Item 2.
Management’s Discussion
and Analysis of Financial Condition and Results of Operations
The following Management’s Discussion
and Analysis of Financial Condition and Results of Operations should be read in conjunction with our condensed financial statements
and the related notes contained in this quarterly report.
Forward Looking Statements
Certain of our statements contained in this
Management’s Discussion and Analysis of Financial Condition and Results of Operations section of this quarterly report and,
in particular, those under the heading “Outlook,” contain forward-looking statements. The words “may,”
“will,” “should,” “expect,” “anticipate,” “believe,” “plans,”
“intend” and “continue,” or the negative of these words or other variations on these words or comparable
terminology typically identify such statements. These statements are based on our management’s current expectations, estimates,
forecasts and projections about the industry in which we operate generally, and other beliefs of and assumptions made by our management,
some or many of which may be incorrect. In addition, other written or verbal statements that constitute forward-looking statements
may be made by us or on our behalf. While our management believes these statements are accurate, our business is dependent upon
general economic conditions and various conditions specific to the industries in which we operate. Moreover, we believe that the
current business environment is more challenging and difficult than it has been in the past several years, if not longer. Many
of our customers, particularly those that are primarily involved in the aviation industry, are currently experiencing substantial
financial and business difficulties. If the business of any substantial customer or group of customers fails or is materially and
adversely affected by the current economic environment or otherwise, they may seek to substantially reduce their expenditures for
our services. Any loss of business from our substantial customers could cause our actual results to differ materially from the
forward-looking statements that we have made in this quarterly report. Further, other factors, including, but not limited to, those
relating to the shortage of qualified labor, competitive conditions and adverse changes in economic conditions of the various markets
in which we operate, could adversely impact our business, operations and financial condition and cause our actual results to fail
to meet our expectations, as expressed in the forward-looking statements that we have made in this quarterly report. These forward-looking
statements are not guarantees of future performance, and involve certain risks, uncertainties and assumptions that we may not be
able to accurately predict. We undertake no obligation to update publicly any of these forward-looking statements, whether as a
result of new information, future events or otherwise.
As provided for under the Private Securities
Litigation Reform Act of 1995, we wish to caution shareholders and investors that the important factors under the heading “Risk
Factors” in our Annual Report on Form 10-K filed with the Securities and Exchange Commission with respect to our fiscal year
ended March 31, 2016, could cause our actual financial condition and results from operations to differ materially from our anticipated
results or other expectations expressed in our forward-looking statements in this quarterly report.
Critical Accounting Policies and Estimates
Critical accounting policies are defined as
those most important to the portrayal of a company’s financial condition and results and that require the most difficult,
subjective or complex judgments. The preparation of financial statements in conformity with accounting principles generally accepted
in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities
at the date of the financial statements, the disclosure of contingent assets and liabilities, and the reported amounts of revenues
and expenses during the reporting period. The estimates that we make include allowances for doubtful accounts, depreciation and
amortization, income tax assets and insurance reserves. Estimates are based on historical experience, where applicable or other
assumptions that management believes are reasonable under the circumstances. We have identified the policies described below as
our critical accounting policies. Due to the inherent uncertainty involved in making estimates, actual results may differ from
those estimates under different assumptions or conditions.
Revenue Recognition
We record revenues as services are provided
to our customers. Revenues consist primarily of aviation and security services, which are typically billed at hourly rates. These
rates may vary depending on base, overtime and holiday time worked. Revenue is reported net of applicable taxes.
Accounts Receivable
We periodically evaluate the requirement for
providing for billing adjustments and/or reflect the extent to which we will be able to collect our accounts receivable. We provide
for billing adjustments where management determines that there is a likelihood of a significant adjustment for disputed billings.
Criteria used by management to evaluate the adequacy of the allowance for doubtful accounts include, among others, the creditworthiness
of the customer, current trends, prior payment performance, the age of the receivables and our overall historical loss experience.
Individual accounts are charged off against the allowance as management deems them to be uncollectible.
Minority Investment in Unconsolidated Affiliate
The Company uses the equity method to account for its investment
in Ocean Protection Services, LLC (“OPS”). Equity method investments are recorded at original cost and adjusted periodically
to recognize: (i) our proportionate share of investees’ net income or losses after the date of the investment; (ii) additional
contributions made or distributions received; and (iii) impairment losses resulting from adjustments to net realizable value. The
Company reviews its investment accounted for under the equity method of accounting for impairment whenever events or changes in
circumstances indicate a loss in the value of the investment may be other than temporary.
