ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
The following discussion
should be read in conjunction with our financial statements and the notes related to those statements. Some of our discussion is
forward-looking and involves risks and uncertainties. For information regarding risk factors that could have a material adverse
effect on our business, refer to the risk factors section of the Annual Report for the year ended June 30, 2013 on Form 10-K.
CAUTION REGARDING FORWARD-LOOKING STATEMENTS
Our Company and its representatives
may from time to time make written or verbal forward-looking statements, including statements contained in this report and other
Company filings with the Securities and Exchange Commission and in our reports to shareholders. Statements that relate to other
than strictly historical facts, such as statements about our plans and strategies, expectations for future financial performance,
new and existing products and technologies, and markets for our products are forward-looking statements. Generally, the words "believe,"
"expect," "intend," "estimate," "anticipate," "will" and other similar expressions
identify forward-looking statements. The forward-looking statements are and will be based on our management's then-current views
and assumptions regarding future events and operating performance, and speak only as of their dates. Investors are cautioned that
such statements involve risks and uncertainties that could cause actual results to differ materially from historical or anticipated
results due to many factors including, but not limited to, our current and future capital needs, uncertainty of capital funding,
our clients' ability to cancel contracts with little or no penalty, ongoing delays by federal agencies of approved projects; cash
flow impact arising from the dispute with prime contractors; government initiatives to implement Homeland Security measures, the
state of the worldwide economy, competition, customers’ ability to pay our invoices within our standard credit terms, and
other risks detailed in our Company's most recent Annual Report on Form 10-K and other Securities and Exchange Commission filings.
We undertake no obligation to publicly update or revise any forward-looking statements.
OVERVIEW
We design, develop, manufacture
and market stand-alone and fully integrated state-of-the-art entry control and perimeter intrusion detection systems for Department
of Defense, Department of Energy, nuclear power stations, and various international customers. We offer U.S. Air Force certified
technology and a comprehensive services portfolio that includes: site survey/risk assessment, design & engineering, systems
manufacturing and integration, factory acceptance testing, installation supervision, commissioning, operations and maintenance
training.
We work closely with architects,
engineers, systems integrators, construction managers and owners in the development and design of security monitoring and control
systems that will afford a normative but secure environment for management, staff and visitors. To support such efforts, ECSI’s
team of key personnel are technically accomplished and fully familiar with advances in planning, programming and designing systems
utilizing standard peripheral components, mini/micro architecture, user friendly software/firmware selection and application.
Our mission is to establish
ourselves as a Small Business (SB) prime contractor to take advantage of the small business opportunities that exist today and
in the foreseeable future. To achieve that end, we have formed a team of both small and large corporation agreements to support
our company in the pursuit of this market. We believe that our past performance and in depth experience as well as that of our
teaming partners will place us in a lead position to capture a good share of this market.
We entered into strategic
partnerships, teaming, and representative relationships with major multi-national corporations in each of the industries that comprise
our target markets. These companies generally enjoy a strong market presence in their respective industries and we believe that
our teaming agreements with these entities afford us added credibility. These entities frequently subcontract our services and
purchase our products in connection with larger projects and, in turn, support the company on projects we are pursuing as the prime
contractor. During fiscal 2011, 2012 and 2013 we entered into teaming and marketing agreements with ITSI, SAIC, Fortis, Calnet,
Honeywell, Culmen, ERIS, and Boeing.
During fiscal 2012, 2013
and 2014, 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 $182,750,000. Of these, other bidders were awarded $16 million and we have been
awarded, as the prime contractor and as a subcontractor, contracts with an approximate value of $35 million over five years. However,
as noted below, we continue to be negatively impacted by the ongoing delays by agencies of the U. S. Government in proceeding with
approved projects, funding projects already awarded, and in awarding new contracts. We anticipate decisions relating to the still-open
proposals during fiscal 2014 and 2015.
Recent Developments
Our revenues and results
from operations for the years ended June 30, 2013 and 2012, and the nine and three month periods ended March 31, 2014, continued
to be negatively impacted by the ongoing delays by agencies of the U.S. Government in proceeding with approved projects, funding
projects already awarded, and in awarding new contracts. We have invested significant time and personnel resources in fiscal 2013
and 2012 and to date in fiscal 2014 in providing proposals on future projects, both as a prime contractor (Small Business) and
as a subcontractor. We are awaiting the results of the bidding process. Additionally, our cash flow and liquidity continue to be
severely impacted with the refusal by Lockheed Martin to pay us for the accounts receivable due from them totaling almost $1 million.
These amounts are the subject of litigation, as described in Item 3 of our Annual Report on Form 10-K for the year ended June 30,
2013.
On June 28, 2013, one
of our wholly-owned subsidiaries amended its previous line of credit agreement with Atlantic Stewardship Bank (“ASB”).
