Indicate by check mark if the registrant
is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o
Yes
x
No
Indicate by check mark if the registrant
is not required to file reports pursuant to Section 13 or 15(d) of the Act.
o
Yes
x
No
Indicate by check mark whether the registrant
(1) has 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.
x
Yes
o
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).
x
Yes No
o
Indicate by check mark if disclosure of delinquent
filers in response to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's
knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment
to this Form 10-K.
x
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 a check mark whether the registrant
is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes
o
No
x
As of October 11, 2013, there were 15,867,146
outstanding shares of the registrant's common stock. The aggregate market value of the shares of the registrant's common stock
held by non-affiliates was $502,973 on December 31, 2012. Such market value was calculated using the closing price of the common
stock as quoted on the OTC Bulletin Board on such date.
Information required by Part III of Form
10-K is incorporated by reference to portions of the registrant’s definitive proxy statement for its 2013 annual meeting
of stockholders, which will be filed on or before October 28, 2013.
THE FOLLOWING DISCUSSION
SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL STATEMENTS AND RELATED NOTES CONTAINED ELSEWHERE IN THIS FORM 10-K. CERTAIN STATEMENTS
MADE IN THIS DISCUSSION ARE “FORWARD LOOKING STATEMENTS” WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995. FORWARD LOOKING STATEMENTS CAN BE IDENTIFIED BY TERMINOLOGY SUCH AS “MAY”, “WILL”, “SHOULD”,
“EXPECTS”, “INTENDS”, “ANTICIPATES”, “BELIEVES”, “ESTIMATES”, “PREDICTS”,
OR “CONTINUE” OR THE NEGATIVE OF THESE TERMS OR OTHER COMPARABLE TERMINOLOGY AND INCLUDE, WITHOUT LIMITATION, STATEMENTS
BELOW REGARDING: THE COMPANY'S INTENDED BUSINESS PLANS; EXPECTATIONS FOR CONTINUING IN BUSINESS; EXPECTATIONS AS TO PRODUCT PERFORMANCE;
EXPECTATIONS AS TO MARKET ACCEPTANCE OF THE COMPANY'S TECHNOLOGY; ONGOING DELAYS BY FEDERAL AGENCIES OF APPROVED PROJECTS; CASH
FLOW IMPACT ARISING FROM DISPUTE WITH PRIME CONTRACTOR; AND BELIEF IN THE SUFFICIENCY OF CASH RESERVES. BECAUSE FORWARD LOOKING
STATEMENTS INVOLVE RISKS AND UNCERTAINTIES, THERE ARE IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM
THOSE EXPRESSED OR IMPLIED BY THESE FORWARD LOOKING STATEMENTS. ALTHOUGH THE COMPANY BELIEVES THAT EXPECTATIONS REFLECTED IN THE
FORWARD LOOKING STATEMENTS ARE REASONABLE, IT CANNOT GUARANTEE FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS. MOREOVER, NEITHER THE
COMPANY NOR ANY OTHER PERSON ASSUMES RESPONSIBILITY FOR THE ACCURACY AND COMPLETENESS OF THESE FORWARD LOOKING STATEMENTS. THE
COMPANY IS UNDER NO DUTY TO UPDATE ANY FORWARD LOOKING STATEMENTS AFTER THE DATE OF THIS REPORT TO CONFORM SUCH STATEMENTS TO ACTUAL
RESULTS.
PART I
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:
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38+ year track record with high customer retention rate;
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U.S. Air Force certified technology;
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Best industry warranty – 10 Years on select equipment;
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General Services Administration (GSA) contract valid through July
2014, which is renewable year to year;
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SeaPort-e contract valid through July 2014;
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Competitive Small Business (SB) capable of taking advantage of government
solicited Small Business Set-Aside contract opportunities;
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Strong teaming arrangements with large systems integrators to supply
technology and offer design and engineering support services to on multiple current and pending contracts;
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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;
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$162,750,000; of these, other bidders were awarded $16.0 million and
we have been awarded, as the prime contractor or as a subcontractor, contracts with an approximate value of $35.0 million over
five years. We anticipate decisions relating to the remainder of these proposals during fiscal
2014;
and
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W
orld-wide implementation and support through robust domestic and
international marketing and distribution network with multiple direct and indirect distribution channels and strategic partnerships.
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We believe that our competitive advantages include the following:
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providing
the highest level of perimeter protection;
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offering
supporting technologies and systems to enable total systems integration;
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delivering systems that are easy to operate and maintain while providing
superior life cycle cost performance;
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solid
credentials in protecting high value targets;
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superior
technologies — technologies targeted to the specific protected environment, and
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Interoperability Device Management System (IDMS) offering situational
awareness and total system management.
