Electronic Control Security (EKCS) 10-Q 2014 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended September 30, 2013

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to _________

Commission File Number: 000-31026

ELECTRONIC CONTROL SECURITY INC.

(Exact name of registrant as specified in its charter)

NEW JERSEY	22-2138196
(State or other jurisdiction	(IRS Employer Identification No.)
of incorporation or organization

790 BLOOMFIELD AVENUE, CLIFTON, NEW JERSEY 07012

(Address of principal executive offices)

(973) 574-8555

(Issuer's telephone number)

Indicate by checkmark whether the registrant has (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes xNo ¨

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 check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ Nox

As of November 9, 2013, Electronic Control Security Inc. had outstanding 15,866,618 shares of common stock, par value $0.001 per share.

INDEX PAGE

PART I — FINANCIAL INFORMATION
Forward Looking Statements
Item 1 - Financial Statements
	Consolidated Balance Sheets September 30, 2013 (Unaudited) and June 30, 2013	F-1
	Unaudited Consolidated Statements of Operations for the three months ended September 30, 2013 and 2012	F-2
	Unaudited Consolidated Statements of Comprehensive Income (Loss) for the three months ended September 30, 2013 and 2012	F-3
	Unaudited Consolidated Statements of Cash Flows for the three months ended September 30, 2013 and 2012	F-4
	Notes to Consolidated Financial Statements	3
Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations		5
Item 4 - Controls and Procedures		9
PART II — OTHER INFORMATION
Item 6 – Exhibits		9
Signatures		10

2

Electronic Control Security Inc.

Consolidated Balance Sheets

	September 30,			June 30,
	2013			2013
	(Unaudited)
ASSETS
Current assets
Cash and cash equivalents	$	556		$	556
Accounts receivable, net of allowanceof $425,000		621,471			586,319
Inventories		1,840,181			1,842,203
Current portion of deferred income taxes		194,986			167,499
Other current assets		13,109			22,828
Total current assets		2,670,303			2,619,405
Property, equipment and software development costs - net		198,193			219,402
Intangible assets - net		779,998			798,932
Deferred income taxes		687,750			678,981
Other assets		16,289			17,643
	$	4,352,533		$	4,334,363
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable and accrued expenses	$	1,211,199		$	1,142,391
Due to officers, shareholders and affiliates		563,780			441,771
Current maturities of debt		32,907			32,418
Total current liabilities		1,807,886			1,616,580
Noncurrent liabilities
Long-term debt		431,892			440,557
Subordinated liabilities to officers and shareholders		848,080			848,080
Other		7,000			7,000
Total liabilities		3,094,858			2,912,217
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		3,000			3,000
Series B 10% Convertible Preferred stock, cumulative, $.001 par value; $2,495 and $2,434 per share liquidation preference; 2,000 shares authorized, 645 shares issued and outstanding		1			1
Common Stock, $.001 par value; 30,000,000 shares authorized;15,967,146 and 15,967,146 shares issued; 15,866,618 and 15,867,146 shares outstanding		15,967			15,967
Additional paid-in capital		14,159,476			14,119,909
Accumulated deficit		(12,915,496	)		(12,711,521	)
Accumulated other comprehensive income		4,790			4,790
Treasury stock, at cost, 100,528 and 100,000 shares		(10,063	)		(10,000	)
Total shareholders' equity		1,257,675			1,422,146
	$	4,352,533		$	4,334,363

See Notes to Consolidated Financial Statements.

F-1

Electronic Control Security Inc.

Consolidated Statements of Operations

	Three Months
	Ended
	September 30,
	2013			2012
	(Unaudited)			(Unaudited)
Revenues	$	171,019		$	432,074
Cost of revenues		157,617			200,190
Gross profit		13,402			231,884
Research and development		16,163			24,931
Selling, general and administrative expenses		174,106			239,805
Loss from operations		(176,867	)		(32,852	)
Other expenses (income)
Interest expense		21,129			17,826
Other, net		1,354			-
Total other expenses (income)		22,483			17,826
Loss before income taxes		(199,350	)		(50,678	)
Income tax benefits		(34,944	)		-
Loss before dividends		(164,406	)		(50,678	)
Dividends related to convertible preferred stock		39,568			35,847
Net loss attributable to common shareholders	$	(203,974	)	$	(86,525	)
Net loss per share:
Basic	$	(0.01	)	$	(0.01	)
Diluted	$	(0.01	)	$	(0.01	)
Weighted average number ofcommon shares and equivalents:
Basic		15,866,635			11,867,146
Diluted		15,866,635			11,867,146

See Notes to Consolidated Financial Statements.

