Electronic Control Securities (PINK:EKCS)

EKCS held a conference call last week.  We view this as possible clue that the company may finally be on the cusp of a turnaround as this is the first conference call EKCS has hosted that i can recall.

"Arthur Barchenko, President and CEO, stated that the Company's marketing and sales objectives, implemented in Fiscal 2008, are now producing the results that were anticipated. Those objectives were to change the direction of the Company from a prime contractor on Department of Defense programs to a technology and support service supplier to the large system integrators and selected end users. Arthur apprised call participants that the Company is now showing strong profitability through improved sales and gross margins which afford positive cash flow. He also outlined the Company's current marketing activity as well as its pipeline of proposals (approximately $53 million), current committed but unreleased backlog ($7.1 million), and $3.5 million which have been released."

Although Arthur was not more specific with regards to profitability, we view this  is a good start to opening up communication with shareholders.

Arthur also stressed a continued emphasis on shoring up an already improving balance sheet and not diluting EKCS stock.

On February 5th, 2009 the GeoTeam coded Electronic Control Securities (OTCBB:EKCS), In general, GeoSpecials are stocks that possess characteristics that may positively influence their prices.

We originally purchased shares a while ago as a result of the company’s endeavors at the time. First EKCS announced that it was selected as a primary contractor for the United States Air Force (USAF) IBDSS project. Second, it was involved with Lockheed Martin Cp (NYSE:LMT), as a subcontractor in an Anti-Terrorism Force Protection initiative (ATFP) for U.S. naval bases worldwide. While the Lockheed contract is still going strong, the IBDSS contract did not pan out as the company had hoped. Consequently, my investment failed to yield any return, putting me under water on EKCS years later. Consequently, we recently had a brief conversation with the company’s President and CEO, Arthur Barchenko, to inquire into why the contract did not meet expectations. He explained that the problem originated from the company’s business model in which EKCS acted as a primary contractor for government projects. Four main problems resulted from this:

• The original IBDSS contract, which has expired, was originally slated to address 34 USAF bases, but in the end it only addressed 5 over five and a half years.
• It was difficult to compete against larger competitors for government contracts due to the company’s smaller size.
• Even when awarded contracts, turning a profit from them could be unpredictable. As a primary contractor, EKCS was involved with the installation of equipment. These are tasks that can quickly erode margins if they were improperly priced at the time of bid.
• The business model was totally dependent on government contracts

About two years ago management decided to shift its business model away from being a primary contractor for government projects. Instead, it chose to become a technology supplier and subcontractor to giants like Lockheed Martin Cp (NYSE:LMT), Raytheon Co. (NYSE:RTN) or Northrop Grum Hol Co (NYSE:NOC). This quasi “partnership” model gives EKCS access to a much larger pool of government and commercial contracts. For example, the company is a technology supplier to the prime contractors on the FPS2 USAF program and has received hundreds of thousands of dollars for their equipment. Also, the company no longer installs equipment for its subcontracted work. It just sells support services and equipment, which reduces its risk and should result in higher sustainable margins. More importantly, EKCS is developing solid relationships with quality firms it intends to grow with.

The fruits of its efforts may be paying off. Albeit minimal, EKCS just reported its first profitable quarter in 13 quarters.

Fiscal Yr. Ends In June	2nd Quarter Dec. 2010	2nd Quarter Dec.2009	Period Change
GAAP Revenue	$1.6 million	$2.4 million	-33.3%
GAAP EPS	$0.01	$-0.03	n/a
Tax Rate	0.00%	0.00%	n/a

Source: 10Q Filing for the period ended December 31, 2009.

Although sales declined due to its gradual shift away from primary contract work, these results show that the company’s new focus is reaping rewards on the margin front. If EKCS can devise a plan to increase sales, then we could have the best of both worlds. And this appears to be the case, at least for the near term. The company will fill contracts during the second half of the year totaling at least $1.5 million compared to about $1 million in the 2008 comparable period. (Year ends in June). Also, it is has submitted proposals on major projects for the Department of Defense facilities and numerous nuclear power stations in the United States and South Korea valued at approximately $2,250,000. A decision relating to these proposals is expected during the third quarter of fiscal 2010.

Still, there are a few flies in the ointment:

• A recent 10Q states, “In January 2006, the Company raised net proceeds of $831,000 from the private placement of $1 million in principal amount of Senior Secured Convertible Debentures. The Debentures had a term of three years and are convertible at the option of the holder at any time into shares of the Company's Common Stock at a conversion price of $.75 per share, subject to certain adjustments. The principal owing on the debentures became due as of January 11, 2009 but was not repaid. The Company has been making payments to the Debenture holders pursuant to a monthly payment program based on free cash flow plus 8% interest. The company has continued principal payments to the Debenture holders proportional to the amount outstanding for each which amounted to $87,500 in aggregate for the six months ended December 31, 2009 leaving a balance due of $365,000 as of such date. However, no assurance can be provided that the Debenture holders will not resort to legal process and/or attempt to foreclose on their lien.”
• Electronic Control Securities’ business has been uneven, so the company will have to prove to investors that its new model can deliver consistent results.
• Contract delays are always a risk when dealing with government projects.

Given some of the existing uncertainties that add a significant level of risk, we have coded EKCS as a low tier GeoSpecial. However, the renewed focus on a higher quality contract pipeline and the fact that the stock is selling under its book value per share of $0.28 may offer a significant opportunity for risk tolerant investors. (Stock currently has wide Bid/Ask Spread)