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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 $2.9 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.
Based of this effort, ECSI is confident
in the government sector over the next five years based on the contracts that have been awarded and now appear to be finally moving
forward, with recent results described below.
On July 10, 2013, ECSI received notice
that its prime contractor, ITSI Gilbane Company, on an Access Control Point (ACP) Design-Build bid was awarded a prime contract
by the U.S. Army Corps of Engineers valued up to $230 million. The prime contract includes a 24 month base period of performance
and three 12-month options. ECSI is awaiting subsequent task orders. As a small business, ECSI will have the opportunity to bid
on a small business percentage goal of 51.43% of planned subcontracting dollars that the prime contractor has allocated under this
contract. During the base period, $7,200,000 is planned to be subcontracted to ECSI and the other small business on the team. For
Option Year 1, 2 and 3 respectively, $3,600,000 is planned to be subcontracted to ECSI and the other small business on the team.
ECSI’s performance scope, dependent on task orders, will include site surveys, design and engineering, procurement and fabrication,
integration, factory acceptance testing, installation supervision, commissioning, training, and depot level support.
On July 19, 2012, VT Milcom was awarded
a prime contract under the SPAWAR National Capital Region (NCR) Security Engineering Support contract. ECSI is a subcontractor
to VT Milcom on this contract.
Prior to the NCR award, ECSI was awarded
a SeaPort-e prime contract for a wide range of engineering, technical and programmatic services and solutions. Functional areas
may include: Engineering, System Engineering and Process Engineering Support;
Prototyping,
Pre-Production, Model-Making, and Fabrication Support; System Design Documentation and Technical Data Support; Configuration Management
(CM) Support; Quality Assurance (QA) Support.
On October 24, 2012, ECSI received a contract
worth up to $7.8 million to supply security systems and support services for the U.S. Navy.
The
contract includes a 5-year period of performance. Anticipated task orders include requirements for electronic security systems
(access control systems, intrusion detection systems, surveillance systems, command and control equipment) and support services
(design and engineering, fabrication and assembly, systems integration, testing and training, logistics and maintenance support).
As previously announced on February 22,
2013, ECSI was awarded a U.S. Navy prime contract with a contract ceiling of $249,590,000 over a five year period of performance.
There are 13 awardees under the contract. While no assurance can be provided, ECSI anticipates capturing at least 10% of the task
orders to be issued under this contract. The scope of this contract covers the entire spectrum of non-inherently governmental services
and solutions (equipment and services) associated with the full system lifecycle support including research, development, test,
evaluation, production and fielding of sustainable, secure, survivable, and interoperable Command, Control, Communications, Computers,
Combat Systems, Intelligence, Surveillance, Reconnaissance (C5ISR), information operations, Enterprise Information Services (EIS)
and space capabilities.
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:
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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;
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perimeter security for airports, maritime, chemical, transportation, energy and pharmaceutical facilities has been mandated by Homeland Security;
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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;
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nuclear power stations both in the United States and overseas have increased the level of security based on recent NRDC security requirements; and
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private industry is operating in more remote geographic locations and higher risk environments.
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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(IPID
Ò
)
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 FOIDS
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.process.
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:
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provide low nuisance and false alarm rates;
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are reliable in virtually any environmental condition;
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in many cases can be user specified and adapted to their environment;
and
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are subject to low installation and maintenance costs.
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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:
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the U.S. Government, its agencies and departments, including the Department of Defense and the Department of Energy;
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large industrial facilities, including pharmaceutical companies and major office complexes;
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energy facilities, including nuclear power stations, utilities, chemical-petrochemical pipelines;
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foreign/export opportunities in all of the above-noted target markets.
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Our open-ended contract with the General
Services Administration (GSA), which has been extended through July 31, 2014 and which is renewable year to year, 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 FPS
2
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:
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Broaden the base of potential clients, domestically and internationally, and
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Demonstrate the efficacy of our products and support services.
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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 through 2013, we entered into teaming and marketing agreements with ITSI, SAIC, Fortis, Calnet, Honeywell, Culmen,
ERIS, and Boeing.
During fiscal 2013, 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 $162,750,000. We anticipate decisions relating to these proposals during fiscal 2014.
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:
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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.
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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.
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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.
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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.
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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.