F-2

Electronic Control Security Inc.

Consolidated Statements of Comprehensive Income (Loss)

	Three Months
	Ended
	September 30,
	2013			2012
	(Unaudited)			(Unaudited)
Loss before dividends	$	(164,406	)	$	(50,678	)
Other comprehensive income, net of tax: Foreign currency translation adjustments		-			-
Comprehensive loss	$	(164,406	)	$	(50,678	)

See Notes to Consolidated Financial Statements.

F-3

Electronic Control Security Inc.

Consolidated Statements of Cash Flows

	Three Months
	Ended
	2013			2012
	(Unaudited)			(Unaudited)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
Cash flows from operating activities:
Net loss before deemed dividends	$	(164,406	)	$	(50,678	)
Adjustments to reconcile loss to net cash provided by (used in) operating activities:
Depreciation and amortization		41,497			40,343
Deferred income taxes		(36,257	)		-
Increase (decrease) in cash attributable to changes in
Accounts receivable		(35,152	)		8,182
Inventories		2,022			(9,237	)
Other current assets		9,718			19,867
Accounts payable and accrued expenses		68,808			73,034
Other assets and liabilities		-			67
Net cash provided by (used in) operating activities		(113,770	)		81,578
Cash flows from investing activities:
Acquisition of property plant and equipment		-			-
Net cash used in investing activities		-			-
Cash flows from financing activities:
Payments on short-term debt		-			(62,500	)
Payments on long-term debt		(8,176	)		-
Purchase of treasury stock		(63	)		-
Increase in due to officers, shareholders and affiliates		122,009			112,607
Net cash provided by financing activities		113,770			50,107
Net increase in cash and cash equivalents		-			131,685
Cash and cash equivalents at beginning of period		556			1,403
Cash and cash equivalents at end of period	$	556		$	133,088
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest	$	-		$	7,561
Taxes	$	-		$	-
Supplemental disclosures of noncash financing activities:
None

See Notes to Consolidated Financial Statements.

F-4

Electronic Control Security Inc.

Notes to the Consolidated Financial Statements

Note 1 – Basis of Presentation

The accompanying unaudited consolidated financial statements of Electronic Control Security Inc. and its subsidiaries (collectively "the Company") have been prepared in accordance with generally accepted accounting principles for interim financial information and Article 8.03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended September 30, 2013 are not necessarily indicative of the results that may be expected for the year ending June 30, 2014. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in the Company's Form 10-K for the year ended June 30, 2013, as filed with the Securities and Exchange Commission.

The consolidated financial statements have been prepared based on the Company continuing as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company incurred losses before dividends of $164,406 in the three months ended September 30, 2013, and $1,221,153 and $1,531,773 in the years ended June 30, 2013 and 2012, respectively. Our cash flow and liquidity have been severely impacted by the refusal of Lockheed Martin to pay us for the accounts receivable due from them totaling nearly $1 million. Atlantic Stewardship Bank (the “Bank”) has converted the prior line of credit to a term loan, and no further borrowings are available under the agreement (refer to note 6 below). Through the periods ended September 30, 2013, June 30, 2013 and 2012, the principal source of funds used to finance the Company’s operations has been advances from officers, shareholders and affiliates and accrued costs due to those parties. There is no assurance that those parties will continue to provide the operating funds. Through Fiscal 2012 and 2013, there were continuing delays in release of funding at the Department of Defense and Department of Energy on projects where we serve as a prime contractor and as a subcontractor. The budget constraints and budget uncertainty at the U.S. government agencies have significantly reduced the issuance of orders and delayed projects for all participants in our industry. These factors were addressed in our Form 10-K for the year ended June 30, 2013.

