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EX-10.10 - EX-10.10 - ELECTRONIC CONTROL SECURITY INCv235834_ex10-10.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K

(Mark One)
 
x
 
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the Fiscal Year Ended June 30, 2011
     
¨
 
TRANSITION REPORT UNDER SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from: _____________ to _____________
 
Commission File Number: 0-30810
 
ELECTRONIC CONTROL SECURITY INC.
(Exact name of registrant as specified in its charter)
 
New Jersey
22-2138196
(State or Other Jurisdiction of
(I.R.S. Employer Identification No.)
Incorporation or Organization)
 
 
790 Bloomfield Avenue, Clifton, New Jersey
07012
(Address of Principal Executive Offices)
(Zip Code)
 
Registrant's telephone number, including area code: (973) 574-8555
 
Securities registered under Section 12(b) of the Exchange Act: None
 
Securities registered under Section 12(g) of the Exchange Act:
$0.001 Par Value Common Stock
(Title of Class)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ¨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. ¨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 ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  ¨ No  ¨
 
Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained in this 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.

Large accelerated filer
¨
 
Accelerated filer
¨
Non-accelerated filer 
¨
 
Smaller reporting company
x
 
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 ¨ No x .
 
As of September 26, 2011, there were 10,952,132 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 $1,311,418 on June 30, 2011  Such market value was calculated using the closing price of the Common Stock as of such date as quoted on the OTC Bulletin Board on such date.
 
DOCUMENTS INCORPORATED BY REFERENCE
Information required by Part III of Form 10-K is incorporated by reference to portions of the registrant’s definitive proxy statement for its 2011 annual meeting of stockholders, which will be filed on or before October 28, 2011.

 
 

 
 
TABLE OF CONTENTS
 
   
Page
PART I
   
     
Item 1.
Business
1
Item 1A.
Risk Factors
13
Item 1B.
Unresolved Staff Comments
19
Item 2.
Properties
19
Item 3.
Legal Proceedings
19
Item 4.
(Removed and Reserved)
19
     
PART II
   
     
Item 5.
Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
20
Item 6.
Selected Financial Data
20
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
21
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
26
Item 8.
Financial Statements and Supplementary Data
27
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
27
Item 9A.
Controls and Procedures
27
Item 9B.
Other Information
28
     
PART III
   
     
Item 10.
Directors, Executive Officers and Corporate Governance
 
Item 11.
Executive Compensation
 
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
Item 13.
Certain Relationships and Related Transactions and Director Independence
29
Item 14.
Principal Accountant Fees and Services
 
Item 15.
Exhibits, Financial Statement Schedules
 

 
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FORWARD LOOKING STATEMENTS
 
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; 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.

 
iii

 
 
PART I
 
Item 1. Business
 
Overview
 
Electronic Control Security Inc. (“ECSI” or the “Company” or “we” or “us”) designs, develops, manufactures and markets 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.
 
Primary markets that we target include:

 
the U.S. Government, its agencies and departments, including the Department of Defense and the Department of Energy;
 
large industrial facilities, including pharmaceutical companies and major office complexes;
 
energy facilities, including nuclear power stations, utilities, chemical-petrochemical pipelines;
 
Commercial aviation and maritime facilities;
 
rail transportation; and
 
foreign/export opportunities in all of the above-targeted areas.

We believe that our company is strategically positioned to leverage our experience and expertise because of the following:

 
·
our unique intelligent perimeter sensors and supporting technologies designed to protect high value assets;
 
·
multi million dollar contract vehicles/teaming including the U.S. General Services Administration (GSA), Anti-Terror Force Protection-Naval Facilities (ATFP-NAVFAC), and Space Warfare Command Electronic Security Systems (SPAWAR-ESS).
 
·
$45 million of proposals under evaluation as of June 30, 2011;
 
·
high quality ISO 9001:2008 Registration

 
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·
world-wide implementation  and  support  through robust domestic and  international  marketing and distribution network with multiple direct and indirect distribution channels and strategic partnerships; and
 
·
Experience in securing high value, high threat facilities and assets
 We believe that our competitive advantages include the following:
 
·
providing the highest level of perimeter protection;
 
·
offering supporting technologies and systems to enable total systems integration;
 
·
delivering systems that are easy to operate and  maintain while providing superior life cycle cost performance;
 
·
solid credentials in protecting high value targets;
 
·
best industry warranty and
 
·
superior technologies — technologies targeted to the specific protected environment, lower power single mode fiber systems and comprehensive integrated alarm analysis and processing.

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 prime contractor to take advantage of the small business opportunities that exist today and in the future. According to published government reports, approximately $1.4 billion was spent last year for small business in the government market. We project that this market sector will continue to grow in the years ahead, and we plan to be an integral part of this program.

To achieve that end we have formed a team of both small and large businesses to support the company in the pursuit of this lucrative 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.
 
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., as well as Pantex, Amarillo, TX.  Each of these projects utilized different hardware and software platforms for the CAS and SAS including Livermore Argus System at the Pantex Facility.

It is imperative for the facility to have remote devices and subsystems integrated with the hardware and software at the Command and Control Center (CCC).  The inherent design of a CCC lends itself to integrate with any of the remote devices and sub-systems that  will be selected for a PIDAS.  Based on our  experience in system design, application, commissioning, training and operation, the integration of the various technologies are operated 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.

 
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Our customers benefit from an integrated, interactive process to determine levels of risk. The systems integrator consults with our design staff to determine systems configurations and human operation requirements that will provide the most cost-effective options for mitigating risk. Our security engineers are technically accomplished and fully familiar with the latest trends in planning, programming, and designing systems utilizing standard peripheral components, mini/micro architecture, and “user friendly” software/ firmware applications. Many of our security engineers have the federal government's highest security clearances.
 
We also provide security system design support services involving the evaluation and specifications of security systems and components that meet a client's operating and budgetary requirements. Typically, these services are provided within the context of a comprehensive security evaluation and implementation program in conjunction with the systems' integrator.
 
We work closely with the customer and facility owner, architect, engineer, system integrators and/or construction manager to develop and design security monitoring and control systems that afford a normal but secure environment for management, staff and visitors. 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 2012 will exceed $10 billion. The industry encompasses a wide ranging, highly fragmented group of products and service providers which includes entities that market comprehensive security systems and offer security consulting services, such as dealers/installers, small single product companies, equipment manufacturers, and large systems integrators. We believe the security industry will continue to grow rapidly because:
 
 
western nations have been the target of high profile terrorist attacks over the last several years that have squarely focused attention on security and threat issues;
 
perimeter security for airports, maritime, chemical, transportation, energy and pharmaceutical facilities has been mandated by Homeland Security;
 
newer, more effective and efficient security equipment incorporating advancements in security technology is replacing obsolete equipment;
 
DoD & DoE are upgrading their facilities to enhance security while reducing manpower;
 
nuclear power stations both in the United States and overseas have increased the level of security based on recent NRDC security requirements; and
 
private industry is operating in more remote geographic locations and higher risk environments.
 
Product Design
 
We design and develop new products based upon market requirements and as deemed necessary to meet clients' specific needs. We research and assess threat and vulnerability issues and design and engineer our products in-house, with outside consultants as needed, and in conjunction with joint venture partners to meet the requirements of clients based upon the results of such research. We investigate new and emerging technologies that have application in the security industry and seek to license these technologies which we may incorporate into our product line.

 
3

 
 
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
 
The Company’s 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.
 
The above diagram depicts a fully integrated security solution approach for a dual redundant command and control center application.
 
The products described below are reflected in the integrated system diagram shown above.

The Standard IPIDÒ System provides undefeatable perimeter security using pulsed infrared technology to create multiple detection zones each with a range of up to 1000 feet.  IPIDs use solid state electronics that are not affected by environmental conditions such as birds, small animals, snow, puddles, leaves, grass and mechanical vibrations.  It works in rain, snow and fog and instantly pinpoints the intrusion zone via normally open or closed dry contacts that can be interfaced with any user’s data communication and enunciator or a data communication system supplied by ECSI.  IPIDÒ does not emit a false alarm.  The system will only alarm if an object breaks the 3.54” diameter beam more than 98.5%.