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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, 2013, there were four customer groups which comprised
a significant portion of our revenues. For Fiscal Year 2013, the Department of Defense accounted for 45% of our net revenues, nuclear
power stations for 10%, Department of Energy for 28%, and foreign customers for 15%. For Fiscal Year 2012, the Department of Defense
accounted for 65% of our net revenues, nuclear power stations, 25%; 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:
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our principal officers, security analysts, design personnel and sales people have an aggregate of over 250 years of experience in the security industry;
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we have the ability to analyze security risks, design, engineer and manufacture products customized to a client's requirements;
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our products address a wide range of security requirements;
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our products are among the most technologically advanced and the highest quality available;
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our products are reliable, and relatively easy and inexpensive to install and maintain; and
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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.
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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 12,200 square feet, including 2,200 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, 2013 and
2012, we expended $82,065 and $139,322, 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, 2013 and 2012, 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, 2013
,
we had 15 employees,
of whom 14 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. 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
Because we depend on U.S. Government contracts, a delay
in the completion of the U.S. Government’s budget process could delay procurement of the products, services and solutions
we provide and have an adverse effect on our future revenues.
The funding of U.S. Government programs is subject to an annual
congressional budget authorization and appropriation process. In years when the U.S. Government does not complete its budget process
before the end of its fiscal year on September 30, government operations are typically funded pursuant to a “continuing
resolution,” which allows federal government agencies to operate at spending levels approved in the previous budget cycle,
but does not authorize new spending initiatives. When the U.S. Government operates under a continuing resolution, delays can occur
in the procurement of the products, services and solutions that we provide and may result in new initiatives being cancelled. We
have from time to time experienced a decline in revenues as a result of this annual budget cycle, and we could experience similar
declines in revenues from future delays in the budget process. In years when the U.S. Government fails to complete its budget process
or to provide for a continuing resolution, a federal government shutdown may result. This could in turn result in our incurrence
of substantial labor or other costs without reimbursement under customer contracts, or the delay or cancellation of key programs,
which could have a negative effect on our cash flows and adversely affect our future results. In addition, when supplemental appropriations
are required to operate the U.S. Government or fund specific programs and passage of legislation needed to approve any supplemental
appropriation bill is delayed, the overall funding environment for our business could be adversely affected.
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 72% and 70% of our revenues for each
of the years ended June 30, 2013 and 2012, 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
and 2013, 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 $162,750,000. Of these, other bidders were awarded $16.0 million and we have
been awarded, as the prime contractor or as a subcontractor, contracts with an approximate value of $35.0 million over five years.
We anticipate decisions relating to the remainder of these proposals during fiscal 2014.
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, 2013 and 2012, we generated approximately 15% and 7%, respectively, of our business from projects outside the United
States. We anticipate that the revenue portion from overseas operations will increase significantly during Fiscal 2014 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:
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unexpected changes in or impositions of legislative or regulatory requirements;
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potential hostilities and changes in diplomatic and trade relationships; and
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political instability.
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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 2014. 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:
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conditions or trends in the industry,
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failure to keep pace with changing technology,
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costs associated with developing new products and services,
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costs associated with marketing products and services may increase significantly,
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the timing of sales and the recognition of revenues from them,
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government regulations may be enacted which affect how we do business and the products which may be used at government facilities,
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downward pressure on prices due to increased competition,
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changes in our operating expenses,
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sales of common stock,
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actual or anticipated variations in quarterly results, and
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changes in financial estimates by securities analysts.
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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:
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make a special written suitability determination for the purchaser,
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receive the purchaser's written agreement to a transaction prior to sale,
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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
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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.
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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 47% 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 16.0 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. Unresolved Staff
Comments
Not applicable.
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. 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. In Fiscal 2013, Lockheed Martin was granted a motion to have the matter
moved from New Jersey to Maryland. We had been aggressively pursuing our claim against Lockheed Martin. However, due to cash flow
constraints, we have not pursued our claims against Lockheed Martin in Maryland.
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. Mine Safety Disclosures
Not Applicable.
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
Basis of Presentation
The consolidated financial
statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of business. The Company incurred losses before dividends of $1,221,153
and $1,531,773 in the years ended June 30, 2013 and 2012, respectively. Our cash flow and liquidity have been severely impacted
by the refusal by Lockheed Martin to pay us for the accounts receivable due from them totaling nearly $1 million. Atlantic Stewardship
Bank (the “Bank”) has converted the prior line of credit to a term loan, and no further borrowings are available under
the agreement (refer to note 6 below). Through the years ended June 30, 2013 and 2012, the principal source of funds used to finance
the Company’s operations has been advances from officers, shareholders and affiliates and accrued costs due to those parties.