The Company has working capital of about $862,000 and shareholders’ equity of about $1.258 million as of September 30, 2013. In June 2013, the Bank converted the prior line of credit into a term loan, due in installments from July 2013 through June 2015. In connection with this agreement, three of the Company’s officers agreed to subordination agreements with the Bank, under which a total of $848,080 of amounts due to those officers has been subordinated to amounts due to the Bank. The classification of the portion of the Bank loan due after June 30, 2014 and the amounts subordinated by the officers resulted in an increase of the Company’s working capital by $1,288,597. Officers, shareholders and affiliates provided funds in the form of cash advances and deferral of accrued costs and expenses due to them during Fiscal 2013 of $524,412 and $122,009 during the three months ended September 30, 2013. If the Company should require financing of its future accounts receivable, the Company has access to a secured accounts receivable line of credit with Amerisource of approximately $3 million.

In Fiscal 2013 the Company was awarded, as the prime contractor or as a subcontractor, several contracts from units of the Department of Defense. These contracts awarded provide that task orders under the contracts will require competitive bids to be submitted by the Company as those task orders are issued. Through Fiscal 2012 and 2013, the Company has sought to expand its business both domestically and internationally by continuing to submit proposals in response to Request for Proposals (“RFP’s”) from various government agencies.

The Company’s ability to continue its operations is dependent upon our ability to generate sufficient cash flow either from operations, from continued funds from officers and shareholders or from additional financing.

New Authoritative Pronouncements

The Company has considered all new accounting pronouncements and has concluded that there are no new pronouncements that may have a material impact on results of operations, financial condition, or cash flows, based on current information.

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Note 2 - Earnings Per Share

Basic earnings per share is computed based on the weighted-average number of shares of the Company’s common stock, par value $0.001 per share, outstanding. Diluted earnings per share is computed based on the weighted-average number of shares of the Company’s common stock, including common stock equivalents outstanding. Certain common stock equivalents consisting of stock options, warrants, convertible debentures and convertible preferred stock that would have an anti-dilutive effect were not included in the diluted earnings per share attributable to common stockholders for the three months ended September 30, 2013 and 2012.

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

	Three Months
	Ended September 30,
	2013		2012
Denominators:
Weighted-average shares outstanding used to compute basic earnings per share		15,866,635		11,867,146
Effect of dilutive stock options		-		-
Weighted-average shares outstanding and dilutive securities used to compute dilutive earnings per share		15,866,635		11,867,146

For the three months ended September 30, 2013 and 2012, there were outstanding potential common stock equivalent shares of 3,881,764 and 4,004,948, respectively, which were excluded from the computation of diluted earnings per share because the effect would have been anti-dilutive. These potential dilutive common stock equivalent shares may be included in the calculation of future diluted earnings per share.

Note 3 - Inventories

Inventories consist of the following:

	September 30,			June 30,
	2013			2013
Raw materials	$	230,072		$	228,553
Work-in-process		317,038			323,836
Finished goods		1,373,071			1,369,814
Subtotal		1,920,181			1,922,203
Allowance		(80,000	)		(80,000	)
	$	1,840,181		$	1,842,203

Note 4 - Due to Officers, Shareholders and Affiliates ans Subordinated Liabilities to Officers and Shareholders

These amounts are composed of the following at September 30, 2013 and June 30, 2013:

	September 30		June 30
	2013		2013
Interest bearing advances, due on demand	$	28,502	$	19,021
Other advances		221,700		181,200
Accrued compensation and other costs		313,578		241,550
Current liabilities to officers, shareholders and affiliates		563,780		441,771
Subordinated liabilities to officers and shareholders		848,080		848,080
	$	1,411,860	$	1,289,851

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Note 5 – Long-Term Debt

The long-term debt consists of the amount outstanding under a term loanECSI International Inc., a wholly-owned subsidiary of the company and Atlantic Stewardship Bank.