Top-of-the-Fence-Terrain-Following (TTFTF) provides pulsed infrared technology along the top of a fence to prevent intruders from vaulting over the fence to gain entrance.

Infrared Perimeter Intrusion Detection System - IPID®  Originally designed for the military and now used in commercial and industrial applications as well.  The sensor is self-diagnostic.  Works in difficult environmental conditions of rain, snow, fog and sand.  Maximum range 1000ft. Impervious to small animals, leaves, trees, etc.  Modular design can be stacked to form an invisible wall that cannot be penetrated without detection.

 
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The Architectural IPID® System provides undefeatable perimeter security using pulsed infrared technology to create multiple detection zones each with a range of up to 1000 feet. IPIDs use solid state electronics that are not affected by environmental conditions such as birds, small animals, snow, puddles, leaves, grass and mechanical vibrations.  It works in rain, snow and fog and instantly pinpoints the intrusion zone via normally open or closed dry contacts  that can be interfaced with any user’s data communication and annunciator, or a data communication system supplied by ECSI.  IPID does not emit a false alarm.  The system will only alarm if an object breaks the 3.54” diameter beam more than 98.5%.

Fiber Optic Intrusion Detection System FOIDSÒ FOIDSÒ is a purely optic technology and does not use electronics in the field, works on fences, walls, and even under the ground.  It has a range of over 60km, and uses single mode fiber optic cable. Advanced algorithm processing at central control permits remote audible alarm assessment and reduces false alarms. Provides the greatest flexibility and information management capability available.

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. Since security professionals are not always available to manually move a camera immediately to the point needed, sometimes problems are not seen or recorded.  The use of PTZ cameras to automatically track an intruder based on an alarm from another technology provides the best solution

Thermal Imagers  The system is a triple field of view thermal imager designed for surveillance and security applications where long standoff ranges are necessary.  The system has vehicle recognition capability to nearly 25km with personnel identification (armed vs. unarmed) beyond 7 km.  Ideal for marine applications, the system’s main telescope with its 1.5 meter focal length allows type recognition of small craft beyond 20km with a high degree of accuracy.

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.  The system consists of 360° endless high speed heavy duty pan/tilt driver with Day 20km, 15km, 6km, 3km, 2km Motorized Zoom true color/night 10M~10KM (30,000 ft) image pick-up by 56-strong “IR” illuminator with collimator & laser “IR”  Illuminator at night (IP66, 20kg)
 
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 for rapid identification of vehicles/personnel for reasonable traffic flow, and vehicle inspection and entry denial techniques (e.g., a gate arm, final denial barrier, bollards, go/no-go light system, under-vehicle surveillance, explosive detection, etc.).
 
Vehicle and Pedestrian Access Control
ECSI offers a complete line of equipment and accessories for perimeter access control, including

 
·
Fixed, Removable and Hydraulic Bollards
 
·
Hydraulic Barriers
 
·
Electric and Pneumatic Lift Gates
 
·
Mobile Barriers
 
·
Turnstiles
 
·
Parking Lot Systems
 
·
Signage and Warning Lights
 
·
Signal Lights

 
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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.  The ability to detect a walking human target at over 1.5 kilometers using 2 watts of peak power, continuously scan 360°, and operate 24 hours a day in all weather, sets this system apart from all its competitors. Vehicles are detected 3-5 km (based on size and orientation). 3, 5, 7, 10, 12, and 15 km versions of the radar for a walking human are also available.

The AIMS has the widest temperature specifications on the market — -40 to +70 degrees C (ambient air). AIMS radar has the finest Doppler (speed) resolution capability on the market. Environmental conditions have little if any effect on the detection or performance of the system. Even trees found in the landscape or in parking lots has little effect on the system. AIMS has a low false alarm rate.  AIMS may be installed as a permanent system or provided as a relocatable tripod mounted system (requires several people to move).  AIMS may also be provided as a “turn-key” system, with monitoring, the radar and cameras all supplied. (Some cameras may require export licensing.) User interfaces graphically present detections on map overlays. Video can be provided integrated into the same display.

WISE™  Water Infrastructure Sensing Equipment provides the greatest flexibility and information management capability available.  Systems monitor the water quality throughout drinking distributions systems to detect the evidence of chemical, biological contamination and report detected problems instantly.  The  WISE™ systems also increase efficiency by saving man-hours and laboratory costs, and potentially, power and chemical costs, through data feedback and process optimization.

Fiber–Optic Communications  ECSI International and Meridian Technologies offer a complete and comprehensive line of digital fiber optic transmission products, including

 
·
Video Transmission Systems
 
·
Audio Transmission Systems
 
·
Data Transmission  Systems
 
·
Video & Data Transmission Systems
 
·
Video & Audio Transmission Systems
 
·
Data & Audio Transmission Systems
 
·
Video ; Data & audio Transmission Systems
 
·
FM  Products
 
·
Intelligent Multidrop Modems
 
·
Specialty Products
 
·
Universal Sub-rack Frames
 
·
Spectra Smart Network Diagnostics

To address the following:

 
·
Security and Surveillance
 
·
Intelligent Transportation Systems (ITS)
 
·
Supervisory Control and Data Acquisition (SCADA)
 
·
Video Teleconferencing
 
·
Campus Educational Networks & Distant Learning
 
·
Trading Floor Market Data Services
 
·
Custom Design Project

ECSI provides a robust security and surveillance management system that lets you truly protects your facilities. It allows you to provide a unified system that monitors and interfaces with security devices such as CCTV, access control systems, security fences, RFID solutions, motion detectors, license plate readers, intrusion detection systems, fire alarms, and much more; all without the need to change your existing devices or procure new proprietary systems, thus optimizing your return on investment.

 
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Command Control Communication and Computer Intelligence and Surveillance and Response (C4ISR) Center

The C4ISR is the custodial and security nerve center where officers in the C4ISR center have the ability to perform the following operations and functions from the monitoring and control consoles: perimeter fence sensors, surveillance camera video and radar targets, mobile patrol positions, monitoring and control capability of all security doors of the building, individual or group release of all electronic doors, monitoring of perimeter and roof detection systems, local video assessment system, fire, smoke and sprinkler alarm, HVAC equipment monitoring, intercom/public address and monitoring for the entire site, monitoring of any motion detector equipment, lighting controls, duress alarms, watch-tour monitoring and annunciation, two-way radio communications as required.

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.  The Command and Control console provides the operator situational awareness and control of sensors and cameras in assigned area of operations.  Access control is monitored at entrances, interior doors and vehicle gates for all key facilities.
 
We believe that the products we offer are qualitatively comparable to or more effective than those offered by our competitors because our products:
 
 
·
provide low nuisance and false alarm rates;
 
·
are reliable in virtually any environmental condition;
 
·
in many cases can be user specified and adapted to their environment; and
 
·
are subject to low installation and maintenance costs.
 
Markets for Our Products
 
We have identified a number of markets for our products and have developed programs to gain access to those target markets. Generally, private industry and government facilities that possess sensitive information, valuable assets or by virtue of the nature of their business may be subject to terrorist threats recognize the need to implement security measures to protect personnel and property. In many instances, laws have been enacted and mandates decreed for compliance with some minimum-security standards. Airport security is a prime example. We target these entities as well as entities where we can demonstrate the need for security measures.
 
Primary markets that we target include:
 
the U.S. Government, its agencies and departments, including the Department of Defense and the Department of Energy;
 
large industrial facilities, including pharmaceutical companies and major office complexes;
 
energy facilities, including nuclear power stations, utilities, chemical-petrochemical pipelines;
 
commercial aviation and maritime facilities;
 
rail transportation; and
 
foreign/export opportunities in all of the above-targeted areas.
 