There is no assurance that those parties will continue to provide the operating funds. Through Fiscal 2012 and 2013, there were
continuing delays in release of funding at the Department of Defense and Department of Energy on projects where we serve as a prime
contractor and as a subcontractor. 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. These factors raise concern about the
Company’s ability to continue as a going concern.
The Company has working capital
of about $1.003 million and shareholders’ equity of about $1.422 million as of June 30, 2013. In June 2013, the Bank converted
the prior line of credit into a term loan, due in installments from July 2013 through June 2015. In connection with this agreement
with the Bank, three of the Company’s officers agreed to subordinate a total of $848,040 of amounts due to those officers
to amounts due by a subsidiary of the Company to the Bank (refer to Notes 6 and 7 below). The classification of the portion of
the Bank loan due after June 30, 2014 and the amounts subordinated by the officers resulted in increased the Company’s working
capital by $1,288,597. Officers, shareholders and affiliates provided funds in the form of cash advances and deferral of accrued
costs and expenses due to them during Fiscal 2013 of $524,412. If the Company should require financing of its future accounts receivable,
the Company has access to a secured accounts receivable line of credit with Amerisource of approximately $3 million.
In Fiscal 2013 the Company
was awarded, as the prime contractor or as a subcontractor, several contracts from units of the Department of Defense. These contracts
awarded provide that task orders under the contracts will require competitive bids to be submitted by the Company as those task
orders are issued. Through Fiscal 2012 and 2013, the Company has sought to expand its business both domestically and internationally
by continuing to submit proposals in response to Request for Proposals (“RFP’s”).
The Company’s ability
to continue its operations is dependent upon our ability to generate sufficient cash flow either from operations, from continued
funds from officers and shareholders or from additional financing. The accompanying financial statements do not include any adjustments
that might result from the outcome of these uncertainties.
Principles of Consolidation
The financial statements include
the accounts of the Company and its wholly-owned subsidiaries. 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 has provided a reserve
for obsolescence of $80,000 of finished goods inventory at June 30, 2013 and 2012.
Property and Equipment and
Depreciation
Depreciation is provided for by
the straight-line method 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, 2013.
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, 2013 and 2012.
The following is a reconciliation
of the denominators of the basic and diluted earnings per share computations:
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Year Ended June 30,
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2013
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2012
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Denominators:
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Weighted-average shares outstanding used to compute basic earnings per share
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13,927,420
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11,123,708
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Effect of dilutive stock options
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Weighted-average shares outstanding and dilutive securities used to compute dilutive earnings per share
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13,927,420
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11,123,708
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For the year ended June 30, 2013,
there were outstanding potential common equivalent shares of 3,829,006 compared to 3,957,153 for the year ended June 30, 2012,
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, 2013, 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, 2013
and 2012, 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, 2013 and 2012 amounted to $82,065 and $139,322,
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, and did not incur advertising costs for the year ended June 30,
2013, and incurred $4,800 in advertising costs for the year ended June 30, 2012.
Shipping
and Handling
Shipping
and handling costs are recorded as costs of revenues and are approximately $14,272 and $25,700 for the years ended June 30, 2013
and 2012, 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 July 2013, the FASB issued
ASU 2013-11,
Income Taxes
, which applies to all entities that have unrecognized tax benefits when a net operating
loss, a similar tax loss, or a tax credit carryforward exists at the reporting date. The amendments in this update are effective
for fiscal years, and interim periods within those years, beginning after December 15, 2013 (our Fiscal 2015). We do not expect
the adoption of this amendment to have a material impact on our consolidated financial statements.
In March 2013, the FASB issued
ASU 2013-05, Foreign Currency Matters
, which applies to the release of the cumulative translation adjustment into net income,
when a parent either sells a part or all of its investment in a foreign entity. The amendments in this update are effective for
public companies prospectively beginning after December 15, 2013 (our Fiscal 2015) and interim and annual periods thereafter. We
do not expect the adoption of this amendment to have a material impact on our consolidated financial statements.
In February 2013, the FASB issued
ASU 2013-02, Comprehensive Income,
which contains amendments to improve the transparency of reporting reclassifications
out of accumulated other comprehensive income. For public entities, the amendments are effective prospectively, for reporting periods
beginning after December 15, 2012 (our interim period beginning January 1, 2013). The adoption of this amendment did not have a
material impact on our consolidated financial statements.