Note 6 – Legal Proceeding

On March 7, 2012, the Company, through its wholly-owned subsidiary, ECSI International, Inc. filed a lawsuit in the United States District Court for the District of New Jersey against Lockheed Martin Global Training and Logistics (“Lockheed Martin”). The lawsuit, as detailed in the First Amended Complaint and Demand for Trial by Jury (the “Amended Complaint”) dated March 29, 2012, alleges breach of contract and tortious interference by Lockheed Martin and seeks actual damages of approximately $978,000, as well as punitive damages, costs and such further relief as the Court deems equitable and proper. In addition, the Amended Complaint seeks payment under Lockheed Martin’s payment bonds required by the United States Navy Facilities Engineering Command. At September 30, 2013, the Company has included in its accounts receivable (prior to allowances) the amount of the actual damages claimed. In Fiscal 2013, Lockheed Martin was granted a motion to have the matter moved from New Jersey to Maryland. We had been aggressively pursuing our claim against Lockheed Martin. While we believe that we have meritorious claims, due to cash flow constraints, we have not yet been able to pursue our claims against Lockheed Martin in Maryland.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion should be read in conjunction with our financial statements and the notes related to those statements. Some of our discussion is forward-looking and involves risks and uncertainties. For information regarding risk factors that could have a material adverse effect on our business, refer to the risk factors section of the Annual Report for the year ended June 30, 2013 on Form 10-K.

CAUTION REGARDING FORWARD-LOOKING STATEMENTS

Our Company and its representatives may from time to time make written or verbal forward-looking statements, including statements contained in this report and other Company filings with the Securities and Exchange Commission and in our reports to shareholders. Statements that relate to other than strictly historical facts, such as statements about our plans and strategies, expectations for future financial performance, new and existing products and technologies, and markets for our products are forward-looking statements. Generally, the words "believe," "expect," "intend," "estimate," "anticipate," "will" and other similar expressions identify forward-looking statements. The forward-looking statements are and will be based on our management's then-current views and assumptions regarding future events and operating performance, and speak only as of their dates. Investors are cautioned that such statements involve risks and uncertainties that could cause actual results to differ materially from historical or anticipated results due to many factors including, but not limited to, our current and future capital needs, uncertainty of capital funding, our clients' ability to cancel contracts with little or no penalty, ongoing delays by federal agencies of approved projects; cash flow impact arising from the dispute with prime contractors; government initiatives to implement Homeland Security measures, the likelihood of completing transactions for which we have entered into letters of intent, the state of the worldwide economy, competition, customers’ ability to pay our invoices within our standard credit terms, and other risks detailed in our Company's most recent Annual Report on Form 10-K and other Securities and Exchange Commission filings. We undertake no obligation to publicly update or revise any forward-looking statements.

OVERVIEW

We design, develop, manufacture and market stand-alone and fully integrated state-of-the-art entry control and perimeter intrusion detection systems for Department of Defense, Department of Energy, nuclear power stations, and various international customers. We offer U.S. Air Force certified technology and a comprehensive services portfolio that includes: site survey/risk assessment, design & engineering, systems manufacturing and integration, factory acceptance testing, installation supervision, commissioning, operations and maintenance training.

We work closely with architects, engineers, systems integrators, construction managers and owners in the development and design of security monitoring and control systems that will afford a normative but secure environment for management, staff and visitors. To support such efforts, ECSI’s team of key personnel are technically accomplished and fully familiar with advances in planning, programming and designing systems utilizing standard peripheral components, mini/micro architecture, user friendly software/firmware selection and application.

5

Our mission is to establish ourselves as a Small Business (SB) prime contractor to take advantage of the small business opportunities that exist today and in the forseeable future. To achieve that end we have formed a team of both small and large corporation agreements to support our company in the pursuit of this market. We believe that our past performance and in depth experience as well as that of our teaming partners will place us in a lead position to capture a good share of this market.