Intangible Assets
Intangible assets are stated at cost and consist
primarily of customer lists and borrowing costs that are being amortized on a straight-line basis over a period of three to ten
years, and goodwill, which is reviewed annually for impairment. The life assigned to acquired customer lists is based on management’s
estimate of our expected customer attrition rate. The attrition rate is estimated based on historical contract longevity and management’s
operating experience. We test for impairment annually or when events and circumstances warrant such a review, if earlier. Any potential
impairment is evaluated based on anticipated undiscounted future cash flows and actual customer attrition in accordance with FASB
ASC 360,
Property, Plant and Equipment
.
Insurance Reserves
General liability estimated accrued liabilities
are calculated on an undiscounted basis based on actual claim data and estimates of incurred but not reported claims developed
utilizing historical claim trends. Projected settlements and incurred but not reported claims are estimated based on pending claims,
historical trends and related data.
Workers’ compensation annual costs are
comprised of premiums as well as incurred losses as determined at the end of the coverage period, subject to minimum and maximum
amounts. Workers’ compensation insurance claims and reserves include accruals of estimated settlements for known claims,
as well as accruals of estimates for claims incurred but not yet reported as provided by a third party. In estimating these accruals,
we consider historical loss experience and make judgments about the expected levels of costs per claim. We believe our estimates
of future liability are reasonable based upon our methodology; however, changes in health care costs, accident frequency and severity
and other factors could materially affect the estimate for these liabilities. The Company continually monitors changes in claim
type and incident and evaluates the workers’ compensation insurance accrual, making necessary adjustments based on the evaluation
of these qualitative data points.
Income Taxes
Income taxes are based on income (loss) for
financial reporting purposes and reflect a current tax liability (asset) for the estimated taxes payable (recoverable) in the current
year tax return and changes in deferred taxes. Deferred tax assets or liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities and are measured using enacted tax laws and rates. A valuation allowance is provided
on deferred tax assets if it is determined that it is more likely than not that the asset will not be realized.
We recognize the effect of income tax positions
only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest
amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in
which the change in judgment occurs. In the event that interest and/or penalties are assessed in connection with our tax filings,
interest will be recorded as interest expense and penalties as selling, general and administrative expense. We did not have any
unrecognized tax benefits as of June 30, 2016 and 2015.
Stock Based Compensation
FASB ASC 718, Stock Compensation, requires
all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements
based on their fair values at grant date and the recognition of the related expense over the period in which the share-based compensation
vests. We use the modified-prospective transition method. Under the modified-prospective transition method, we recognize compensation
expense in our financial statements issued subsequent to the date of adoption for all share-based payments granted, modified or
settled. Non-cash charges of $4,052 and $35,907 for stock based compensation have been recorded for the three months ended June
30, 2016 and 2015, respectively.
Overview
We principally provide uniformed security officers
and aviation services to commercial, residential, financial, industrial, aviation and governmental customers through approximately
28 offices throughout the United States. In conjunction with providing these services, we assume responsibility for a variety of
functions, including recruiting, hiring, training and supervising all operating personnel as well as paying such personnel and
providing them with uniforms, fringe benefits and workers’ compensation insurance.
Our customer-focused mission is to provide
the best personalized supervision and management attention necessary to deliver timely and efficient security solutions so that
our customers can operate in safe environments without disruption or loss. Technology underpins our efficiency, accuracy and dependability.
We use a sophisticated software system that integrates scheduling, payroll and billing functions, giving customers the benefit
of customized programs using the personnel best suited to the job.
Renewing and extending existing contracts and
obtaining new contracts are crucial to our ability to generate revenues, earnings and cash flow. In addition, our growth strategy
involves the acquisition and integration of complementary businesses in order to increase our scale within certain geographical
areas, increase our market share in the markets in which we operate, gain market share in the markets in which we do not currently
operate and improve our profitability. We intend to pursue suitable acquisition opportunities for contract security officer businesses.