In October 2012, the FASB issued
ASU 2012-04, Technical Corrections and Improvement
, which contains amendments to make technical corrections, clarifications,
and limited-scope improvements to various topics throughout the Codification. The amendments apply to all reporting entities within
the scope of the affected accounting guidance. For public entities, the amendments that are subject to the transition guidance
will be effective for fiscal periods beginning after December 15, 2012 (our Fiscal 2014). We do not expect the adoption of this
amendment to have a material impact on our consolidated financial statements.
In July 2012, the FASB issued
ASU 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment
. This update amends ASC 350,
Intangibles –
Goodwill and Other
to allow an entity to first assess qualitative factors to determine whether it is necessary to perform the
two-step quantitative impairment test. Under that option, an entity would no longer be required to calculate the fair value of
the intangible asset unless the entity determines, based on a qualitative assessment, that it is more likely than not that its
fair value is less than its carrying amount. The amendments in this update are effective for annual and interim impairment tests
performed for fiscal years beginning after September 15, 2012 (our Fiscal 2014). This update does not have a material impact on
our consolidated financial statements.
In June 2011, the FASB issued
ASU 2011-05, Presentation of Comprehensive Income,
on comprehensive income presentation to allow an entity the option to
present the total of comprehensive income, the components of net income, and components of other comprehensive income either in
a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity
is required to present each component of net income along with total net income, each component of other comprehensive income,
and a total amount for comprehensive income. This update eliminates the option to present the components of other comprehensive
income as part of the statement of changes in stockholders’ equity. The amendments to the Codification in the ASU do not
change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified
to net income. This update should be applied retrospectively. The adoption of this amendment resulted in the addition of the Consolidated
Statements of Comprehensive Income (Loss) to our 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, 2013 and
2012 consisted of the following:
|
|
|
2013
|
|
|
2012
|
|
|
Raw materials
|
|
$
|
228,553
|
|
|
$
|
281,021
|
|
|
Work-in-process
|
|
|
323,836
|
|
|
|
277,570
|
|
|
Finished goods
|
|
|
1,369,814
|
|
|
|
1,482,076
|
|
|
Subtotal
|
|
|
1,922,203
|
|
|
|
2,040,667
|
|
|
Allowance
|
|
|
(80,000
|
)
|
|
|
(80,000
|
)
|
|
|
|
$
|
1,842,203
|
|
|
$
|
1,960,667
|
|
Note 4 – Property, Equipment and Software Development
Costs
Property, equipment and
software development costs at June 30, 2013 and 2012
consisted of the following:
|
|
|
2013
|
|
|
2012
|
|
|
Furniture and fixtures
|
|
$
|
54,032
|
|
|
$
|
54,032
|
|
|
Machinery and equipment
|
|
|
1,064,183
|
|
|
|
1,064,182
|
|
|
Improvements
|
|
|
23,008
|
|
|
|
23,008
|
|
|
Software
|
|
|
125,914
|
|
|
|
116,914
|
|
|
Software development costs
|
|
|
163,896
|
|
|
|
163,896
|
|
|
|
|
|
1,431,033
|
|
|
|
1,422,032
|
|
|
Less: accumulated depreciation and amortization
|
|
|
1,211,631
|
|
|
|
1,126,345
|
|
|
|
|
$
|
219,402
|
|
|
$
|
295,687
|
|
Depreciation and amortization expense
was $85,285 and $117,204 for the years ended June 30, 2013 and 2012, respectively.
Note 5 – Intangibles
|
|
|
June 30, 2013
|
|
|
June 30, 2012
|
|
|
|
|
Gross
Carrying
|
|
|
Accumulated
|
|
|
Gross
Carrying
|
|
|
Accumulated
|
|
|
|
|
Amount
|
|
|
Amortization
|
|
|
Amount
|
|
|
Amortization
|
|
|
Amortized intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Licenses
|
|
$
|
50,000
|
|
|
$
|
50,000
|
|
|
$
|
50,000
|
|
|
$
|
50,000
|
|
|
Patent
|
|
|
852,793
|
|
|
|
390,598
|
|
|
|
852,793
|
|
|
|
343,726
|
|
|
Trademarks
|
|
|
577,263
|
|
|
|
240,526
|
|
|
|
577,263
|
|
|
|
211,663
|
|
|
Other
|
|
|
8,881
|
|
|
|
8,881
|
|
|
|
8,881
|
|
|
|
8,881
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,488,937
|
|
|
$
|
690,005
|
|
|
$
|
1,488,937
|
|
|
$
|
614,270
|
|
Amortization expense charged to
operations was $75,735 for each of the years ended June 30, 2013 and 2012. 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 $146,962 in exchange for their shares in the subsidiary. The Company recorded this additional investment in the
subsidiary to goodwill. This goodwill was written off in Fiscal 2013.
