refer to the risk factors section of the Annual Report for the year ended June 30, 2011 on Form 10-K.
CAUTION REGARDING FORWARD-LOOKING STATEMENTS
Our Company and its representatives may from time to time make written or verbal forward-looking statements, including statements contained in this report and other Company filings with the Securities and Exchange Commission and in our reports to shareholders. Statements that relate to other than strictly historical facts, such as statements about our plans and strategies, expectations for future financial performance, new and existing products and technologies, and markets for our products are forward-looking statements. Generally, the words "believe," "expect," "intend," "estimate," "anticipate," "will" and other similar expressions identify forward-looking statements. The forward-looking statements are and will be based on our management's then-current views and assumptions regarding future events and operating performance, and speak only as of their dates. Investors are cautioned that such statements involve risks and uncertainties that could cause actual results to differ materially from historical or anticipated results due to many factors including, but not limited to, our Company's current and future capital needs, uncertainty of capital funding, our clients' ability to cancel contracts with little or no penalty, government initiatives to implement Homeland Security measures, the likelihood of completing transactions for which we have entered into letters of intent, the state of the worldwide economy, competition, customers’ ability to pay our invoices within our standard credit terms, and other risks detailed in our Company's most recent Annual Report on Form 10-K and other Securities and Exchange Commission filings. We undertake no obligation to publicly update or revise any forward-looking statements.
We are engaged in the design, development, manufacture and marketing of technology-based integrated entry control and perimeter security solutions. We also perform 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.
We market our products domestically and internationally to:
We believe we are one of the few true comprehensive security solution providers in the industry. We are able to analyze a security risk and develop security solutions specifically tailored to mitigate that risk, including design, engineering and manufacturing individual components of a system as may be necessary to deliver a fully integrated security system customized to a client's requirements. We are frequently engaged by security system integrators, security system dealers/installers, and commercial architects and engineers because we are able to deliver the integrated platform of design, engineering services and fully integrated security solutions that support their requirements for the completion of a given project.
We believe that we have developed a superior reputation as a provider of integrated security systems since our inception in 1976 because we:
During fiscal 2011 and 2012, we submitted proposals on projects for Department of Defense facilities and certain nuclear power stations in the United States and Southeast Asia, which remain pending proposals, valued at approximately $37,500,000. We anticipate decisions relating to these proposals during the remainder of fiscal 2012 and fiscal 2013.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements and accompanying notes have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires that we make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Management continually evaluates the accounting policies and estimates it uses to prepare the consolidated financial statements. We base our estimates on historical experience and assumptions believed to be reasonable under current facts and circumstances. Actual amounts and results could differ from these estimates made by management.
We do not participate in, nor has there been created, any off-balance sheet special purpose entities or other off-balance sheet financing. In addition, we do not enter into any derivative financial instruments for speculative purposes.
We have identified the following critical accounting policies that affect the more significant judgments and estimates used in the preparation of our condensed consolidated financial statements.
Inventories are valued at the 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. We currently have a reserve of $80,000 against inventory.
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 for 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.
FAIR VALUE OF EQUITY INSTRUMENTS
The valuation of certain items, including valuation of warrants or stock options that may be offered as compensation for goods or services, involve significant estimations with underlying assumptions judgmentally determined. Warrants are valued using the most reliable measure of fair value, such as the value of the goods or services rendered, if obtainable. If such value is not readily obtainable, the valuation of warrants and stock options are then based on the Black-Scholes valuation model, which involves estimates of stock volatility, expected life of the instruments and other assumptions.
RESULTS OF OPERATIONS
COMPARISON OF THE NINE AND THREE MONTHS ENDED MARCH 31, 2012 COMPARED TO NINE AND THREE MONTHS ENDED MARCH 31, 2011
REVENUES. We had net revenues of $2,010,970 for the nine months ended March 31, 2012 compared to $2,888,625 for the nine months ended March 31, 2011, representing a decrease in net revenues of approximately 30%. Revenues for the three months ended March 31, 2012 were $343,970 compared to $1,006,662 in the comparable period in 2011, representing a decrease in net revenues of approximately 66%. The decreases in net revenues during the nine and three months ended March 31, 2012 compared to the corresponding periods in 2011 are primarily attributable to a decrease in deliverable products and support services billings resulting from continuing delays in release of funding at the Department of Defense and Department of Energy on projects where we serve as a subcontractor as well as at other customers. The budget constraints and budget uncertainty at the U.S. government agencies have significantly reduced the issuance of orders and delayed projects for all participants in our industry. We anticipate that these budgetary constraints will be addressed in the remainder of fiscal 2012 and in fiscal 2013.