We frequently evaluate acquisition opportunities and, at any given time, may be in various stages of due diligence or preliminary
discussions with respect to a number of potential acquisitions. However, we cannot assure you that we will identify any suitable
acquisition candidates or, if identified, that we will be able to complete the acquisition of such candidates on favorable terms
or at all.
The global security industry has grown largely
due to an increasing fear of crime and terrorism. In the United States, the demand for security-related products and central station
monitoring services also has grown steadily. We believe that there is continued heightened attention to and demand for security
due to worldwide events, and the ensuing threat, or perceived threat, of criminal and terrorist activities. For these reasons,
we expect that security will continue to be a key area of focus both domestically in the United States and abroad.
Demand for security officer services is dependent
upon a number of factors, including, among other things, demographic trends, general economic variables such as growth in the gross
domestic product, unemployment rates, consumer spending levels, perceived and actual crime rates, government legislation, terrorism
sensitivity, war/external conflicts and technology.
Results of Operations
Revenues
Our revenues increased by $2.6 million, or
7.9%, to $36.3 million for the three months ended June 30, 2016 from $33.7 million in the corresponding period of the prior year.
The increase in revenues for the three months ended June 30, 2016 was due mainly to a $3.6 million increase in revenues driven
by the commencement of work on a new multi-state security services contract with a large on-line retailer in April 2016 and the
addition of revenues from the above-mentioned commencement of work under the contract with the USPS. In addition, revenues from
New York based healthcare facilities increased approximately $0.4 million together with increases from various other commercial
and industrial customers of approximately $0.9 million. These increases were partly offset by a reduction of approximately $0.9
million in revenues from California based technology companies, a reduction of approximately $0.9 million from temporary construction
related services and reductions from various other residential and retail related customers of approximately $0.5 million.
Gross Profit
Our gross profit decreased by $0.3 million,
or 5.6%, to $4.5 million (12.5% of revenues) for the three months ended June 30, 2016, from $4.8 million (14.3% of revenues) in
the corresponding period of the prior year. The decrease was due mainly to an increase in workers’ compensation expense of
approximately $0.3 million, a decline in profits from construction related services of approximately $0.3 million and reductions
in profits from California based technology companies of approximately $0.3 million. These decreases were partly offset by increases
from the above mentioned commencement of work on new contracts with the USPS, the multi-state security services contract with a
large on-line retailer and increases in profits from various other commercial and industrial customers.
General and Administrative Expenses
Our general and administrative expenses decreased
by $19,769, or 0.5%, to $4,094,912 (11.3% of revenues) for the three months ended June 30, 2016, from $4,114,681 (12.2% of revenues)
in the corresponding period of the prior year. The decrease in general and administrative expenses for the three months ended June
30, 2016 was driven primarily by lower legal fees and labor settlement costs, partly offset by slightly higher employee compensation
and benefits costs.
Provision for Doubtful Accounts
The provision for doubtful accounts for the
three months ended June 30, 2016, net of recoveries, decreased by $235,499 to net recoveries of $74,861 as compared with net expense
of $160,638 in the corresponding period of the prior year. The decrease in the net provision for doubtful accounts for the
three months ended June 30, 2016 related primarily to the recovery of approximately $21,000 of specific accounts previously considered
uncollectible and changes in reserves needed for specific accounts.
We periodically evaluate the requirement for
providing for billing adjustments and/or credit losses on our accounts receivable. We provide for billing adjustments in cases
where our management determines that there is a likelihood of a significant adjustment for disputed billings. Criteria used by
management to evaluate the adequacy of the allowance for doubtful accounts include, among others, the creditworthiness of the customer,
current trends, prior payment performance, the age of the receivables and our overall historical loss experience. Individual accounts
are charged off against the allowance for doubtful accounts as our management deems them to be uncollectible. We do not know if
bad debts will increase in future periods.
Interest Expense
Interest expense increased by $21,935, or 68.4%,
to $53,985 for the three months ended June 30, 2016, from $32,050 in the corresponding period of the prior year. The increase in
interest expense for the three months ended June 30, 2016 was due to slightly higher interest rates and higher average outstanding
borrowings under our credit agreement with Wells Fargo, described below.