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:

 
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The U.S. Department of Defense and a number of its subdivisions have been using our products for force and asset protection at numerous military bases and air force installations around the world. Certain of our products have been certified and included as part of the government's tested and approved technologies.
 
The U.S. Department of Energy, in connection with the clean-up and operation of military bases and government-owned nuclear processing facilities, offers an expansive and varied market. We are involved with the supply and support services at nine sites on an ongoing basis.
 
The Department of Transportation includes airports, trucking and distribution centers and marine terminals. Our products and systems directly apply to the security needs of this multi-billion dollar market opportunity.
 
Our open-ended contract with the General Services Administration (GSA), which has been extended through July 31, 2014, authorizes the U.S. Government and a network of eligible sources to purchase materials and services from us without having to undergo a full competition based on negotiated and approved prices  In September 2003, we announced the finalization of a five-year indefinite delivery/indefinite quantity contract with Lockheed Martin for ATFP-NAVFAC to secure highly strategic military facilities throughout the world. This contract has been extended through 2012.  The Company is a technology supplier to the three large system integrators selected for the FPS2 program addressing United States Air Force Bases over the next four years.
 
Large Industrial Facilities and Major Office Complexes. These types of facilities, such as pharmaceutical companies, frequently house sensitive data where research and product development occur and are likely to acquire integrated security packages to create a “smart building.” The technologies required to create a smart building in today's environment must address life, safety, power, lighting, information technology protection and other security systems to create a normal yet secure environment for employees, visitors and service personnel.
 
Energy Facilities, Including Nuclear Power Stations, Utilities, Chemical-Petrochemical Pipeline Facilities. Nuclear power stations and utilities that house sensitive information and dangerous materials represent a large and lucrative market for our products. Chemical-petrochemical, natural gas and pipeline companies, many of which operate in high risk environments and remote geographic locations, invest huge sums in the materials necessary to operate those businesses and adopt appropriate measures to protect their investments through the acquisition of security equipment and systems.
 
Commercial Aviation and Maritime Transportation. Infrastructure security has been at the forefront of security consciousness for many years. The federal government appropriated significant funds for the acquisition and installation of new, high-technology security systems at these facilities. There are approximately 1,200 facilities in the U.S. that the Federal Aviation Agency has identified and mandated for perimeter and access control security systems upgrade to be completed over the next several years and we will bid to provide products and services for many of these sites.  In addition, we are marketing our advanced Anti-Piracy products directly to the maritime community of private and commercial ship owners and newly built shipyards.
 
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 markets.

 
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Marketing
 
We have developed a multi-tiered marketing plan, allowing us to effectively market products to each of the separate government and industry segments identified as target markets both in the United States and internationally. Our marketing strategy highlights product and support service strengths as they apply to each particular industry.
 
The primary goals of our marketing strategy are to:
 
Broaden the base of potential clients, and
 
Demonstrate the efficacy of our products.
 
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 association with these entities affords the Company and our products added credibility. These entities frequently subcontract our services and purchase our products in connection with larger projects. During fiscal 2011, we entered into teaming and marketing agreements with VT Milcom, SAIC, Catalyst Partners, Shegaw Engineering, and Paul J. Scariano, Inc.

During fiscal 2011, the Company submitted proposals on projects for Department of Defense facilities and certain nuclear power stations in the United States and Southeast Asia valued at approximately $16,750,000.  We anticipate decisions relating to these proposals during fiscal 2012.

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 attempt to maintain direct contact with key employees of the major corporate accounts and government agencies encompassing our target markets.

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. We rely on our dealer/installer base to represent our product line throughout the world and to apprise us of potential projects where the products can be incorporated. In addition, we rely on our dealers/installers to introduce our company and products to key government and private enterprise personnel in their respective geographic regions.

We also market directly to providers of integrated security systems, security systems dealers/installers, systems engineers and other entities that may be contracted for a security system on behalf of a client.

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

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:
 
Expand our base of dealers/installers/integrators worldwide. This is an effective and cost efficient means of increasing sales. These entities serve as our local agents to market products and provide customer support. Furthermore, these entities are familiar with local laws and frequently have local contacts in government and business at decision-making levels.

 
9

 

 
Expand our global presence.  We entered into sales agreements with a number of multi-national companies to represent and support our products in Africa, India, China, and the Middle East.
 
Design and develop new systems. We will continue to develop new security systems to expand our portfolio of proprietary products. We believe that this will help us to open new markets and retain our position as a leading edge provider of technology based security equipment.
 
License new and emerging technologies. We will continue to identify, analyze and acquire new and emerging technologies for application in the security industry. We will seek to acquire technologies that will enhance our existing systems and develop new products.
 
Upgrade existing products. We have and will continue to upgrade existing products by taking advantage of technological advancements to ensure that they remain state-of-the-art.

Customers

We provide products and services to certain customers who maintain their own integration engineering and installation departments. During the past five years we have provided products to approximately 50 nuclear power stations, Department of Energy and other government agencies covering over 220 projects.

Under usual business conditions, given the nature of our customers and products, 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, 2011, there were three customer groups from which we had significant sales volume.  The Department of Defense accounted for 60% of net revenues, nuclear power stations for 33% and Department of Energy for 5%.  In Fiscal Year 2010, the Department of Defense accounted for 60% of net revenues, nuclear power stations, 30%; and the non-government sector 10 %.

Our clients include utilities, nuclear facilities, oil and gas facilities, military bases, industrial complexes, correctional institutions, border and port security agencies, and airports and airlines.

Competition
 
Competition for U.S. government contracts is intense.  We compete against a large number of established multi-national corporations as well as  smaller, more specialized companies that concentrate their resources in particular areas.  As a result of the diverse requirements of the U.S. Government and our commercial customers, we frequently collaborate with other companies to compete for large contracts and bid against these team members in other situations.
 
Competition is intense among a fragmented and wide ranging group of product and service providers, including security equipment manufacturers, providers of integrated security systems, systems integrators, consulting, engineering and design firms and others that provide individual elements of a system. in the future against existing or potential competitors.
 
We believe we are able to sustain our competitive position in the industry because:
 
our principal officers, security analysts, design personnel and sales people have an aggregate of over 230 years of experience in the security industry;
 
we have the ability to analyze security risks, design, engineer and manufacture products customized to a client's requirements;
 
our products address a wide range of security requirements;
 
our products are among the most technologically advanced and the highest quality available;

 
10

 

 
our products are flexible in that many of them can be configured and customized to meet a client's specific needs and can be integrated in new or existing security systems;
 
our products are reliable, and relatively easy and inexpensive to install and maintain; and
 
we have been successful in teaming with large multinational companies to market and incorporate our products into their product offerings, thereby contributing to the credibility and efficacy of our products.
 
Manufacturing
 
Manufacturing operations are maintained at our facility in New Jersey.  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 the Company. We cannot be certain, however, that we can limit unauthorized or wrongful disclosures of unpatented trade secret information.

 
11

 
 
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, 2011 and 2010, we expended $129,722 and $129,358, 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, 2011 and 2010, 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, Vindicator/Honeywell for data acquisition, and a cross licensing agreement with JMAR for real-time, online water monitoring and detection system.
 
Employees
 
As of September 6, 2011, we employed 22 individuals on a full-time basis including four design and engineering staff, seven manufacturing and assembly employees, three marketing employees, three project managers, one program manager and four administrative employees. A number of employees serve in multiple capacities. For example, Arthur Barchenko serves as our President but is also an integral member of our marketing team. Our manufacturing staff may oversee site installation of the products.
 
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.

 
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Item 1A. RISK FACTORS
 
Our business, financial condition and results of operations could be materially adversely affected by various risks, including, but not limited to the principal risks noted below.
 