GROSS MARGINS. Gross margins for the nine months ended March 31, 2012 were 32% as compared to 57% for the corresponding period in 2011. Gross margins were negative for the three months ended March 31, 2012 compared to 48% for the three months ended March 31, 2011. The decrease in gross margins for each of the nine and three month periods ended March 31, 2012 is primarily attributable to the decrease in revenues caused by the budgetary constraints in the U.S. government discussed above, a change in the order mix of equipment sales and support services billings and an increase in the cost of certain materials and components.
RESEARCH AND DEVELOPMENT. Research and development expenses consist primarily of those incurred in designing and developing upgrades to existing products and systems as well as new product development work such as the WISE® (Water Infrastructure Sensing Equipment) water technology. Research and development expenses were $104,167 for the nine months ended March 31, 2012 and $97,817 for the corresponding nine months in 2011. Research and development expenses were $35,156 for the three months ended March 31, 2012 and $36,606 for the corresponding three months in 2011.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses were $1,169,343 for the nine months ended March 31, 2012 compared to $1,098,224 for the corresponding nine months in 2011. Selling, general and administrative expenses were $309,332 for the three months ended March 31, 2012 compared to $417,644 for the corresponding three months in 2011. The increase in selling, general and administrative expenses during the nine months ended March 31, 2012 as compared to the corresponding nine months in 2011 is primarily attributable to an increase in our allowance for doubtful accounts in the amount of $200,000, which more than offset a 12% reduction in other components of the selling, general and administrative expenses, primarily lower selling expenses. The decrease in selling, general and administrative expenses during the three months ended March 31, 2012 as compared to the corresponding three months in 2011is primarily due to lower selling expenses resulting from the lower revenues.
STOCK BASED COMPENSATION. From time to time, we issue stock options to our directors and employees and consultants. In the nine months ended March 31, 2012, we recognized expense for stock based compensation of $96,815. Stock-based compensation is non-cash and, therefore, has no impact on cash flow or liquidity.
INCOME (LOSS) FROM OPERATIONS. The loss from operations for the nine months ended March 31, 2012 of $(733,192) included non-cash costs of the allowance for bad debts of $200,000 and stock based compensation of $96,815 compared to a profit of $422,845 for the corresponding nine months of 2011. For the three months ended March 31, 2012, we had loss from operations of $(487,379) compared to a profit of $31,104 for the corresponding three months in 2011. The decrease in income from operations during the 2012 periods compared to the 2011 periods was attributable to the 2012 allowance for doubtful accounts and cost of stock-based compensation discussed above, and receipt of lower gross margin orders, a less profitable mix of design and engineering support services billings, and a reduction in funded and released backlog.
INTEREST EXPENSE. Interest expense in the nine months ended March 31, 2012 was $50,871 compared to $44,276 incurred during the corresponding nine months in 2011.
INCOME (LOSS) BEFORE DIVIDENDS. The income (loss) before dividends related to convertible preferred stock for the nine months ended March 31, 2012 was $(784,063) compared to $379,637 in the corresponding nine months in 2011. The reduction in the income (loss) before dividends was impacted by certain non-cash costs - allowance for bad debts of $200,000 and cost of stock based compensation of $96,815 - as well as the impact of lower revenues.
DIVIDENDS RELATED TO PREFERRED STOCK.
We recorded dividends totaling $114,912 on our Series B Convertible Preferred Stock in the nine months ended March 31, 2012 and $110,139 in the corresponding nine months in 2011. In lieu of a cash payment, we have elected, under the terms of these securities, to add this amount to the stated value of the Series B Convertible Preferred Stock.
These dividends are non-cash and, therefore, have no impact on our net worth, cash flow or liquidity.