Equity Earnings (Loss) in Minority Investment of Unconsolidated
Affiliate
The Company uses the equity method to account
for its investment in OPS. The Company’s proportionate share of net loss of OPS for the three months ended June 30, 2016
was $100,000 as compared with net income of $61,500 in the corresponding period of the prior year. The decrease in the Company’s
proportionate share of net income of OPS was due to a reduction in revenues driven by a decrease in total missions during the quarter
ended June 30, 2016 as compared to the quarter ended June 30, 2015, as well as changes in the number and composition of assigned
security personnel. In addition, during the quarter ended June 30, 2016, OPS recognized approximately $600,000 of costs related
to certain strategic growth initiatives. Equity method investments are recorded at original cost and adjusted periodically to recognize:
(i) our proportionate share of investees’ net income or losses after the date of the investment; (ii) additional contributions
made or distributions received; and (iii) impairment losses resulting from adjustments to net realizable value. The Company reviews
its investment accounted for under the equity method of accounting for impairment whenever events or changes in circumstances indicate
a loss in the value of the investment may be other than temporary.
During the past two fiscal years ended December
31, 2015 and 2014, and continuing into the first six months of 2016, OPS has experienced a decline in revenues and net income from
continuing operations. Specifically, for the year ended December 31, 2015, revenues declined 16.1% from the year ended December
31, 2014, gross profits declined by 10.2% and net income from continuing operations declined by 31.4%. However, during the same
periods, gross profit as a percent of revenues increased from 30.6% to 32.8%.
Revenues for the three months ended June 30,
2016 and 2015 were $2.3 million and $2.4 million, respectively. Gross profit margins were 34.6% and 41.3%, respectively.
The decline in revenues during the 18 months
ended June 30, 2016, was driven by an overall reduction in world-wide shipping activity, reduced demand for security personnel
as a result of declines in attempted and successful piracy attacks, lower insurance rates and lower oil prices allowing operators
the option of longer routes through lower risk areas further leading to a decline in demand for security services. The maturing
of this industry has also led to price competition further compressing revenues and margins.
In addition, during the past six months, OPS
has pursued certain strategic growth opportunities costing approximately $1.0 million that have resulted in increases in a variety
of related costs including salaries and wages, legal, consulting, travel and financing costs.
The decline in revenues and increased costs
associated with the pursuit of strategic opportunities has resulted in net losses for the past three quarters ending June 30, 2016,
and accordingly, the Company has recorded its proportionate share of these losses totaling $71,013 for the two quarters ended March
31, 2016, and income of $65,291 for the year ended March 31, 2016. Further, as previously mentioned, OPS has reported net losses
of $100,000 for the quarter ended June 30, 2016, primarily driven by the above-mentioned costs associated with the pursuit of strategic
growth initiatives that are no longer believed to be viable or expected to materialize.
The combination of the above-mentioned decline
in revenues and increased costs has resulted in short-term liquidity pressures that may impact OPS’s ability to remain current
in its obligations under its senior debt. However, the Company and OPS believe the core business will continue to generate gross
profit margins reasonably consistent with historical results and further, there are initiatives underway to reduce operating expenses.
While there can be no assurance that OPS will be able to increase revenues and/or net income from continuing operations in the
foreseeable future or improve its liquidity outlook so as to avoid a default under its credit agreement, the Company believes there
is a reasonable possibility to return OPS to more stable and predictable levels of profitability. Management performed an impairment
analysis as of March 31, 2016 and concluded its investment in OPS was not impaired at that time. The Company has and will continue
to closely monitor the operations of OPS and review its investment for impairment whenever events or changes in circumstances indicate
a loss in the value of the investment may be other than temporary.
Provision for income taxes
The provision for income taxes decreased by
$31,000 to $214,000 for the three months ended June 30, 2016 compared with $245,000 in the corresponding period of the prior year
due to lower pre-tax earnings. The Company’s effective tax rate for the three months ended June 30, 2016 was 57.1% as compared
with 42.7% in the corresponding period of the prior year. The increase in the Company’s effective tax rate was primarily
attributable to the equity loss in our minority investment in OPS.
Liquidity and Capital Resources
We pay approximately 80% of our employees on
a bi-weekly basis with the remaining employees being paid on a weekly basis, while customers pay for services generally within
60 days from the invoice date. We maintain a commercial revolving loan arrangement, currently with Wells Fargo Bank,
National Association (“Wells Fargo”). We fund our payroll and operations primarily through borrowings under
our $20.0 million credit facility with Wells Fargo (as amended, the “Credit Agreement”), described below under “Short
Term Borrowings.”