We entered into strategic partnerships, teaming, and representative relationships with major multi-national corporations in each of the industries that comprise our target markets. These companies generally enjoy a strong market presence in their respective industries and we believe that our teaming agreements with these entities afford us added credibility. These entities frequently subcontract our services and purchase our products in connection with larger projects and, in turn, support the company on projects we are pursuing as the prime contractor. During Fiscal 2011, 2012 and 2013, we entered into teaming and marketing agreements with ITSI, SAIC, Fortis, Calnet, Honeywell, Culmen, ERIS, and Boeing.

During fiscal 2012 and 2013, we submitted proposals on projects for Department of Defense facilities and certain nuclear power stations in the United States and Southeast Asia valued at approximately $162,750,000. Of these, other bidders were awarded $16 million and we have been awarded, as the prime contractor and as a subcontractor, contracts with an approximate value of $35 million over five years. We anticipate decisions relating to the still-open proposals during fiscal 2014.

Recent Developments

Our revenues and results from operations for the years ended June 30, 2013 and 2012, and the quarter ended September 30, 2013, continued to be negatively impacted by the ongoing delays by agencies of the U.S. Government in proceeding with approved projects, funding projects already awarded, and in awarding new contracts. We have invested significant time and personnel resources in fiscal 2013 and 2012 in providing proposals on future projects, both as a prime contractor (Small Business) and as a subcontractor. We are awaiting the results of the bidding process. Additionally, our cash flow and liquidity continue to be severely impacted with the refusal by Lockheed Martin to pay us for the accounts receivable due from them totaling almost $1 million. These amounts are the subject of litigation, as described in Item 3 of our Annual Report on Form 10-K for the year ended June 30, 2013.

On June 28, 2013, one of our wholly-owned subsidiaries amended its previous line of credit agreement with Atlantic Stewardship Bank (“ASB”). Under the terms of the amended loan agreement, the principal balance outstanding on June 28, 2013 will be paid in monthly installments of $5,000 including interest, beginning July 15, 2013 and continuing through May 15, 2015. The remaining outstanding balance is due on June 15, 2015. Under the terms of the amended agreement, the variable interest rate increased to the prime rate plus 1%, with a minimum of 5.875%. The prior line of credit agreement had carried an interest rate of the prime rate plus .25%, with a minimum rate of 4.5%. The previous covenant requiring a minimum debt service coverage ratio was eliminated in the amended agreement.

The above term loan is collateralized by the subsidiary’s accounts receivable, inventories, equipment and general intangibles. As part of the amended agreement, our President and Chief Executive Officer provided a personal guaranty of the amounts due to ASB, up to a maximum of $250,000. Three of our officers executed subordination agreements which subordinated a combined total of $848,080 of amounts due to those officers to amounts due by the subsidiary to ASB. Because these subordinated amounts are not to be paid until ASB has been repaid, the subordinated amounts have been classified as noncurrent liabilities.

CRITICAL ACCOUNTING POLICIES

Our consolidated financial statements and accompanying notes have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires that we make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Management continually evaluates the accounting policies and estimates it uses to prepare the consolidated financial statements. We base our estimates on historical experience and assumptions believed to be reasonable under current facts and circumstances. Actual amounts and results could differ from these estimates made by management.

6

We do not participate in, nor has there been created, any off-balance sheet special purpose entities or other off-balance sheet financing. In addition, we do not enter into any derivative financial instruments for speculative purposes.

We have identified the following critical accounting policies that affect the more significant judgments and estimates used in the preparation of our condensed consolidated financial statements.

INVENTORY VALUATION

Inventories are valued at the lower of cost or market. We routinely evaluate the composition of our inventory to identify obsolete or otherwise impaired inventories. Inventories identified as impaired are evaluated to determine if reserves are required. We currently have a reserve of $80,000 against inventory.

ALLOWANCE FOR DOUBTFUL ACCOUNTS

The allowance for doubtful accounts is comprised of two parts, a specific account analysis and a general reserve. Accounts where specific information indicates a potential loss may exist are reviewed and a specific reserve against amounts due is recorded. As additional information becomes available, such specific account reserves are updated. Additionally, a general reserve is applied to the aging categories based on historical collection and write-off experience.