Note 6 – Short-Term and Long-term
Debt
On June 28, 2013, ECSI International,
Inc., (the “Subsidiary”), one of the wholly-owned subsidiaries of the Company, and Atlantic Stewardship Bank (the “Bank”)
amended the terms of the credit line established in March 2011 (the “Amendment”), such that, effective May 15, 2013,
the agreement became a term loan. Under the terms of the Amendment, the principal amount outstanding of $472,975 under the credit
line is to be paid in monthly installments of $5,000, including interest, beginning July, 15, 2013 and continuing through May 15,
2015. The variable interest rate has been increased to the prime rate plus 1%, with a minimum interest rate of 5.875%. The interest
rate under the line of credit, prior to the Amendment, had been prime plus .25%, with a minimum of 4.5%.
On March 15, 2011, the Company,
through the Subsidiary, had entered into a revolving line of credit agreement with the Bank which allowed for borrowings up to
$475,000. The line of credit had included a Minimum Debt Service Coverage Ratio, as defined in the agreement, of 1.1. This requirement
was eliminated in the Amendment.
The above term loan is collateralized
by Subsidiary’s accounts receivable, inventories, equipment and general intangibles. As part of the Amendment, the Company’s
President and Chief Executive Officer provided a personal guaranty of the amounts due to the Bank, up to a maximum of $250,000.
Three of the Company’s officers executed subordination agreements which subordinated a combined total of $848,040 of amounts
due to those officers to amounts due by the Subsidiary to the Bank. Because these subordinated amounts are not to be paid until
the Bank has been repaid, the subordinated amounts have been classified as noncurrent liabilities.
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.
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 of $2,639 was paid in the year ended June 30, 2013.
Note 7 – Due to Officers, Shareholders
and Affiliates and Subordinated Liabilities to Officers and Shareholders
These amounts are composed of
the following at June 30, 2013 and 2012:
|
|
|
2013
|
|
|
2012
|
|
|
Interest bearing advances, due on demand
|
|
$
|
19,021
|
|
|
$
|
197,756
|
|
|
Other advances
|
|
|
181,200
|
|
|
|
—
|
|
|
Accrued compensation and other costs
|
|
|
241,550
|
|
|
|
827,683
|
|
|
Current liabilities to officers, shareholders and affiliates
|
|
|
441,771
|
|
|
|
1,025,439
|
|
|
Subordinated liabilities to officers and shareholders
|
|
|
848,080
|
|
|
|
—
|
|
|
|
|
$
|
1,289,851
|
|
|
$
|
1,025,439
|
|
Related to the Amendment of the
loan agreement with the Bank discussed in Note 6 above, three of the Company’s officers agreed to subordinate a total of
$848,040 of amounts due to those officers to amounts due by the Subsidiary to the Bank.
Note 8 - Income Taxes
The provision for taxes for the year ended June 30,
2013 and 2012 includes the following components:
|
|
|
2013
|
|
|
2012
|
|
|
Current
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
-
|
|
|
$
|
-
|
|
|
State
|
|
|
6,078
|
|
|
|
9,461
|
|
|
Foreign
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
6,078
|
|
|
|
9,461
|
|
|
Deferred
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(168,621
|
)
|
|
|
(188,276
|
)
|
|
State
|
|
|
(26,060
|
)
|
|
|
58,276
|
|
|
Foreign
|
|
|
-
|
|
|
|
|
|
|
|
|
|
(194,681
|
)
|
|
|
(130,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(188,603
|
)
|
|
$
|
(120,539
|
)
|
The components of the deferred
tax accounts as of June 30, 2013 and 2012 are as follows:
|
|
|
2013
|
|
|
2012
|
|
|
Deferred tax assets
|
|
|
|
|
|
|
|
|
|
Net operating loss carryforward
|
|
$
|
2,644,373
|
|
|
$
|
2,421,787
|
|
|
Allowance for doubtful accounts
|
|
|
169,745
|
|
|
|
89,865
|
|
|
Accrued compensation and other costs
|
|
|
264,042
|
|
|
|
3,994
|
|
|
Stock based compensation
|
|
|
214,695
|
|
|
|
214,695
|
|
|
Other
|
|
|
49,925
|
|
|
|
49,925
|
|
|
|
|
|
3,342,780
|
|
|
|
2,780,266
|
|
|
Deferred tax liabilities
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
80,073
|
|
|
|
72,645
|
|
|
Subtotal
|
|
|
3,262,707
|
|
|
|
2,707,621
|
|
|
Valuation allowance
|
|
|
(2,416,226
|
)
|
|
|
(2,055,821
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
$
|
846,481
|
|
|
$
|
651,800
|
|
The valuation allowance at June
30, 2011 was $1,566,159.