We principally use short-term borrowings under
our Credit Agreement to fund our accounts receivable. Our short-term borrowings have supported the accounts receivable associated
with our organic growth. We intend to continue to use short-term borrowings to support our working capital requirements.
We believe that our existing funds, cash generated
from operations, and existing sources of and access to financing are adequate to satisfy our working capital, capital expenditure
and debt service requirements for the foreseeable future. However, we cannot assure you that this will continue to be the case.
We may be required to obtain alternative or additional financing to maintain and expand our existing operations through the sale
of our securities, an increase in the amount of available borrowings under our Credit Agreement, obtaining additional financing
from other financial institutions, or otherwise. The failure by us to obtain such financing, if needed, would have a material adverse
effect upon our business, financial condition and results of operations.
Short-Term Borrowings:
On February 12, 2009, we entered into a $20.0
million credit facility (the “Credit Agreement”) with Wells Fargo Bank, National Association (“Wells Fargo”).
This credit facility, which was most recently amended in February 2016 (see below), matures in October 2016, contains customary
affirmative and negative covenants, including, among other things, covenants requiring us to maintain certain financial ratios
and is collateralized by customer accounts receivable and certain other assets of the Company as defined in the Credit Agreement.
The Credit Agreement provides for a letter
of credit sub-line in an aggregate amount of up to $3.0 million. The Credit Agreement also provides for interest to be calculated
on the outstanding principal balance of the revolving loans at the prime rate (as defined in the Credit Agreement) plus 1.50%.
For LIBOR loans, interest will be calculated on the outstanding principal balance of the LIBOR loans at the LIBOR rate (as defined
in the Credit Agreement) plus 1.75%.
On November 13, 2015, we entered into a fifth
amendment (the “Fifth Amendment”) to our Credit Agreement. The Fifth Amendment amends a financial covenant of the Credit
Agreement to allow for certain legal settlement costs associated with the Company’s settlement of a class action lawsuit
(Leal v. Command Security Corporation).
On February 12, 2016, we entered into a sixth
amendment (the “Sixth Amendment” to our Credit Agreement). The Sixth Amendment amends the Credit Agreement to replace
the “Minimum Debt Service Coverage Ratio” covenant with a “Minimum Excess Availability” covenant that was
effective as of December 31, 2015. If we breach a covenant, Wells Fargo has the right to immediately request the repayment in full
of all borrowings under the Credit Agreement, unless Wells Fargo waives the breach. For the three months ended June 30, 2016, we
were in compliance with all covenants under the Credit Agreement.
Under the Credit Agreement, as of June 30,
2016, the interest rate was 2.25% for LIBOR loans and 2.50% for revolving loans. At June 30, 2016, we had approximately $0.5 million
of cash on hand. We also had $5.0 million in LIBOR loans outstanding, $3.8 million of revolving loans outstanding and $0.5 million
outstanding under our letters of credit sub-line under the Credit Agreement, representing 51% of the maximum borrowing capacity
under the Credit Agreement based on our “eligible accounts receivable” (as defined in the Credit Agreement) as of such
date.
Investments and Capital Expenditures
We have no material commitments for capital
expenditures at this time.
Working Capital
Our working capital increased by $0.9 million,
or 8.3%, to $11.6 million as of June 30, 2016, from $10.7 million as of March 31, 2016.
We had checks drawn in advance of future deposits
of $0.6 million at June 30, 2016, compared with $0.5 million at March 31, 2016. Cash balances, book overdrafts and payroll and
related expenses can fluctuate materially from day to day depending on such factors as collections, timing of billing and payroll
dates, and are covered via advances from the revolving loan as checks are presented for payment.
Outlook
Operating Initiatives
During the last few years the Company has pursued
several initiatives to improve our competitive and strategic position. Significant progress has been made in rebuilding and strengthening
our management team and improving the efficiency and functional effectiveness of our organization, systems and processes. In December
2014 we re-entered the U.S. federal government market with the award of the U.S. Postal Service (“USPS”) contract which
had been the subject of a long and challenging protest process. On April 7, 2016, the Court of Federal Claims dismissed the
protest filed by Universal Protective Services (“Universal”) on January 27, 2016. Following the dismissal of Universal’s
claim, the Company reinitiated activities to fully assume the USPS Contract in two phases. On June 6, 2016, the Company commenced
work at approximately half the locations and on June 13, 2016, commenced work at the remaining locations.
