TMCnet News
ELECTRONIC CONTROL SECURITY INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Overview We design, develop, manufacture and market stand-alone and fully integrated state-of-the-art perimeter intrusion detection systems for all environments, including land, air and water through a secure communications infrastructure to central or distributed command and control centers. We support system integrators and end users in addressing risk assessment and vulnerability concerns in order to mitigate risk and ascertain a customer's security requirements. 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. Based on ECSI's flexibility, cost effective systems are developed that provide ease of operational maintenance. ECSI has been involved in the design and implementation of Entry Control Portals (ECP) and Perimeter Intrusion Detection and Assessment Systems (PIDAS) for the past 35 years for national and international high-threat facilities. During that time ECSI researched and evaluated the latest developments in technologies through government and university programs. In addition, we have participated in testing various manufacturers' products through technology transfer and teaming relations in the U.S. and abroad. 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), State Department-approved foreign government facilities (International Airport in Southeast Asia and pending upgrades for international airports in the Middle East and Central America), commercial and residential sites. Critical Accounting Policies We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, management evaluates its estimates, including those related to inventory reserves, allowance for doubtful accounts and deferred taxes. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies and the related judgments and estimates affect the preparation of our financial statements. Inventory Valuation - Inventories are valued at lower of cost or market. We routinely evaluate the composition of our inventory to identify obsolete or otherwise impaired inventories. Inventories identified as impaired are evaluated to determine if reserves are required. Allowance for Doubtful Accounts - The allowance for doubtful accounts is comprised of two parts, a specific account analysis and a general reserve. Accounts where specific information indicates a potential loss may exist are reviewed and a specific reserve against amounts due is recorded. As additional information becomes available such specific account reserves are updated. Additionally, a general reserve is applied to the aging categories based on historical collection and write-off experience. 21 -------------------------------------------------------------------------------- Accounting for Income Taxes - We record a valuation allowance to our deferred tax assets to the amount that is more likely than not to be realized. While we consider historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event that we determine that we would be able to realize deferred tax assets in the future in excess of the net amount recorded, an adjustment to the deferred tax asset would increase income in the period such determination has been made. Likewise, should we determine that we would not be able to realize all or part of the net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged against income in the period such determination was made. A valuation allowance in the amount of $1,566,159 has been recorded against our deferred tax asset at June 30, 2011. We account for stock-based compensation in accordance accounting guidance now codified as Financial Accounting Standards Board (FAS) Accounting Standards Codification (ASC) Topic 718, "Compensation - Stock Compensation." Under the fair value recognition provision of FAS ASC Topic 718, stock-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period of the individual equity. We use the Black-Scholes option-pricing model to estimate the fair value of options. In order to calculate the fair value of the options, assumptions are made for certain components of the model, including risk-free interest rate, volatility, expected dividend yield rate and expected option life. Although we use available resources and information when setting these assumptions, changes to the assumptions could cause significant adjustments to the valuation. Results of Operations Year Ended June 30, 2011 ("Fiscal 2011 Period") Compared to Year Ended June 30, 2010 ("Fiscal 2010 Period") Revenues. We had net revenues of $3,958,941 for the Fiscal 2011 Period, as compared to revenues of $4,513,737 for the Fiscal 2010 Period, representing a decrease of approximately 12%. Of the revenues reported in the Fiscal 2011 period, approximately 90% are attributable to domestic projects and 10% are attributable to international projects. The decrease in sales in the Fiscal 2011 Period is attributable to the delays encountered by the Government related to the Navy contract with Lockheed Martin, in which we are a subcontractor. The Government has delayed the review and approval process and has implemented design changes that had a $2 million negative impact on sales for this fiscal year. Gross Margins. Gross margins for the Fiscal 2011 Period were 50% of revenue as compared to 55% of revenue for the Fiscal 2010 Period. The decrease in gross margins is primarily attributable to a change in the order mix of equipment sales and support services. Although we encountered a small decrease in material cost, we experienced an increase in design and engineering support service costs which, combined, resulted in the decrease in gross margins for the Fiscal 2011 Period. Research and Development (R&D). Research and development expenses increased less than 1% in the Fiscal 2011 Period to $129,722 from $129,358 in the Fiscal 2010 Period. Research and development expenses were maintained at previous levels for continued new product development during this period. Selling, General and Administrative (SG&A). Selling, general and administrative expenses decreased 20% in the Fiscal 2011 Period to $1,413,240 from $1,771,923 for the Fiscal 2010 Period. The decrease in selling, general and administrative expenses is attributable to our enhanced collection on receivables thus eliminating any unforeseen write-offs during this period. 