Risks Relating to Our Business
 
We derive a substantial amount of our revenues from the sale of our solutions either directly or indirectly to U.S. government entities pursuant to government contracts, which differ materially from standard commercial contracts and may be subject to cancellation or delay without penalty, any of which may produce volatility in our revenues and earnings.
 
We derived approximately 60% of our revenues for each of the years ended June 30, 2011 and 2010 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.
 
 
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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.
 
We anticipate that business from programs and projects both inside the United States and overseas will significantly increase during fiscal 2012 based on the number of proposals outstanding that we believe will be funded and released for manufacture during this period.
 
During fiscal 2011, the Company submitted proposals on projects for Department of Defense and Department of Energy facilities and certain nuclear power stations in the United States and southeast Asia valued at approximately $16,750,000.  We anticipate decisions relating to these proposals during fiscal 2012.
 
 
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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, 2011 and 2010, we generated approximately 0% and 10%, respectively, of our business from projects outside the United States. We anticipate that the revenue portion from overseas operations will  increase significantly during Fiscal 2012 as a percentage of sales. Our international business operations are subject, generally, to the financial and operating risks of conducting business internationally, including, but not limited to:
 
unexpected changes in or impositions of legislative or regulatory requirements;
 
potential hostilities and changes in diplomatic and trade relationships; and
 
political instability.
One or more of these or other factors not referenced herein or now known to us could materially impact our business and results of operations could suffer.
 
We depend on our relationships with strategic partners as a source of business and our business and results of operations could suffer if these relationships are terminated.
 
We have entered into strategic partnerships or teaming arrangements with several large multinational corporations that promote our products and services and incorporate our products into their projects. In the event that we are unable to maintain these strategic relationships for any reason, our business, operating results and financial condition could be adversely affected.
 
We compete against entities that have significantly greater name recognition and resources than we do, enabling them to respond more quickly to changes in customer requirements and allocate these resources to marketing efforts.
 
The security industry is highly competitive and continues to become increasingly so as security issues and concerns have become a primary consideration at both government and private facilities worldwide. Competition is intense among a wide ranging and fragmented group of product and service providers, including security equipment manufacturers, providers of integrated security systems, systems integrators, consulting firms, engineering and design firms and others that provide individual elements of a system, some of which are larger than us 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.

 
15

 
 
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 2011. 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 791 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.

 
16

 
 
Our common stock price has fluctuated considerably and may not appreciate in value.
 
Prices for our common stock have in the past, and could continue to, fluctuate significantly and will be influenced by many factors, including the liquidity of the market for the common stock, investor perception of the industry in which we operate and our products, and general economic and market conditions. Factors which could cause fluctuation in the price of our common stock include:

 
conditions or trends in the industry,
 
failure to keep pace with changing technology,
 
costs associated with developing new products and services,
 
costs associated with marketing products and services may increase significantly,
 
the timing of sales and the recognition of revenues from them,
 
government regulations may be enacted which affect how we do business and the products which may be used at government facilities,
 
downward pressure on prices due to increased competition,
 
changes in our operating expenses,
 
sales of common stock,
 
actual or anticipated variations in quarterly results, and
 
changes in financial estimates by securities analysts.
 
The stock market in general has experienced extreme price and volume fluctuations. The market prices of shares of security-related companies experienced fluctuations that often have been unrelated or disproportionate to the operating results of these companies. Continued market fluctuations could result in extreme volatility in the price of our common stock, which could cause a decline in the value of our common stock. Price volatility might be worse if the trading volume of our common stock is low.
 
Our common stock is considered a “penny stock” and may be difficult to trade.
 
The SEC has adopted regulations that generally define “penny stock” as an equity security with a market or exercise price of less than $5.00 per share, subject to specific exemptions. The market price of our common stock is less than $5.00 per share, and therefore may be designated as a “penny stock” according to SEC rules. Under these rules, broker-dealers who recommend such securities to persons other than institutional accredited investors must:

 
make a special written suitability determination for the purchaser,
 
receive the purchaser's written agreement to a transaction prior to sale,
 
provide the purchaser with risk disclosure documents which identify certain risks associated with investing in “penny stocks” and which describe the market for these “penny stocks” as well as a purchaser's legal remedies, and
 
obtain a signed and dated acknowledgment from the purchaser demonstrating that the purchaser has actually received the required risk disclosure document before a transaction in a “penny stock” can be completed.
 
Under these rules, broker-dealers may find it difficult to effectuate customer transactions and trading activity in our securities may be adversely affected. As a result, the market price of our securities may be depressed, and it may be more difficult to sell our securities. In addition, you may find it difficult to obtain accurate quotations of our common stock and may experience a lack of buyers to purchase such stock or a lack of market makers to support the stock price.

 
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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 33% 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.
 
Investors in our securities will suffer dilution.
 
The issuance of shares of our common stock pursuant to the equity line with Auctus will dilute the equity interest of existing stockholders who do not have anti-dilution rights and could have a significant adverse effect on the market price of our common stock. The sale of our common stock acquired, or converted or exercised into, at a discount could have a negative impact on the market price of our common stock and could increase the volatility in the market price of our common stock. In addition, we may seek additional financing which may result in the issuance of additional shares of our common stock and/or rights to acquire additional shares of our common stock. The issuance of our common stock in connection with such financing may result in substantial dilution to the existing holders of our common stock who do not have anti-dilution rights. The sale of our common stock, or securities convertible or exercisable into shares of our common stock, could trigger the anti-dilution rights of our outstanding securities that have such rights, specifically our preferred stock, convertible debentures and some of our warrants, which could result in further dilution to the existing holders of our common stock who do not have anti-dilution rights.
 
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 10.9 million shares of our common stock, 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.
 
 
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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 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

We are not involved in any pending legal proceedings that we anticipate would result in a material adverse effect on our business or operations.
 
Item 4. Reserved and removed.

 
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The Common Stock of the Company trades on the OTC Bulletin Board under the trading symbol EKCS. Although trading in our Common Stock has occurred on a relatively consistent basis, the volume of shares traded has been sporadic. There can be no assurance that an established trading market will develop, that the current market will be maintained or that a liquid market for our Common Stock will be available in the future. Investors should not rely on historical stock price performance as an indication of future price performance.
 
The following table shows the quarterly high and low bid prices for our Common Stock over the last two completed fiscal years as quoted on the OTC Bulletin Board. The prices represent quotations by dealers without adjustments for retail mark-ups, mark-downs or commission and may not represent actual transactions. The closing price of our Common Stock on September 26, 2011, was $.20 per share
 
   
Closing Bid
 
   
High
   
Low
 
Fiscal 2011
           
April 1 – June 30, 2011
    0.33       0.18  
January 1 – March 31, 2011
  $ 0.40     $ 0.31  
October 1 – December 31, 2010
  $ 0.44     $ 0.28  
July 1 – September 30, 2010
  $ 0.49     $ 0.27  
                 
Fiscal 2010
               
April 1 – June 30, 2010
  $ 0.72     $ 0.23  
January 1 – March 31, 2010
  $ 0.43     $ 0.14  
October 1 – December 31, 2009
  $ 0.24     $ 0.06  
July 1 – September 30, 2009
  $ 0.18     $ 0.08  
 
As of September 15, 2011, ECSI had 180 holders of record of common stock. This number of holders of record does not include beneficial owners of the Company's common stock whose shares are held in the names of various security holders, dealers, and clearing agencies.
 
Dividend Policy
 
The Company has not paid any cash dividends on its common stock and does not anticipate paying cash dividends in the foreseeable future. The Company intends to retain any earnings to finance the growth of its business. There can be no assurance that the Company will ever pay cash dividends.
 
Issuer Purchases of Equity Securities

We do not have a stock repurchase program for our common stock.
 
Item 6. Selected Financial Data

Not applicable.

 
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Overview
 
We design, develop, manufacture and market stand-alone and fully integrated state-of-the-art 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.
 
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
 
Not applicable.