Under the terms of the amended loan agreement, the principal balance outstanding on June 28, 2013 will be paid in monthly installments
of $5,000 including interest, beginning July 15, 2013 and continuing through May 15, 2015. The remaining outstanding balance is
due on June 15, 2015. Under the terms of the amended agreement, the variable interest rate increased to the prime rate plus 1%,
with a minimum of 5.875%. The prior line of credit agreement had carried an interest rate of the prime rate plus .25%, with a minimum
rate of 4.5%. The previous covenant requiring a minimum debt service coverage ratio was eliminated in the amended agreement.
The above term loan is
collateralized by the subsidiary’s accounts receivable, inventories, equipment and general intangibles. As part of the amended
agreement, our President and Chief Executive Officer provided a personal guaranty of the amounts due to ASB, up to a maximum of
$250,000. Three of our officers executed subordination agreements which subordinated a combined total of $848,080 of amounts due
to those officers to amounts due by the subsidiary to ASB. Because these subordinated amounts are not to be paid until ASB has
been repaid, the subordinated amounts have been classified as noncurrent liabilities.
CRITICAL ACCOUNTING POLICIES
Our condensed consolidated
financial statements and accompanying notes have been prepared in accordance with U.S. generally accepted accounting principles.
The preparation of these financial statements requires that we make estimates, judgments and assumptions that affect the reported
amounts of assets, liabilities, revenues and expenses. Management continually evaluates the accounting policies and estimates it
uses to prepare the condensed consolidated financial statements. We base our estimates on historical experience and assumptions
believed to be reasonable under current facts and circumstances. Actual amounts and results could differ from these estimates made
by management.
We do not participate in,
nor has there been created, any off-balance sheet special purpose entities or other off-balance sheet financing. In addition, we
do not enter into any derivative financial instruments for speculative purposes.
We have identified the following
critical accounting policies that affect the more significant judgments and estimates used in the preparation of our condensed
consolidated financial statements.
INVENTORY VALUATION
Inventories are valued at
the lower of cost or market. We routinely evaluate the composition of our inventory to identify obsolete or otherwise impaired
inventories. Inventories identified as impaired are evaluated to determine if reserves are required. We currently have a reserve
of $80,000 against inventory.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The allowance for doubtful
accounts is comprised of two parts, a specific account analysis and a general reserve. Accounts where specific information indicates
a potential loss may exist are reviewed and a specific reserve against amounts due is recorded. As additional information becomes
available, such specific account reserves are updated. Additionally, a general reserve is applied to the aging categories based
on historical collection and write-off experience.
ACCOUNTING FOR INCOME TAXES
We record a valuation allowance
to our deferred tax assets for the amount that is more likely than not to be realized. While we consider historical levels of income,
expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies
in assessing the need for the valuation allowance, in the event that we determine that we would be able to realize deferred tax
assets in the future in excess of the net amount recorded, an adjustment to the deferred tax asset would increase income in the
period such determination has been made. Likewise, should we determine that we would not be able to realize all or part of the
net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged against income in the period such
determination was made.
FAIR VALUE OF EQUITY INSTRUMENTS
The valuation of certain
items, including valuation of warrants or stock options that may be offered as compensation for goods or services, involve significant
estimations with underlying assumptions judgmentally determined. Warrants are valued using the most reliable measure of fair value,
such as the value of the goods or services rendered, if obtainable. If such value is not readily obtainable, the valuation of warrants
and stock options are then based on the Black-Scholes valuation model, which involves estimates of stock volatility, expected life
of the instruments and other assumptions.
RESULTS OF OPERATIONS
COMPARISON OF THE NINE AND THREE MONTH PERIODS
ENDED MARCH 31, 2014 COMPARED TO THE NINE AND THREE MONTH PERIODS ENDED MARCH 31, 2013
REVENUES. We had net revenues
for the nine months ended March 31, 2014 of $309,204 compared to $936,168 in the corresponding period in 2013, representing a decrease
of approximately 67%. Revenues for the three months ended March 31, 2014 were $76,197 compared to $81,990 for the three months
ended March 31, 2013, representing a decrease of approximately 7%. The decrease in net revenues in the nine and three month periods
ended March 31, 2014 compared to the corresponding periods in 2013 are primarily attributable to a decrease in deliverable products
and support services billings resulting from continuing delays in release of funding at the Department of Defense and Department
of Energy on projects where we serve as a subcontractor as well as at other customers. The budget constraints and budget uncertainty
at the U.S. government agencies have significantly reduced the issuance of orders and delayed projects for all participants in
our industry.
GROSS PROFIT (LOSS).