22 -------------------------------------------------------------------------------- Stock Based Compensation. In the 2011 Period, we did not issue stock options to our directors or employees. The value of options is amortized over the vesting period of the underlying award. In the 2010 Period, we issued stock options to various consultants and to the directors that were valued at $45,688. Stock-based compensation is non-cash and, therefore, has no impact on cash flow or liquidity. Interest Expense. Interest expense in the Fiscal 2011 Period was $1,078 as compared to $178,925 for the Fiscal 2010 Period. Included in interest expense for fiscal 2010 is the interest on the convertible debentures and the settlement accrued for the convertible debenture holders. The debentures matured in January 2009 and were repaid in July 2010. Income Tax Benefit. We recognized a net $128,000 deferred tax benefit from net operating profits or losses in Fiscal 2011 and did not recognize any income tax benefit for 2010. Net Profit/Loss. Net profit before dividends for the Fiscal 2011 period was $530,130 as compared to a net profit of $382,858 in Fiscal 2010. Dividends Related to 10% Series B Convertible Preferred Stock. We recorded dividends totaling $148,564 on our Series B Convertible Preferred Stock in Fiscal 2011 and $134,592 in Fiscal 2010. In lieu of a cash payment, we have elected, under the terms of the agreement whereby these securities were sold, to add this amount to the stated value of the Series B Convertible Preferred Stock. These dividends are non-cash and, therefore, have no impact on our net worth or cash flow. Liquidity and Capital Resources We believe that cash on hand, together with anticipated collection of accounts receivable during the short term, will be sufficient to provide for our working capital needs for the next twelve months. However, we may need to raise funds in order to allow for shortfalls in anticipated revenue or to expand existing capacities and/or to satisfy any additional significant purchase order that we may receive. At the present time, we have no commitments or assurances of additional revenue beyond the firm purchase orders we have received. However, in March 2011, we entered into, through our wholly owned subsidiary, ECSI International Inc., a credit facility with a New Jersey based commercial bank enabling us to borrow up to $475,000 for working capital purposes on an as needed basis. We have also registered with the U.S. Securities and Exchange Commission ("SEC") shares of our common stock underlying an equity line agreement entered into with Auctus Private Equity Fund in February 2011 pursuant to which they have agreed under certain conditions, to purchase up to $10 million of our common stock over a five year period. At June 30, 2011, we had working capital of $1.8 million compared to $1.3 million at June 30, 2010. Net cash provided by operating activities for Fiscal 2011 was $33,480 as compared to $687,689 for Fiscal 2010. Inventory increased by $133,433 in Fiscal 2011. However, we anticipate a decrease during the first half of 2012 for shipments on committed projects that have been or are being released. Day's sales outstanding (DSO) were approximately 97 days at June 30, 2011 as compared with 153 DSO at June 30, 2010. This is due to a concerted effort by management to collect outstanding invoices and settle questionable accounts in order to improve cash flow in Fiscal 2011. 23 -------------------------------------------------------------------------------- Accounts payable and accrued expenses have decreased by $1,455,110 in the Fiscal 2011 Period. Investing activities for Fiscal 2011 included equipment and software purchases totaling $357,515, primarily related to upgrade two major product lines. We do not have any material commitments for capital expenditures going forward. Investing activities for Fiscal 2010 included $15,214 for product upgrades. In Fiscal 2008, the Company financed the purchase of equipment from a vendor in the amount of $101,762, evidenced by a bearing interest at the rate of 8% per annum. As the Company purchases product from the vendor a portion of each invoice will be charged to reduce the note balance. Management expects that the note will be repaid within the next 12 months. The balances at June 30, 2011 and 2010 were $14,237 and $43,754, respectively. In July of 2010, $33,500 of loans due to officers was converted into stock though the exercise of options issued under the Employee Stock Option Plan. Discussion of Results, Business Outlook and Identifiable Industry Trends Spending in the security industry has stabilized over the last year as the U.S. Congress has continued to allocate money to fund homeland security initiatives including Department of Energy and Department of Defense programs. We expect this trend will continue for the foreseeable future. As a result, the level of new proposals continues and our committed backlog, including awards for the U.S. Navy, U.S. Air Force and nuclear power stations, is one of the largest in our history. We cannot, however, assure you that we will complete any or all of the orders comprising our backlog within the anticipated time frame. Our experience has taught us that all of these anticipated releases and new contracts are subject to cancellation or delay, thus we cannot be certain of the total realized revenue amount of our backlog and do not even reference the total dollar amount of our present backlog or submitted proposals. Our sales dependency has continued to shift from our President and Chief Executive Officer, Arthur Barchenko, to marketing and sales representatives, program and project managers to meet our revenue objectives. During the last year, we continued to mitigate the concentration of sales efforts by (i) engaging independent sales representatives to market our products and generate sales opportunities and (ii) expanding sales efforts through dealer-installers and system integrators in geographic regions on which we have not focused our resources in years past such as Latin America, Egypt and the Middle East, China and Africa, where we are developing projects that management believes will result in ongoing revenue. During the Fiscal 2011 period, we submitted bids on 33 new projects for work to be performed at our Clifton, New Jersey facilities. We cannot be certain that we will be successful in winning any of the bids tendered. Even if we do receive orders, contracts are subject to cancellation by customers upon short notice with little or no penalty, as is typical in our industry. During Fiscal 2011, in conjunction with JMAR, LLC, we upgraded our water monitoring and detection system to include biological detection and will offer three versions to the market under a cross licensing agreement for chemical, biological or combined chemical/biological detection. During Fiscal 2011, we entered into an OEM agreement for the manufacture of an extensive line of thermal imaging cameras. We are committed to offering our customers comprehensive, integrated security system solutions that employ the latest technologies and address the most critical security requirements. The security industry continues to evolve rapidly as new technologies are developed specifically to meet security challenges and existing technologies are being adapted for new uses. In addition, the public and private sectors continue to analyze and distinguish new security risks and industry participants seek to develop technologies and products to fill these newly discerned requirements. We remain committed to pursuing teaming and OEM agreements that may add to our revenues and enhance both our product line and, ultimately, our ability to compete in our industry. 