 
26

 
 
 Item 8. Financial Statements
 
The information called for by this Item 8 is included following the “Index to Financial Statements” contained in this Annual Report on Form 10-K.
 
 Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
 
None.
 
 Item 9A Controls and Procedures.
 
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
 
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to management, including our President and Chief Executive Officer (who also serves as our principal executive officer and principal financial and accounting officer) to allow timely decisions regarding required disclosure based closely on the definition of "disclosure controls and procedures" in Rule 13a-15(e).
 
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with participation of management, including our President and Chief Executive Officer (who also serves as our principal executive officer and principal financial and accounting officer), of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our President and Chief Executive Officer concluded that our disclosure controls and procedures were effective.
 
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING.
 
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States. Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements.
 
The Company’s management, including our principal executive officer who also serves as our principal financial and accounting officer, does not expect that our disclosure controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
 
Our management, including our principal executive officer who also serves as our principal financial and accounting officer, conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on his evaluation under the framework in Internal Control -  Integrated Framework , our management concluded that our internal control over financial reporting was effective as of June 30, 2011.

 
27

 
 
This annual report does not include an attestation report of the Company's registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company's registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this Annual Report.
 
During the year ended June 30, 2011, there have been no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, these controls.
 
Item 9B. Other Information.
 
None.

 
28

 
 
PART III
 
The information called for by Items 10, 11, 12, 13 and 14 will be contained in the Company's definitive proxy statement which the Company intends to file within 120 days after the end of the Company's fiscal year ended June 30, 2011 and such information is incorporated herein by reference.
 
Item 15. Exhibits

Exhibit
No.
 
Description
 
Location
Reference
 3.1
 
Certificate of Incorporation of Electronic Control Security Inc.
 
1
 3.2
 
Certificate of Amendment to Certificate of Incorporation of Electronic Control Security Inc.
 
2
 3.3
 
Certificate of Amendment to Certificate of Incorporation
 
3
 3.4
 
By-Laws of Electronic Control Security Inc.
 
1
 3.5
 
Certificate of Incorporation of SEM Consultants III, Inc.
 
1
 3.6
 
By-Laws of SEM Consultants III, Inc.
 
1
 3.7
 
Certificate of Incorporation of ECSI International, Inc.
 
1
 3.8
 
By-Laws of ECSI International, Inc.
 
1
 3.9
 
Certificate of Incorporation of ECSI FOIDS, Inc.
 
1
 3.10
 
By-Laws of ECSI FOIDS, Inc.
 
1
 3.11
 
Certificate of Incorporation of ECSI-DSA, Inc.
 
1
 3.12
 
By-Laws of ECSI-DSA, Inc.
 
1
 3.13
 
Memorandum of Association of ECSI Security Communications, Inc., a Middle East Corporation
 
2
 3.14
 
Articles of Association of ECSI Security Communications, Inc., a Middle East Corporation
 
2
 4.1
 
Form of Common Stock Purchase Warrant issued June 30, 2004
 
3
 4.2
 
Form of Common Stock Purchase Warrant issued January 13, 2006
 
4
 4.3
 
Form of Senior Secured Convertible Debenture due January 11, 2009.
 
4
 4.4
 
Registration Rights Agreement dated as of January 11, 2006, by and among Electronic Control Security Inc. and the investors specified therein.
 
4
10.1
 
Lease Agreement with 580 Brighton Road Associates for space in Clifton, New Jersey.
 
1
10.2
 
Securities Purchase Agreement dated June 30, 2004.
 
3
10.3
 
Registration Rights Agreement dated June 30, 2004.
 
3
10.4
 
Securities Purchase Agreement dated as of January 11, 2006, by and among Electronic Control Security Inc. and the purchasers named therein.
 
4
10.5
 
Security Agreement, dated January 11, 2006, by and among Electronic Control Security Inc. and the investors specified therein.
 
4
10.6
 
Drawdown Equity Financing Agreement, dated as of February 8, 2011 by and between Electronic Control Security Inc. Inc. and Auctus Private Equity Fund, LLC.
 
5
10.7
 
Registration Rights Agreement, dated as of February 8, 2011 by and between Electronic Control Security Inc. Inc. and Auctus Private Equity Fund, LLC.
 
5
10.8
 
Business Loan Agreement dated as of March 15, 2011 between ECSI International, Inc. and Atlantic Stewardship Bank
 
6
10.9
 
Commercial Security Agreement dated as of March 15, 2011 between ECSI International, Inc. and Atlantic Stewardship Bank
 
6
10.10
 
Letter Agreement dated as of June 30, 2010 between Eigerhawk, Ltd. and Electronic Control Security Inc.
 
7
14.1
 
Code of Ethics and Business Conduct
 
4
23.1
 
Consent of Demetrius & Company, L.L.C.
 
7
 
 
29

 
 
31
 
Certifications of Chief Executive Officer.
 
7
32
 
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
7
 
* * * *
1.
Incorporated by reference to such exhibit filed with Electronic Control Security Inc.'s Registration Statement on Form 10-SB filed with the Commission on February 16, 2001.
2.
Incorporated by reference to such exhibit filed with Electronic Control Security Inc.'s Registration Statement on Form SB-2 filed with the Commission on June 6, 2002.
3.
Incorporated by reference to such exhibit filed with Electronic Control Security Inc.'s Current Report on Form 8-K filed with the Commission on July 1, 2004.
4.
Incorporated by reference to such exhibit filed with Electronic Control Security Inc.'s Current Report on Form 8-K filed with the Commission on January 18, 2006
5.
Incorporated by reference to such exhibit filed with Electronic Control Security Inc.'s Quarterly Report on Form 10-Q filed with the Commission on February 10, 2011.
6
Incorporated by reference to such exhibit filed with Electronic Control Security Inc.'s Quarterly Report on Form 10-Q filed with the Commission on May 3, 2011.
7.
Filed as an Exhibit hereto.

 
30

 
 
SIGNATURES
 
Pursuant to the requirements of The Exchange Act of 1934 as amended, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 
By:
/s/ Arthur Barchenko
   
Name: Arthur Barchenko
   
Title: President, Chief Executive Officer
   
(and Principal Financial and Accounting Officer
   
Dated: September 27, 2011
 
In accordance with the Exchange Act, this report has been signed below by the following person on behalf of the registrant and in the capacities and on the dates indicated.

Person
 
Capacity
 
Date
/s/ Arthur Barchenko
 Arthur Barchenko
 
President, Chief Executive Officer
(and Principal Financial and
Accounting Officer) and Director
 
September 27, 2011
         
/s/ Natalie Barchenko
 Natalie Barchenko
 
Treasurer and Director
 
September 27, 2011
         
/s/ Edward Snow
 Edward Snow
 
Director
 
September 27, 2011
         
/s/ Stephen Rossetti
 Stephen Rossetti
 
Director
 
September 27, 2011
         
/s/ Gordon E. Fornell
 Gordon E. Fornell
 
Director
 
September 27, 2011
         
/s/ Ronald Thomas
 Ronald Thomas
 
Director
 
September 27, 2011
         
/s/ Norman Barta
 Norman Barta
 
Director
 
September 27, 2011
 
 
31

 
 
ELECTRONIC CONTROL SECURITY INC.
AND SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS
With Report of Independent Registered Public Accounting Firm

Report of Independent Registered Public Accounting Firm
 
F-1
     
Consolidated Balance Sheets
 
F-2
     
Consolidated Statements of Operations
 
F-3
     
Consolidated Statements of Cash Flow
 
F-4
     
Consolidated Statement of Changes in Shareholders’ Equity
 
F-5
     
Notes to Consolidated Financial Statements
 
F-6-F-18

 
 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Electronic Control Security Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of Electronic Control Security, Inc. and Subsidiaries as of June 30, 2011 and 2010, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the two years in the period ended June 30, 2011. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Electronic Control Security, Inc. and Subsidiaries as of June 30, 2011 and 2010, and the consolidated results of their operations and cash flows for each of the two years in the period ended June 30, 2011, in conformity with accounting principles generally accepted in the United States of America.

