Tuesday, February 21, 2017

EKCS Update: Turning the Corner

I first wrote about Electronic Control Security (EKCS) in Aug 2016: EKCS has big potential.  Since then the company has produced 2016 financial statements, given me a quick 2017 projection, and announced a couple more contracts.  EKCS now has a market cap of $400k with revenue set to more than double in 2017.  My thesis is the same it was when I first wrote about EKCS, but they are further into a turnaround than I thought.

I've talked with the CEO by phone and email several times since my first blog post.  The company is doing well and I'd like to give an update

For anyone new to the story I recommend you start by reading my first post.  Here is a quick recap.  EKCS is in the perimeter control security business.  They install and service security systems for correctional facilities, power plants, government facilities, etc.  A few years ago they won a ridiculously large dollar value of contracts from the U.S. government which are still active but have not been acted upon.  And when I say ridiculous I mean almost unbelievable: ~$300M for a company with a market cap of now $400k.  As the company concentrated on large government contracts their other business dropped off with annual revenue falling from $4.5M in 2010 to $0.5M in 2016.  Debt piled up and continues to increase.  Over the past three years revenue has flattened out in the $0.5M - $0.7M range.  The CEO, Arthur Barchenko, is 83 years old and owns 47% of the company.  The company deregistered from the SEC in 2014 then filed again with OTC Markets in Sept 2015 and haven't filed anything since.   

I like to keep my reasons for buying a stock simple and EKCS is no different.  It can be explained in just a few bullet points:
  • 83 year old CEO with large ownership
  • huge government contracts provide almost unlimited upside
  • chart shows stock at a 10 year low with a drop of 99% from 10 years ago
  • company is dark and claims to be coming back towards the light
  • company has changed direction and new focus is showing promise
  • revenue has flattened out after years in free fall

An update on each thesis point:

-- 83 year old CEO with large ownership
I asked the CEO about selling the company, retiring, or merging into a bigger company.  He has no plans to retire. The huge government IDIQ contracts would carry over if he sold or merged.  He said he's definitely open to a merger but no one wants to buy a company with debt and no revenue.  It sounded to me like wants to get the company back on firm footing then check his options.

I don't know if there is a relative to pass the company on to but he can't hold it forever.  

-- huge government contracts provide almost unlimited upside
No change here.  The contracts have been won and are waiting.  The company, and my investment, is not reliant on these contracts though they would certainly be welcome.  Read my first post for the details.

-- chart shows stock at a 10 year low with a drop of 99% from 10 years ago
No change here either.  Price was $0.015 when I first wrote about EKCS and is now at $0.024.  

-- company is dark and claims to be coming back towards the light
The company has shared FYE June 2016 financial statements with me.  The CEO says they'll be posting an annual report to OTC Markets once it gets through accounting.  An additional delay has come from switching accounting firms.  He hopes to publish reports for FY16 annual as well as first two quarters for FYE June 2017 in the next couple months.  

The CEO tells me they plan to file with OTC Markets and pay the hostage fee to get removed from the stop designation list.  

-- company has changed direction and new focus is showing promise
As the CEO explained to me, EKCS invested a lot of time and money on large Indefinite Delivery Indefinite Quantity (IDIQ) government contracts that have not delivered revenue so they changed directions.  This is why revenue has fallen so far.  EKCS put everything they had into these big IDIQ contracts.  They were successful in winning contracts with a ceiling around $300M but the problem is these contracts are not a guarantee of actual purchase.  EKCS has 6 large IDIQ government contracts.  All active and have been extended by the government.  But the gov't has never placed an order for physical security.  The way these work is a supplier wins the contract and that sets up a price for the goods but for any work to be done the gov't has to allocate a budget and place a separate order.  I don't know if they'll ever be acted on and neither does EKCS.  All I can say is they are present and possible.