ACCOUNTING FOR INCOME TAXES

We record a valuation allowance to our deferred tax assets for the amount that is more likely than not to be realized. While we consider historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event that we determine that we would be able to realize deferred tax assets in the future in excess of the net amount recorded, an adjustment to the deferred tax asset would increase income in the period such determination has been made. Likewise, should we determine that we would not be able to realize all or part of the net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged against income in the period such determination was made.

FAIR VALUE OF EQUITY INSTRUMENTS

The valuation of certain items, including valuation of warrants or stock options that may be offered as compensation for goods or services, involve significant estimations with underlying assumptions judgmentally determined. Warrants are valued using the most reliable measure of fair value, such as the value of the goods or services rendered, if obtainable. If such value is not readily obtainable, the valuation of warrants and stock options are then based on the Black-Scholes valuation model, which involves estimates of stock volatility, expected life of the instruments and other assumptions.

RESULTS OF OPERATIONS

COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 2013 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2012

REVENUES. We had net revenues for the three months ended September 30, 2013 of $171,019 compared to $432,074 in the corresponding period in 2012, representing a decrease of approximately 60%. The decrease in net revenues is primarily attributable to a decrease in deliverable products and support services billings resulting from continuing delays in release of funding at the Department of Defense and Department of Energy on projects where we serve as a subcontractor as well as at other customers. The budget constraints and budget uncertainty at the U.S. government agencies have significantly reduced the issuance of orders and delayed projects for all participants in our industry.

GROSS MARGINS. Gross margins for the three months ended September 30, 2013 were 8% as compared to 54% for the corresponding period in 2012. The decrease in gross margins for the three months is primarily attributable to the decrease in revenues discussed above, partially offset by a change in the mix of sales of equipment and support services and a reduction in personnel costs due to the lower revenues.

RESEARCH AND DEVELOPMENT. Research and development expenses were $16,163 for the three months ended September 30, 2013 compared to $24,931 for the corresponding three months in 2012. The reduction in research and development expenses was due to reductions in personnel costs.

7

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses were $174,106 for the three months ended September 30, 2013 compared to $239,805 for the corresponding three months in 2012. The decrease in selling, general and administrative expenses during the three months ended September 30, 2013 as compared to the corresponding period in 2012 is primarily attributable to reduced personnel costs and professional fees.

LOSS FROM OPERATIONS. The loss from operations for the three months ended September 30, 2013 of $(176,867) compared to $(32,852) for the corresponding three months of 2012. The increase in the loss from operations during the 2013 period compared to the 2012 period was primarily attributable to the lower revenues.

INCOME TAX BENEFIT. We recognized a net $36,257 deferred income tax benefit in the quarter ended September 30, 2013. The deferred income tax benefits were recorded based on expectations of that we will utilize a portion of our existing net operating loss carryforwards with future operating earnings

DIVIDENDS RELATED TO CONVERTIBLE PREFERRED STOCK. We recorded dividends totaling $39,568 on our Series B Convertible Preferred Stock in the three months ended September 30, 2013 and $35,847 in the corresponding three months in 2012. In lieu of a cash payment, we have elected, under the terms of these securities, to add this amount to the stated value of the Series B Convertible Preferred Stock.

These dividends are non-cash and, therefore, have no impact on our net worth, cash flow or liquidity.

LIQUIDITY AND CAPITAL RESOURCES

The consolidated financial statements have been prepared based on our continuing as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. We incurred losses before dividends of $164,406 in the three months ended September 30, 2013, and $1,221,153 and $1,531,773 in the years ended June 30, 2013 and 2012, respectively. Our cash flow and liquidity have been severely impacted by the refusal of Lockheed Martin to pay us for the accounts receivable due from them totaling nearly $1 million. Atlantic Stewardship Bank (the “Bank”) has converted the prior line of credit to a term loan, and no further borrowings are available under the agreement (refer to note 6 below). Through the periods ended September 30, 2013, June 30, 2013 and 2012, the principal source of funds used to finance the Company’s operations has been advances from officers, shareholders and affiliates and accrued costs due to those parties. There is no assurance that those parties will continue to provide the operating funds. Through Fiscal 2012 and 2013, there were continuing delays in release of funding at the Department of Defense and Department of Energy on projects where we serve as a prime contractor and as a subcontractor. The budget constraints and budget uncertainty at the U.S. government agencies have significantly reduced the issuance of orders and delayed projects for all participants in our industry. These factors were addressed in our Form 10-K for the year ended June 30, 2013.