DEMETRIUS & COMPANY, L.L.C.

Wayne, New Jersey
September 27, 2011

 
F-1

 
 
Electronic Control Security Inc.
Consolidated Balance Sheets

   
June 30,
 
   
2011
   
2010
 
             
ASSETS
           
Current assets
           
Cash and cash equivalents
  $ 7,040     $ 168,465  
Accounts receivable, current portion, net of allowance of $25,000
    1,063,502       1,932,910  
Inventories, net of allowance of $80,000 and $15,000, respectively
    1,943,676       1,875,243  
Current portion of deferred income taxes
    180,000       -  
Other current assets
    125,946       165,854  
                 
Total current assets
    3,320,164       4,142,472  
                 
Property, equipment and software development costs - net
    388,090       142,386  
Intangible assets – net
    950,401       1,032,469  
Goodwill
    196,962       196,962  
Deferred income taxes, net of current portion
    395,050       437,350  
Other assets
    7,205       8,786  
    $ 5,257,872     $ 5,960,425  
LIABILITIES AND SHAREHOLDERS' EQUITY
               
                 
Current Liabilities
               
Accounts payable and accrued expenses
  $ 987,573     $ 2,442,683  
Due to officers and shareholders
    93,405       259,778  
Line of credit
    425,000       -  
Current maturities of debt
    14,237       43,754  
8% Convertible debentures
    -       100,000  
                 
Total current liabilities
    1,520,215       2,846,215  
                 
Noncurrent liabilities
               
Deferred income taxes
    53,250       43,550  
                 
Total liabilities
    1,573,465       2,889,765  
                 
Shareholders' equity
               
Series A Convertible Preferred stock, cumulative, $.01 par value;
               
$2.00 liquidation preference; 5,000,000 shares authorized,
               
300,000 and 300,000 shares issued and outstanding, respectively
    3,000       3,000  
Series B 10% Convertible Preferred stock, cumulative, $.001 par value;
               
$1,997 and $1,809 per share liquidation preference; 2,000 shares authorized,
               
791 shares issued and outstanding, respectively
    1       1  
Common Stock, $.001 par value; 30,000,000 shares authorized;
               
10,529,911 and 10,259,259 shares issued; 10,429,911 and 10,159,259
               
shares outstanding
    10,530       10,259  
Additional paid-in capital
    13,337,534       13,105,624  
Accumulated deficit
    (9,661,448 )     (10,043,014 )
Accumulated other comprehensive income
    4,790       4,790  
Treasury stock, at cost, 100,000 shares
    (10,000 )     (10,000 )
                 
Total shareholders' equity
    3,684,407       3,070,660  
    $ 5,257,872     $ 5,960,425  

See Notes to Consolidated Financial Statements.

 
F-2

 

Electronic Control Security Inc.
Consolidated Statements of Operations

   
Year
 
    
Ended
 
    
June 30,
 
    
2011
   
2010
 
             
Revenues
  $ 3,958,941     $ 4,513,737  
Cost of revenues
    1,984,392       2,012,013  
                 
Gross profit
    1,974,549       2,501,724  
                 
Research and development
    129,722       129,358  
Selling, general  and administrative expenses
    1,413,240       1,771,923  
Stock based compensation
    31,041       45,688  
                 
Income from operations
    400,546       554,755  
                 
Other expenses (income)
               
Interest expense
    1,078       178,925  
Interest income
    (3,262 )     (661 )
Loss on disposal of intangible assets
    600       -  
Legal settlement
    -       (6,367 )
                 
Total other expenses (income)
    (1,584 )     171,897  
                 
Income before income taxes
    402,130       382,858  
                 
Income taxes
    (128,000 )     -  
                 
Income before dividends
    530,130       382,858  
                 
Dividends related to convertible preferred stock
    148,564       134,592  
                 
Net income attributable to common shareholders
  $ 381,566     $ 248,266  
                 
Net income per share:
               
Basic
  $ 0.04     $ 0.02  
Diluted
  $ 0.04     $ 0.02  
                 
Weighted average number of common shares and equivalents:
               
Basic
    10,404,884       10,150,437  
Diluted
    10,589,115       10,512,680  

See Notes to Consolidated Financial Statements.

 
F-3

 

Electronic Control Security Inc.
Consolidated Statements of Cash Flows

   
Year
 
    
Ended
 
    
June 30,
 
    
2011
   
2010
 
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
           
Cash flows from operating activities:
           
Net income before deemed dividends
  $ 530,130     $ 382,858  
Adjustments to reconcile income to net cash provided by operating activities:
               
Depreciation and amortization
    193,279       167,597  
Deferred income taxes
    (128,000 )     -  
Decrease in allowance for doubtful accounts
    -       (75,000 )
Increase in inventory reserve
    65,000       15,000  
Stock based compensation
    31,041       49,888  
Issuance of shares in repayment of amounts owed
    19,076       -  
Loss on disposal of intangible assets
    600       -  
Increase (decrease) in cash attributable to changes in
               
Accounts receivable
    869,408       (605,655 )
Inventories
    (133,433 )     254,890  
Other current assets
    39,908       (44,275 )
Accounts payable and accrued expenses
    (1,455,110 )     542,386  
Other assets
    1,581       -  
                 
Net cash provided by operating activities
    33,480       687,689  
                 
Cash flows from investing activities:
               
Acquisition of property plant and equipment
    (357,515 )     (15,214 )
                 
Net cash used in investing activities
    (357,515 )     (15,214 )
                 
Cash flows from financing activities:
               
Proceeds from line of credit
    425,000       -  
Principal payments on 8% convertible debentures
    (100,000 )     (352,500 )
Payments on debt
    (29,517 )     (21,263 )
Increase (decrease) in loans from officers
    (132,873 )     (145,982 )
                 
Net cash provided by (used in) financing activities
    162,610       (519,745 )
                 
Net (decrease) increase in cash and cash equivalents
    (161,425 )     152,730  
                 
Cash and cash equivalents at beginning of year
    168,465       15,735  
                 
Cash and cash equivalents at end of year
  $ 7,040     $ 168,465  
                 
Supplemental disclosures of cash flow information
               
Cash paid during the period for:
               
Interest
  $ 58,306     $ 83,244  
Taxes
  $ 2,230     $ -  
                 
Supplemental disclosures of noncash financing activities:
               
Exercise price of stock options paid via reduction in shareholder loans
  $ 33,500     $ 4,200  

See Notes to Consolidated Financial Statements.

 
F-4

 

Electronic Control Security Inc.
Consolidated Statements of Changes in Shareholders Equity

    
Series A Convertible
 
Series B 10% Convertible
         
Additional
       
Other
                 
    
Preferred Stock
 
Preferred Stock
 
Common Stock
 
Paid-in
 
Accumulated
   
Comprehensive
   
Treasury
       
Comprehensive
 
    
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Capital
 
Deficit
   
Income
   
Stock
   
Total
 
Income (Loss)
 
                                                         
Balances at June 30, 2009
    300,000   $ 3,000     791   $ 1     10,249,259   $ 10,249   $ 12,921,154   $ (10,291,280 )   $ 4,790     $ (10,000 )   $ 2,637,914   $ (667,059 )
                                                                                 
Dividend on preferred stock
                                        134,592     (134,592 )                     0        
                                                                                 
Issuance of stock and warrants for services
                            10,000     10     4,190                             4,200        
                                                                                 
Stock based compensation
                                        45,688                             45,688        
                                                                                 
Net loss
                                                      382,858                         382,858     382,858  
                                                                                 
Balances at June 30, 2010
    300,000     3,000     791     1     10,259,259     10,259     13,105,624     (10,043,014 )     4,790       (10,000 )     3,070,660   $ 382,858  
                                                                                 
Dividend on preferred stock
                                        148,564     (148,564 )                     0        
                                                                                 
Exercise of stock options
                            200,000     200     33,300                             33,500        
                                                                                 
Stock based compensation
                                        31,041                             31,041        
                                                                                 
Stock issued to convertible debenture holders
                            70,652     71     19,005                             19,076        
                                                                                 
Net loss
                                                      530,130                         530,130     530,130  
                                                                                 
Balances at June 30, 2011
    300,000   $ 3,000     791   $ 1     10,529,911   $ 10,530   $ 13,337,534   $ (9,661,448 )   $ 4,790     $ (10,000 )   $ 3,684,407   $ 530,130  

See Notes to Consolidated Financial Statements.