24 -------------------------------------------------------------------------------- Business Outlook As global economic prospects changed during 2011, orders and commitments increased due to the need for improved security levels while reducing manpower and maintenance costs. Currently, proposals for new orders continue to grow. However, our historical results have taught us that the release of funds that support proposals may never be forthcoming. Furthermore, as is customary in the security industry, our contracts are subject to cancellation or delay at any time with little notice or penalty. Government based purchase orders which are subject to legislative appropriations are particularly sensitive to economic and political conditions. Thus, we cannot be certain of the total realized value and revenue which we will generate from committed orders. We expect to receive releases and task orders for a significant portion of our contract commitments within the next twelve months, although we cannot be certain that we will complete any or all of such orders within the anticipated time frame. The security industry as a whole has changed. The security market historically has been a product oriented opportunity for manufacturers, both within the United States and internationally. The difficulty the industry traditionally faced has been the ability to develop a standard security platform that would permit systems integrators to design a seamless interface between the multiple products and subsystems required to address threats in high-security environments. The Company has developed a platform that addresses seamless integration of multiple technologies including legacy and government-furnished equipment. We expect this trend to continue for the foreseeable future, since the demand for integrated platforms has become a necessity. We continue to seek to improve our integrated systems and have retained highly-competent systems and computer-oriented electronic engineers to further develop and enhance the integrated platform for current and future projects. Business Approach Over the last several years we have tried to develop contacts and relationships through our marketing programs and staff with clearly defined and targeted potential strategic partners. The strategic relationship framework provides a comprehensive and thorough mechanism for developing and implementing corporate strategy. Our advisory board determined early in our existence that, given our size and the criticality of our business situation, the strategic relationship framework would provide us with a non-resource exhaustive and more expedient and efficient means of entering new markets. This approach has met with considerable success and we continue to seek strategic alliances. We believe we are positioned for economic success during Fiscal 2012 which should continue into 2013 and beyond. A number of factors contribute to this outlook. • Our estimate that orders recently received, including nuclear power station security upgrades; U.S. Air Force and U.S. Navy base equipment purchases; relationships developed with M.C. Dean, Sandia, Enercon, and the Shaw Group may result in product purchase orders that should yield significant sales in 2012. • The conclusion of agreements with new strategic partners for the U.S. Navy base security upgrade program will be a source of material orders during Fiscal 2013 through Fiscal 2018.. • We have entered into marketing and sales agreements with five firms well positioned in the Middle and Far East, eastern Europe and Africa to address ports, airports and border security opportunities. 25-------------------------------------------------------------------------------- Recently Issued Accounting Pronouncements In January 2010, the FASB issued amended standards that require additional fair value disclosures. These amended standards require disclosures about inputs and valuation techniques used to measure fair value as well as disclosures about significant transfers, beginning in the first quarter of 2010. Additionally, these amended standards require presentation of disaggregated activity within the reconciliation for fair value measurements using significant unobservable inputs (Level 3), beginning in the first quarter of 2011. Management does not expect these new standards to significantly impact its consolidated financial statements. The Financial Accounting Standards Board ("FASB") amended ASC 350, "Intangibles - Goodwill and Other," with Accounting Standards Update ("ASU") 2010-28, "When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts." This update requires that step 2 of the goodwill impairment test (i.e., measurement and recognition of an impairment loss) be performed if a reporting unit has a carrying value equal to or less than zero and qualitative factors indicate that it is more likely than not that a goodwill impairment exists. The provisions of this update are effective for annual reporting periods beginning after December 15, 2010. Management does not expect these new standards to significantly impact its consolidated financial statements. In June 2011, the FASB issued ASU Topic No. 2011-05, Comprehensive Income (Topic 220)-Presentation of Comprehensive Income, which updates the presentation requirements related to comprehensive income. The total of comprehensive income, the components of net income, and the components of other comprehensive income may be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU No. 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. The update is effective for interim and annual periods beginning after December 15, 2011. Management does not expect these new standards to significantly impact its consolidated financial statements. In May 2011, the FASB issued ASU Topic No. 2011-04, Fair Value Measurement (Topic 820)-Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, which expands the disclosure requirements for fair value measurements. More quantitative and qualitative disclosures will be required for fair value measurements using level 3 inputs. ASU No. 2011-04 is effective for interim and annual periods beginning after December 15, 2011. Management does not expect these new standards to significantly impact its consolidated financial statements. 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. |