We had a gross loss for the nine months ended March 31, 2014 of $(69,854) as compared to a gross profit of $432,122 for the
corresponding period in 2013, and we had a gross loss for the three months ended March 31, 2014 of $(45,890) as compared to a
gross loss of $(47,415) for the three months ended March 31, 2013. The decrease in gross profit for the nine month period of
2014 compared to the same period in 2013 is primarily attributable to the decrease in revenues discussed above. The
improvement or reduction in the gross loss in the three months ended March 31, 2014, as compared to the same period in 2013
was due primarily to reduced personnel costs substantially offset by the reduced revenues in the 2014 period.
RESEARCH AND DEVELOPMENT.
Research and development expenses were $33,605 and $-0- for the nine and three months ended March 31, 2014, respectively, compared
to $68,657 and $21,863 for the corresponding periods of 2013. The decrease in research and development expenses was due to reductions
in personnel costs and to the elimination of research and development in the three months ended March 31, 2014.
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES. Selling, general and administrative expenses were $639,768 and $212,205 for the nine and three months ended March 31,
2014, respectively, compared to $758,020 and $268,960 for the corresponding periods in 2013. The decrease in selling, general and
administrative expenses during the periods ended March 31, 2014 as compared to the corresponding periods in 2013 is primarily attributable
to reduced personnel costs.
LOSS FROM OPERATIONS.
The loss from operations for the nine months ended March 31, 2014 was $(743,227) compared to a loss of $(394,555) for the corresponding
nine months of 2013. The increase in the loss from operations during the nine months ended March 31, 2014 as compared to the 2013
period was primarily attributable to the reduced revenues partially offset by reduced operating costs. The loss from operations
for the three months ended March 31, 2014 was $(258,095) compared to a loss of $(338,238) for the corresponding three months of
2013. The decrease, or improvement, in the loss from operations during the three months ended March 31, 2014 as period compared
to the 2013 period was primarily attributable to the reduced personnel costs and other operating expenses.
DIVIDENDS RELATED TO
CONVERTIBLE PREFERRED STOCK. We recorded dividends totaling $120,817 on our Series B Convertible Preferred Stock in the nine months
ended March 31, 2014 and $109,455 in the corresponding nine months in 2013. In lieu of a cash payment, we have elected, under the
terms of these securities, to add this amount to the stated value of the Series B Convertible Preferred Stock.
These dividends are non-cash
and, therefore, have no impact on our net worth, cash flow or liquidity.
LIQUIDITY AND CAPITAL RESOURCES
The condensed consolidated
financial statements have been prepared based on our continuing as a going concern, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of business. We incurred losses before dividends of $691,269 in the nine
months ended March 31, 2014, and $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 of 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. Through the periods ended March 31, 2014, 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 needed to maintain operations. Through Fiscal 2012, 2013 and to date in 2014, 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 were addressed in our Form 10-K for the year ended June
30, 2013.
We have working capital
of approximately $334,000 and stockholders’ equity of approximately $731,000 as of March 31, 2014. 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, three of the Company’s officers agreed to subordination agreements with the Bank, under which a total of $848,080
of amounts due to those officers has been subordinated to amounts due to the Bank. 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 $1,288,637. 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 and $458,739 during the nine months ended March 31, 2014. In March 2014,
the Company received a commitment letter from Amerisource Funding (“Amerisource”) for a working capital credit facility
in the amount of $5 million line supported by accounts receivable. The Company has not yet accepted the commitment letter.
In Fiscal 2013 we were
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 us as those task orders are
issued. Through Fiscal 2012 and 2013 and to date in Fiscal 2014, we have sought to expand our business both domestically and internationally
by continuing to submit proposals in response to Request for Proposals.
Our ability to continue
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.
Our
cash flow has been adversely impacted by the refusal of Lockheed Martin to forward to us the proceeds of accounts receivable payable
to us. This matter is currently the subject matter of litigation initiated by us in March 2012 and discussed in Item 3 of our
Annual Report on Form 10-K for the year ended June 30, 2013. Nonetheless, we believe that cash on hand, together with collection
of anticipated accounts receivable during the short term, will be sufficient to maintain operations for the next 12 months. However,
we may need to raise funds in order to allow for shortfalls in anticipated revenue or to expand existing capacities and/or to
satisfy any additional significant purchase orders that we may receive. At the present time, we have no assurances of additional
revenue beyond the firm purchase orders we have received. In March 2014, the Company received a commitment letter from Amerisource
for a working capital credit facility in the amount of $5 million line supported by accounts receivable. The Company has not yet
accepted the commitment letter. In addition to Americsource , we have held discussions with various parties in order to raise
additional funds through debt or equity issuance; to date we have not entered into any agreements; however, no assurance can be
provided that we will be able to enter into such agreements on commercially reasonable terms..
Accounts payable and accrued
expenses have increased by $284,062 to $1,426,453 for the nine months ended March 31, 2014. Current liabilities to officers, shareholders
and affiliates increased by $458,739 to $900,510 in the nine months ended March 31, 2014.
We do not have any major
material commitments for capital expenditures going forward.