 
F-5

 
 
ELECTRONIC CONTROL SECURITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 - Nature of Operations

Electronic Control Security, Inc. (the “Company”) is engaged in the design, development, manufacture and marketing of technology-based integrated security solutions.  The Company also performs support services consisting of risk assessment and vulnerability studies to ascertain a customer's security requirements in developing a comprehensive risk management and mitigation program as well as product design and engineering services in support of the systems integrators and dealers/installers providing these services to a client.

The Company’s office and manufacturing facilities are located in Clifton, New Jersey.  Products and services are marketed domestically and internationally to national and local government entities, chemical and petrochemical facilities, energy facilities, commercial transportation centers, border security, and water and agricultural resources.
 
Note 2 - Summary of Significant Accounting Policies

Principles of Consolidation

The financial statements include the accounts of the Company, its wholly owned subsidiaries, and its majority owned subsidiary. All significant inter-company accounts and transactions have been eliminated.

Accounts Receivable

Trade accounts receivable are recorded net of an allowance for expected losses.  The allowance is estimated from historical performance and projections of trends.

Inventories

Inventories are stated at the lower of cost (first-in, first-out) or market.  A reserve for potentially obsolete or slow-moving inventory is provided based on management’s analysis of inventory aging, inventory levels and future sales forecasts.  The Company reserved for $80,000 and $15,000 of finished goods inventory at June 30, 2011 and 2010, respectively.

Property and Equipment and Depreciation

Depreciation is provided for by straight-line and accelerated methods over the estimated useful lives of the assets, which vary from three to ten years.  Cost of repairs and maintenance are charged to operations in the period incurred.

Software Development Costs

Software development costs are expensed as incurred until technological feasibility is established. Software development costs incurred subsequent to establishing technological feasibility are capitalized and amortized. Amortization is provided based on the greater of the ratios that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product, or the straight-line method over the estimated useful life of the product. The estimated useful life for the straight-line method is determined to be five years. There were software development costs capitalized in the amount of $20,879 for the year ended June 30, 2011.

 
F-6

 

ELECTRONIC CONTROL SECURITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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, warrants, convertible debentures and convertible preferred stock that would have an anti-dilutive effect were not included in the diluted earnings per share attributable to common stockholders for the years ended June 30, 2011 and 2010.

The following is a reconciliation of the denominators of the basic and diluted earnings per share computations:

   
Year
 
    
Ended June 30,
 
    
2011
   
2010
 
             
Denominators:
           
             
Weighted-average shares outstanding used to compute basic earnings per share
    10,404,884       10,150,437  
                 
Effect of dilutive stock options
    184,231       362,243  
                 
Weighted-average shares outstanding and dilutive securities used to compute dilutive earnings per share
    10,589,115       10,512,680  

For the year ended June 30, 2011, there were outstanding potential common equivalent shares of 4,577,107 compared to 4,874,354 for the year ended June 30, 2010, 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 short-term deposits with a 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.

 
F-7

 

ELECTRONIC CONTROL SECURITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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.

The Company also provides professional and technical services under a specific contract, based on a time and material plus fixed profit basis. Revenue on this contract is 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, 2011 and 2010, 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, 2011 and 2010 amounted to $129,722 and $129,358, 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.

 
F-8

 

ELECTRONIC CONTROL SECURITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 did not incur advertising costs for the years ended June 30, 2011 and 2010.
 
Shipping and Handling
 
Shipping and handling costs are recorded as costs of revenues and are approximately $21,400 and $12,300 for the years ended June 30, 2011 and 2010, 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, other current liabilities and convertible debentures, are carried at, or approximate, fair value because of their short-term nature or because they carry market rates of interest.

Recent 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. These new standards have not significantly impacted the consolidated financial statements.

The FASB amended ASC 350, “Intangibles — Goodwill and Other,” with Accounting Standards Update (“ASU”) 2010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” This update requires that step 2 of the goodwill impairment test (i.e., measurement and recognition of an impairment loss) be performed if a reporting unit has a carrying value equal to or less than zero and qualitative factors indicate that it is more likely than not that a goodwill impairment exists. The provisions of this update are effective for annual reporting periods beginning after December 15, 2010.   Management does not expect these new standards to significantly impact its consolidated financial statements.

 
F-9

 

ELECTRONIC CONTROL SECURITY, INC.
NOTES TO 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.

Note 3 - Inventories

Inventories at June 30, 2011 and 2010 consisted of the following:

   
2011
   
2010
 
Raw materials
  $ 470,259     $ 307,935  
Work-in-process
    243,344       215,188  
Finished goods
    1,310,073       1,367,120  
Subtotal
    2,023,676       1,890,243  
Allowance
    (80,000 )     (15,000 )
    $ 1,943,676     $ 1,875,243  

Note 4 – Property, Equipment and Software Development Costs

Property, equipment and software development costs at June 30, 2011 and 2010 consisted of the following:

   
2011
   
2010
 
Furniture and fixtures
  $ 54,032     $ 70,551  
Machinery and equipment
    1,042,572       881,064  
Improvements
    23,008       23,008  
Software
    113,724       106,415  
Software development costs
    163,896       526,760  
      1,397,232       1,607,798  
Less: accumulated depreciation and amortization
    1,009,142       1,465,412  
    $ 388,090     $ 142,386  
 
Depreciation and amortization expense was $111,811 and $84,943 for the years ended June 30, 2011 and 2010, respectively.

 
F-10

 

ELECTRONIC CONTROL SECURITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 5 – Intangibles

   
June 30, 2011
   
June 30, 2010
 
    
Gross
         
Gross
       
    
Carrying
   
Accumulated
   
Carrying
   
Accumulated
 
    
Amount
   
Amortization
   
Amount
   
Amortization
 
Amortized intangible assets:
                       
Licenses
  $ 50,000     $ 50,000     $ 74,000     $ 67,669  
Patent
    852,793       296,855       852,793       249,982  
Trademarks
    577,263       182,800       577,263       153,936  
Other
    8,881       8,881       8,881       8,881  
                                 
    $ 1,488,937     $ 538,536     $ 1,512,937     $ 480,468  

Amortization expense charged to operations was $81,468 and $82,654 for the years ended June 30, 2011 and 2010, respectively.  Future annual amortization expense for the licenses and other intangible assets is expected to be approximately $75,700 each year for the patents and trademarks through 2022, their estimated remaining useful lives.

In January 2009, the Company agreed to release the minority shareholders of its Middle East subsidiary of all claims, including amounts receivable from them in the amount of $149,962 in exchange for their shares in the subsidiary. The Company recorded this additional investment in the subsidiary to Goodwill.

Note 6 – Line of Credit

On March 15, 2011, the Company, through its wholly owned subsidiary, ECSI International Inc. (the “Subsidiary”), entered into a revolving line of credit agreement with a financial institution which allows for borrowings up to $475,000.  The line bears interest at a rate of New York prime plus .25%, floating with a floor of 4.5%.  The interest rate that the line was subject to at June 30, 2011 was 4.5% per annum.  The line of credit requires an annual cleanup and matures on March 15, 2012, at which time the outstanding balance plus any accrued and unpaid interest is due and payable.  The outstanding balance was $425,000 at June 30, 2011.
 