LIQUIDITY AND CAPITAL RESOURCES
We believe that cash on hand, existing line of credit with Atlantic Stewardship Bank, which was fully utilized with a balance of $475,000 at March 31, 2012, together with anticipated collection of accounts receivable during the short term, will be sufficient to provide for our working capital needs for the next 12 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 orders that we may receive. At the present time, we have no assurances of additional revenue beyond the firm purchase orders we have received.
Our working capital of approximately $1.36 million at March 31, 2012 declined from $1.8 million at June 30, 2011 primarily due to the loss before dividends. Net cash used in operating activities for the nine months ended March 31, 2012 was $216,754 as compared to about $523,115 provided by operating activities for the corresponding nine months in 2011.
Inventory increased by $404,507 during the nine months ended March 31, 2012. The increase is primarily due to work in process for orders that were recently released from the backlog. The shipments of our primary products are scheduled to be delivered over the next nine months.
Accounts receivable have increased by $161,334 to $1,249,836 for the nine months ended March 31, 2012 over the corresponding nine months in 2011. This increase is due to the dispute with Lockheed Martin which has resulted in the legal proceedings.
Accounts payable and accrued expenses have increased by $657,800 to $1,645,375 for the nine months ended March 31, 2012 as compared to a reduction of $1,247,285 in the corresponding nine months in 2011. Included in accrued expenses are accrued salaries and expenses to officers and other key employees in the amount of about $664,000. The increase in accounts payable and accrued expenses is directly related to the timing of payments due to delays in cash receipts.
We purchased equipment in the aggregate of $18,767 during the nine months ended March 31, 2012. We do not have any major material commitments for capital expenditures going forward.
Subsequent Event – Contract Award
On May 4, 2012, ECSI was advised that a contract was awarded to a team, of which ECSI is a member, for support and technology services to the Department of Defense (“DoD”). The cumulative contract ceiling of the award to include five prime contractors and their respective subcontractors is $228,700,000 over five years. The contract ceiling for the ECSI team in the base year is $39,800,740. The contract is an Indefinite Delivery Indefinite Quantity (“IDIQ”) contract, and the work to be performed under it will be awarded to the five teams on individual task orders on a competitive basis. There is no assurance that ECSI will be awarded work under any task orders on the contract.
The contract is in response to initiatives promulgated by the DoD and other Government agencies, require engineering development, design, procurement, fabrication of entry control and perimeter detection technologies, installation, information assurance, logistics, maintenance, and life cycle support services for Infrastructure Protection purposes. These systems will support the operational requirements of high value DoD and other Government agencies where security is of high or vital interest.
ITEM 4. CONTROLS AND PROCEDURES.
We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. As of the end of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer (and Principal Financial Officer and Accounting Officer), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, management and our Chief Executive Officer (and Principal Financial Officer and Accounting Officer) concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms.
There was no change in our internal controls over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) identified in connection with the foregoing evaluation that occurred during the period covered by this Quarterly Report on Form 10-Q that materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ECSI International, Inc. v. Lockheed Martin global Training and Logistics. 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.
ITEM 2. UNREGISTERED SALES OF SECURITIES AND USE OF PROCEEDS
The following set forth certain information with respect to all securities sold by us during the nine months ended March 31, 2012.
In September 2011, the Company issued 522,221 shares of common stock to officers in consideration of the conversion of certain amounts due to them in the aggregate amount of $94,000. In February 2012, the Company issued 150,000 of common stock to an officer in consideration of a reduction in the amount of $15,000 of accrued compensation due to such officer.
The shares were issued in the transactions described above without registration under the Securities Act in reliance upon the exemptions provided in Section 4(2) of the Securities Act. The recipient of the shares acquired the securities for investment only and not with a view to or for sale in connection with any distribution thereof. Appropriate legends were affixed to the share certificates issued in all of the above transactions. The recipients represented that it was an “accredited investor” within the meaning of Rule 501(a) of Regulation D under the Securities Act, or had such knowledge and experience in financial and business matters as to be able to evaluate the merits and risks of an investment in its common stock. The recipient had adequate access, through its relationships with the Company and its officers and directors, to information about the Company. None of the transactions described above involved general solicitation or advertising. No underwriters were utilized and no related fees or expenses were incurred.
ITEM 5. EXHIBITS.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.