We have working capital of approximately $862,000 and stockholders’ equity of approximately $1.258 million as of September 30, 2013. In June 2013, the Bank converted the prior line of credit into a term loan, due in installments from July 2013 through June 2015. In connection with this agreement, three of the Company’s officers agreed to subordination agreements with the Bank, under which a total of $848,040 of amounts due to those officers has been subordinated to amounts due to the Bank. (refer to Notes 6 and 7 below). The classification of the portion of the Bank loan due after June 30, 2014 and the amounts subordinated by the officers resulted in increased the Company’s working capital by $1,288,637. Officers, shareholders and affiliates provided funds in the form of cash advances and deferral of accrued costs and expenses due to them during Fiscal 2013 of $524,412. If we should require financing of our future accounts receivable, we have access to a secured accounts receivable line of credit with Amerisource of approximately $3 million.

In Fiscal 2013 we were awarded, as the prime contractor or as a subcontractor, several contracts from units of the Department of Defense. These contracts awarded provide that task orders under the contracts will require competitive bids to be submitted by us as those task orders are issued. Through Fiscal 2012 and 2013 and to date in Fiscal 2014, we have sought to expand our business both domestically and internationally by continuing to submit proposals in response to Request for Proposals (“RFP’s”).

Our ability to continue operations is dependent upon our ability to generate sufficient cash flow either from operations, from continued funds from officers and shareholders or from additional financing.

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Our cash flow has been adversely impacted by the refusal of Lockheed Martin to forward to us the proceeds of accounts receivable payable to us. This matter is currently the subject matter of litigation initiated by us in March 2012 and discussed in Item 3 of our Annual Report on Form 10-K for the year ended June 30, 2013. Nonetheless, we believe that cash on hand, together with anticipated collection of accounts receivable during the short term, will be sufficient to provide for our working capital needs for the next 12 months. However, we may need to raise funds in order to allow for shortfalls in anticipated revenue or to expand existing capacities and/or to satisfy any additional significant purchase orders that we may receive. At the present time, we have no assurances of additional revenue beyond the firm purchase orders we have received. We have held discussions with various parties in order to raise additional funds through debt or equity issuance; to date we have not entered into any agreements.

Accounts payable and accrued expenses have increased by $68,808 to $1,211,199 for the three months ended September 30, 2013. Current liabilities to officers, shareholders and affiliates increased by $122,009 to $563,780 in the three months ended September 30, 2013.

In order to conserve our cash resources, we did not purchase any property, plant and equipment during the three-month periods ended September 30, 2013 or 2012. We do not have any major material commitments for capital expenditures going forward.

ITEM 4. CONTROLS AND PROCEDURES.

We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. As of the end of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer (our principal executive officer) and our Chief Financial Officer (our principal financial and accounting officer), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, management and our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms.

During the quarter ended September 30, 2013, there was no change in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II. OTHER INFORMATION

ITEM 6. EXHIBITS.

Exhibit No.	Title
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
32.1	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.
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*	XBRL Instance Document
101.SCH*	XBRL Taxonomy Extension Schema
101.CAL*	XBRL Taxonomy Extension Calculation Linkbase
101.DEF*	XBRL Taxonomy Extension Definition Linkbase
101.LAB*	XBRL Taxonomy Extension Label Linkbase
101.PRE*	XBRL Taxonomy Extension Presentation Linkbase

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SIGNATURES

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

	ELECTRONIC CONTROL SECURITY INC.
Date:  November 14, 2013	By:
	/s/ Arthur Barchenko
	Arthur Barchenko
	President, Chief Executive Officer
	(duly authorized officer and  principal executive officer)
Date:  November 14, 2013	By:
	/s/ Daryl Holcomb
	Daryl Holcomb
	Chief Financial Officer
	(principal financial officer and  principal accounting officer)

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