The above credit line is collateralized by Subsidiary’s accounts receivable, inventories and general intangibles and is subject to various financial and non-financial covenants that are measured on a consolidated basis.  The Company is the sole guarantor of the line of credit.
 
Note 7 - Long-Term Debt

In fiscal 2008, the Company financed the purchase of equipment from a vendor in the amount of $101,762, evidenced by a note bearing interest at the rate of 8%. As the Company purchases product from the vendor a portion of each invoice will be charged to reduce the note balance. Management expects that the note will be repaid over the next 12 months. Collateral for the note is the underlying equipment. The balance on the note at June 30, 2011 and 2010 was $14,237 and $43,754, respectively.
 
Note 8 – Convertible Debentures

In January 2006, the Company raised net proceeds of $831,000 from the proceeds of the private placement of $1,000,000 in principal amount of our Senior Secured Convertible Debentures (“the Debentures”).  All outstanding balances of the original principal amount and related interest were repaid by July 2010.
 
 
F-11

 

ELECTRONIC CONTROL SECURITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
There was a continuing Event of Default under these secured convertible debentures.  For the purpose of curing such event, in August and September 2010, the Company offered to the three debenture holders, an aggregate of 282,608 shares of its common stock in satisfaction thereof.  As of the date of the filing of this report, the Company has issued 70,652 shares of common stock to one of the debenture holders.
 
Note 9 – Financing Agreement
 
On February 8, 2011, the Company executed a drawdown equity financing agreement and registration rights agreement (collectively, the “Agreements”) with Auctus Private Equity Fund, LLC (“Auctus”) pursuant to which, Auctus has committed, subject to certain conditions, to purchase up to $10 million of the Company’s common stock, over a term of up to five years commencing from the effective date of the registration statement (as defined below).
 
While the Company is not required to sell shares under the Agreements, the Agreements give the Company the option to sell to Auctus, shares of common stock at a per share purchase price of equal to 96% of the lowest closing value weighted average price (VWAP) during the five trading days following the Company’s delivery to Auctus of a draw-down notice (the “Notice”).  At the Company’s option, the Company may set a floor price under which, Auctus may not sell the shares which were the subject of the Notice.  The maximum amount of common stock that the Company can sell pursuant to any Notice is the greater of an amount of shares with  an aggregate maximum purchase price of $200,000 or 200% of the average daily volume based on the trailing ten (10) days preceding the Notice date, whichever is of a larger value.
 
Auctus is not required to purchase the shares, unless the shares, which are subject to the Notice, have been registered for resale and are freely tradable in accordance with the Federal securities laws, including the Securities Act of 1933, as amended.  The Company was obligated to file with the U.S. Securities and Exchange Commission (the “SEC”) a registration statement on Form S-1 (the “Registration Statement”) within 180 days from the date of the Agreements and to use all commercially reasonable efforts to have such registration statement declared effective by the SEC within 120 days of filing. The Registration Statement was filed on June 13, 2011, as subsequently amended on June 28, 2011 and declared effective on July 1, 2011.
 
The Company paid a non-refundable fee in the amount of $5,000 to Auctus and is subject to an additional $7,500 fee payable from the proceeds of the first drawdown.
 
Note 10 – Due to Officers and Shareholders

These amounts represent interest bearing advances and are due on demand.

 
F-12

 

ELECTRONIC CONTROL SECURITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 11 - Income Taxes

The provision for taxes for the year ended June 30, 2011 and 2010 includes the following components:

   
2011
   
2010
 
Current
           
Federal
  $ -     $ -  
State
    -       -  
Foreign
    -       -  
      -       -  
Deferred
               
Federal
    (153,000 )     -  
State
    (27,000 )     -  
Foreign
    52,000       -  
      (128,000 )     -  
                 
    $ (128,000 )   $ -  

The components of the deferred tax accounts as of June 30, 2011 and 2010 are as follows:

   
2011
   
2010
 
Deferred tax assets
           
Net operating loss carryforward
  $ 1,912,318     $ 2,154,357  
Stock based compensation
    215,017       202,601  
Other
    14,000       14,000  
      2,141,335       2,370,958  
Deferred tax liabilities
               
Depreciation and amortization
    53,376       43,631  
Subtotal
    2,087,959       2,327,327  
Valuation allowance
    (1,566,159 )     (1,933,527 )
                 
Net deferred tax assets
  $ 521,800     $ 393,800  

The valuation allowance at June 30, 2009 was $2,057,155.

The reconciliation of estimated income taxes attributed to operations at the statutory tax rates to the reported income tax benefit is as follows:

   
2011
   
2010
 
Expected federal tax at statutory rate
  $ 86,150     $ 90,653  
State taxes, net of federal tax effect
    15,214       16,006  
Foreign rate differential
    (11 )      
Non deductible expenses
    63,827       56,728  
Change in valuation allowance
    (367,372 )     (176,120 )
Other
    74,192       12,733  
    $ (128,000 )   $ -  

At June 30, 2011, and 2010, the Company had net operating loss carryforwards for federal and state income tax purposes of $3,965,599 and $4,472,697 respectively, expiring through 2031. The Company has foreign net operating loss carryforwards of $607,402 with no expiration date.

At June 30, 2011 and 2010, 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, 2011 and 2010.

 
F-13

 

ELECTRONIC CONTROL SECURITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
The Company files U.S. and state income tax returns in jurisdictions with varying statutes of limitations. The 2007 through 2010 tax years generally remain subject to examination by federal and most state tax authorities.
 
Note 12 - 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 commencing one year from date of issuance 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, 2009, 700,000 shares of Series A Preferred were converted into a like amount of common stock.

Cumulative but undeclared dividends at June 30, 2011 total approximately $300,000.

Series B Convertible Preferred Stock
 
On June 30, 2004, the Company completed a private placement of 2,000 shares of its 10% Series B Convertible Preferred Stock (“Series B  Preferred”) and warrants to purchase up to 2,000,000 shares of common stock for an aggregate purchase price of $2,000,000. The Preferred Stock provides for a dividend at the rate of 10% per annum, payable quarterly, (payable in cash or by adding the dollar amount of such dividends to the Stated Value), dividends will be paid on a cumulative basis.  The preferred shares have a liquidation preference in the amount of $1,000 per share and have preference to any payments to the Preferred A shareholders. Each preferred share is convertible at the option of the holder into 1,000 shares of common stock. The conversion price is subject to anti-dilution adjustments, including, among other things, in the event that the Company sells common stock during the next three years for a price of less than one dollar per share.  The Company may require the conversion of all (but not less than all) of the then outstanding shares of Series B Preferred Stock, if at any time the volume weighted average trading price per share of common stock for each of 20 consecutive trading days prior to a conversion notice is greater than $2.50 (subject to adjustment), and the daily trading volume of the common stock is at least 100,000 shares. In addition all shares of common stock underlying the Series B Preferred Stock must be covered by an effective registration statement.
 
The Warrants are exercisable for a period of four years from the date of issuance at an exercise price per share of $1.00 per share and have similar anti-dilution privileges as the Series B Preferred Stock.
 
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. All of the Warrants issued in connection with this offering have since expired unexercised.

 
F-14

 

ELECTRONIC CONTROL SECURITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 will be 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.

 
F-15

 

ELECTRONIC CONTROL SECURITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Option activity for 2011 and 2010 is summarized as follows:

             
Weighted
 
               
Average
 
               
Exercise
 
         
Options
   
Price
 
Options outstanding, June 30, 2009
        1,442,000       .66  
                     
Granted
        300,000     $ .17  
Forfeited
        (10,000 )     .75  
                     
Options outstanding, June 30, 2010
        1,732,000     $ .57  
                     
Granted
                 
Forfeited
        (2,000 )     .75  
Exercised
        (200,000 )     .07-.22  
                     
Options outstanding June 30, 2011
        1,530,000     $ .63  
Aggregate intrinsic value
     
$____26,000