The
reconciliation of estimated income taxes attributed to operations at the statutory tax rates to the reported income tax benefit
is as follows
:
|
|
|
2013
|
|
|
2012
|
|
|
Expected federal tax at statutory rate
|
|
$
|
(529,077
|
)
|
|
$
|
(612,628
|
)
|
|
State taxes, net of federal tax effect
|
|
|
(84,497
|
)
|
|
|
(108,057
|
)
|
|
Non deductible expenses
|
|
|
119,255
|
|
|
|
63,685
|
|
|
Change in valuation allowance
|
|
|
360,403
|
|
|
|
489,662
|
|
|
Other
|
|
|
(54,687
|
)
|
|
|
46,789
|
|
|
|
|
$
|
(188,603
|
)
|
|
$
|
(120,539
|
)
|
At June 30, 2013, and 2012,
the Company had net operating loss carryforwards for federal and state income tax purposes of $6,445,732 and $3,521,381 respectively,
expiring through 2033. The Company has foreign net operating loss carryforwards of $608,268 with no expiration date.
At June 30, 2013 and 2012, 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, 2013 and 2012.
The Company files U.S. and state income tax returns
in jurisdictions with varying statutes of limitations. The 2007 through 2013 tax years generally remain subject to examination
by federal and most state tax authorities.
Note 9 - 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, 2013, 700,000 shares of Series A Preferred
had been converted into a like amount of common stock.
Cumulative but undeclared dividends
at June 30, 2013 total approximately $675,000.
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 were 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 2013 and 2012 is summarized
as follows:
|
|
|
Options
|
|
|
Weighted Average
Exercise Price
|
|
|
Options outstanding, June 30, 2011
|
|
|
1,530,000
|
|
|
$
|
.63
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
530,000
|
|
|
|
.19
|
|
|
Forfeited
|
|
|
(260,000
|
)
|
|
|
.57
|
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
|
Options outstanding, June 30, 2012
|
|
|
1,800,000
|
|
|
$
|
.51
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
|
Forfeited
|
|
|
(325,000
|
)
|
|
|
.31
|
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
|
Options outstanding June 30, 2013
|
|
|
1,475,000
|
|
|
$
|
.55
|
|
|
Aggregate intrinsic value
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at June 30, 2013
|
|
|
1,475,000
|
|
|
$
|
.55
|
|
|
Shares of common stock available for future grant under the plans
|
|
|
2,370,000
|
|
|
|
|
|
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 2013 and fiscal 2012.
The following
table summarizes information about stock options outstanding at June 30, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Exercisable
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
Remaining
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
Number
|
|
|
Contractual
|
|
|
Exercise
|
|
|
Number
|
|
|
Exercise
|
|
|
Ranges of price
|
|
|
Outstanding
|
|
|
Life
|
|
|
Price
|
|
|
Exercisable
|
|
|
Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
.07
|
|
|
|
80,000
|
|
|
|
5.47
|
|
|
$
|
.07
|
|
|
|
80,000
|
|
|
$
|
.07
|
|
|
$
|
.17
|
|
|
|
190,000
|
|
|
|
6.44
|
|
|
$
|
.17
|
|
|
|
190,000
|
|
|
$
|
.17
|
|
|
$
|
.19
|
|
|
|
220,000
|
|
|
|
8.36
|
|
|
$
|
.19
|
|
|
|
220,000
|
|
|
$
|
.19
|
|
|
$
|
.21-.22
|
|
|
|
290,000
|
|
|
|
4.98
|
|
|
$
|
.22
|
|
|
|
290,000
|
|
|
$
|
.22
|
|
|
$
|
.75
|
|
|
|
295,000
|
|
|
|
3.73
|
|
|
$
|
.75
|
|
|
|
295,000
|
|
|
$
|
.75
|
|
|
$
|
1.00-1.07
|
|
|
|
175,000
|
|
|
|
1.17
|
|
|
$
|
1.02
|
|
|
|
175,000
|
|
|
$
|
1.02
|
|
|
$
|
1.20
|
|
|
|
225,000
|
|
|
|
1.53
|
|
|
$
|
1.20
|
|
|
|
225,000
|
|
|
$
|
1.20
|
|
|
$
|
.07-$1.20
|
|
|
|
1,475,000
|
|
|
|
4.47
|
|
|
$
|
.55
|
|
|
|
1,475,000
|
|
|
$
|
.55
|
|
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 year ended June
30, 2012, using the Black-Scholes option-pricing (no options were granted during the fiscal year ended June 30, 2013):
|
|
|
2012
|
|
|
Risk free interest rate
|
|
|
0.90
|
%
|
|
Expected life
|
|
|
9.6
|
|
|
Expected volatility
|
|
|
186.3
|
%
|
|
Dividend yield
|
|
|
0
|
%
|
|
Weighted-average grant date fair value per share
|
|
$
|
0.183
|
|
As of June 30, 2013, there
was no unrecognized compensation cost related to nonvested options granted because all options have vested.