EKCS has been soured on the large gov't IDIQ contracts and shifted focus. No more IDIQ contracts. They are currently bidding on correctional, nuclear (private), DOE, DOD, oil and gas facility, domestic and international contracts. This shift in focus is what has led to the increase in revenue so far in 2017 and hopefully it continues.  

Some of these bids are in the multi-millions.  Imagine what that would do the stock price of a company earning $600k for the past few years.  

CEO says the company is growing.  They are hiring back workers they'd laid off in the past and plan to continue on like this.  

-- revenue has flattened out after years in free fall
Now it gets interesting.  In my first post I noted the company expected revenue for FYE 6/30/2016 to be about $700k but some has slipped into FYE 2017 so 2016 ended up being only $513k.  Annual revenue from 2016 -> 2010 is $513k, $580k, $660k, $980k, $2.2M, $4.0M, $4.5M, respectively.  

The encouraging thing is what's happened so far in FYE 2017.  Only halfway through the year EKCS has shipped as much product as in all of 2016 and they project $1.2M in revenue for FY17.  A quote from the CEO:
"We have received as of December 31st $1.2M in booked business. We have shipped $623,000 as of December 31st. Therefore, we believe the $1.2 Projection is a safe bet. We will probably beat that by a few hundred thousand."

2016 Financials:
The CEO sent me only the financial statements as they do not have a full report ready yet.  Overall not pretty.  Revenue dropped to $513k from $580k.  They wrote off the Lockheed Martin lawsuit I mentioned in my first post, dropping AR and raising SGA by about $500k.  This write off is an expected non-recurring event so not that big a deal.  Accounts payable and due to officers continues to rise.  They issued some stock and converted some debt so common shares outstanding rose from 16.5M to 17.1M.  

One bright spot is gross margin of 44%.  The CEO says it should be about 50% in 2017 due to sales mix.  GM was around 50% in 2011, 2010 but reduced to nothing in 2012-2015.  Going forward I think it should be in the 40-50% range.


The Future:
What will happen next is always the question and I don't know.  I think we have a turnaround sitting at all time lows..  There is clear evidence the recent directional changes are working.  In the background we have the relatively unlimited gov't contracts.  The CEO is not getting any younger.  Security spending can only go up.  They are coming out of the darkness to file reports again with OTC Markets.  

This is exactly what I look for in a beaten down tiny company.  Stock price drops to nothing as revenue decreases.  The company reacts by trimming costs, restructuring, and changing course.  The steep drop in revenue decreases as the new focus comes into play.  At some point revenue starts increasing as it all takes hold.  ...  Hopefully revenue continues on this course then earnings and stock price follow.  


-- Dan
disclosure: Long EKCS

6 comments:

  1. Dan, thanks for the kind update.

    83 year old CEO! Jeez, who else is on the board of directors?

    What kind of debt is outstanding? Who owns it? is it listed bonds?

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    1. No bonds that I know of. I suggest you read my first post as well as their most recent annual report and 10k

      https://www.otcmarkets.com/ajax/showFinancialReportById.pdf?id=145024

      https://www.otcmarkets.com/edgar/GetFilingHtml?FilingID=9555506

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  2. Also, how do the preffered stock convert to common? I don't understand the filing...

    And "$2.3M due to officers, shareholders, and affiliates" - What the heck does this mean?

    that's the next 3-4 year profits gone!

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    Replies
    1. They have way too much debt for sure. That's problem number 1 for EKCS. I talked more about that in my first post so start there. The market cap is super small but EV is much higher due to debt. There's your risk. The debt is all to officers and affiliates and they keep deferring it. It's in their interest to do what it takes to keep the company going.

      The money due back to officers, etc is unpaid loans, salary, and preferred dividends. It's growing. See note 8 in the most recent annual

      Series B pref converts to common at $0.75 per share. I think Series A converts at $0.88 but it's worded strangely. I would love for the stock price to be high enough that they convert this preferred...

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  3. Can you buy this on IBRK or Fidelity?

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    Replies
    1. Fidelity no. IBRK I think probably yes but I don't have an account there so not certain

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