Note 10 - Concentrations
and Economic Dependency
The
Company had four customers that accounted for 22%, 18%, 13%, and 6% of net revenues for the year ended June 30, 2013 and three
customers that accounted for 63%, 7%, and 6% of net revenues for the year ended June 30, 2012. One customer accounted for approximately
93% of the accounts receivable as of June 30, 2013. At June 30, 2013 approximately 2% of 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, 2013 and
2012, 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, 2013 and 2012.
Note 11 – Commitments and Contingencies
Lease Agreements
Future minimum annual rental payments
required under non-cancelable operating leases for years after June 30, 2013 are as follows:
|
2014
|
|
$
|
74,141
|
|
|
2015
|
|
|
75,624
|
|
|
2016
|
|
|
77,137
|
|
|
2017
|
|
|
78,679
|
|
|
2018
|
|
|
66,655
|
|
|
|
|
$
|
372,236
|
|
Rent
expense under all operating leases was $95,270 and $91,213 for the years ended June 30, 2013 and 2012, 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 (FOIDS
â
). In conjunction
with these two license agreements whereby royalties totaling 5.4% are due on revenues from the Fiber Optic Intelligence Detection
System (FOIDS
â
).
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, 2013,
the Company has included in its accounts receivable (prior to allowances) the amount of the actual damages claimed. In Fiscal 2013,
Lockheed Martin was granted a motion to have the matter moved from New Jersey to Maryland. We had been aggressively pursuing our
claim against Lockheed Martin. However, due to cash flow constraints, we have not pursued our claims against Lockheed Martin in
Maryland.
Loss Contingencies
During the year ended June
30, 2013, litigation incidental to the business of SEM Consultants III, Inc., a wholly-owned subsidiary of the Company resulted
in an award to the plaintiff of $20,000 in damages and $42,398 in attorney fees. Plaintiff’s attorney filed an appeal requesting
additional legal fees of $138,000. The Court had originally denied the request for additional legal fees, but it is possible the
appeal could increase the legal fees awarded to the plaintiff’s counsel.
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, other than the matter discussed in the paragraph above.
Note 12 – 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:
|
|
|
U.S.
|
|
|
% of total
|
|
|
Middle East
|
|
|
% of total
|
|
|
For the year ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
835,064
|
|
|
|
85.06
|
%
|
|
$
|
146,636
|
|
|
|
14.94
|
%
|
|
Operating income (loss)
|
|
|
(1,114,860
|
)
|
|
|
88.32
|
%
|
|
|
(147,465
|
)
|
|
|
11.68
|
%
|
|
Identifiable assets
|
|
|
4,226,540
|
|
|
|
97.51
|
%
|
|
|
107,821
|
|
|
|
2.49
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the year ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2012
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
2,054,754
|
|
|
|
92.72
|
%
|
|
$
|
161,328
|
|
|
|
7.28
|
%
|
|
Operating income (loss)
|
|
|
(1,629,548
|
)
|
|
|
(103.13
|
)%
|
|
|
50,234
|
|
|
|
3.18
|
%
|
|
Identifiable assets
|
|
|
4,686,427
|
|
|
|
94.08
|
%
|
|
|
294,647
|
|
|
|
5.92
|
%
|
Note 13 – Related Party Transactions
The Company made non-interest
bearing advances, due on demand, to a former officer and director of the Company. The balance outstanding at June 30, 2012 was
$49,765. During the year ended June 30, 2013, the amount due from the former officer and director was offset against amounts due
to the officer and director. Refer to Note 10 above for information regarding amounts due to officers and directors of the Company.