Also consistent with the Company’s initiative
to compete for larger contract opportunities, the Company commenced work on a new multi-state security services contract with a
large on-line retailer in April 2016. With a stronger foundation and a more effective organization, the Company is currently engaged
in a corporate-wide campaign with four basic focus areas:
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Improved performance through better systems, procedures and training;
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Profitable top line revenue growth through identification of larger bid and proposal opportunities including new Federal and/or international opportunities and potential acquisitions;
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Dedicated marketing and sales efforts in specific industry sectors that complement our core capabilities, geography and operational expertise; and,
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Attention to details and discipline that will drive operating efficiencies, and enhance enterprise value.
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These strategic initiatives may result in future
costs related to new business development expenses, severance and other employee-related matters, litigation risks and expenses,
and other costs. At this time we are unable to determine the scope of these potential costs.
Financial Results
Our future revenues will largely depend on
our ability to gain additional business from new and existing customers in our security officer and aviation services divisions
at acceptable margins, while minimizing terminations of contracts with existing customers. In addition, our growth strategy involves
the acquisition and integration of complementary businesses to increase our scale within certain geographical areas, capture market
share in the markets in which we operate, enter new markets and improve our profitability. We intend to pursue acquisition opportunities
for contract security officer businesses. Our ability to complete future acquisitions will depend on our ability to identify suitable
acquisition candidates, negotiate acceptable terms for their acquisition and, if necessary, finance those acquisitions. Our security
services division continues to experience organic growth over recent quarters and over the past few years, as demand for our security
services has steadily increased. Our current focus is on increasing our revenues, as our sales and marketing team and branch managers’
work to develop new business and retain profitable contracts. However, several of our airline and security services customers have
reduced capacity within their systems, which typically results in reductions of service hours provided by us to such customers.
Also, competition from other security services companies impacts our ability to gain or maintain sales, gross margins and/or employees.
During recent years, the Department of Homeland Security and the Transportation Security Administration have implemented numerous
security measures that affect airline operations, including expanded cargo and baggage screening, and are likely to implement additional
measures in the future. Additional measures taken to enhance either passenger or cargo security procedures in the future may increase
the airline industry’s demand for third party services provided by us. Additionally, our aviation services division is continually
subject to such government regulation, which has adversely affected us in the past with the federalization of the pre-board screening
services and the document verification process at several of our domestic airport locations.
Our gross profit margin during the three months
ended June 30, 2016 was 12.5%. We expect gross profit to remain under pressure due primarily to continued price competition, including
competition from companies that have substantially greater financial and other resources than we have. However, we expect these
effects will be moderated by continued operational efficiencies resulting from better management and leveraging of our cost structures,
workflow process efficiencies associated with our integrated financial software system and higher contributions from our continuing
new business development.
Our security services division generated approximately
$21.6 million or 60% of our total revenues in the three months ended June 30, 2016. Our aviation services division generated approximately
$ 14.7 million or 40% of our total revenues in the three months ended June 30, 2016.
In the fiscal quarter ended June 30, 2016,
the Company had seven customers who, in the aggregate, represented approximately 51% of the Company’s revenues for the quarter
ended June 30, 2016, with two of those individually customers representing 13% and 12% of total revenues. These customers include
one domestic and one international airline, three major transportation & logistics customers, a northeast U.S. based healthcare
facility and an airline consortium. Any loss of business with these customers could have a material adverse effect on our business,
financial condition and results of operation.
As noted earlier, on February 12,
2009, we entered into a $20.0 million Credit Agreement with Wells Fargo, which was most recently amended in February 2016,
as described above. As of the close of business on August 10, 2016, our total outstanding borrowings under the Credit Agreement
were approximately $9.5 million and our total availability was approximately $6.6 million, which we believe is sufficient
to meet our needs for the foreseeable future barring any increase in reserves imposed by Wells Fargo. We believe that
existing funds, cash generated from operations, and existing sources of and access to financing are adequate to satisfy our
working capital, planned capital expenditures and debt service requirements for the foreseeable future, barring any increase
in reserves imposed by Wells Fargo. However, we cannot assure you that this will be the case, and we may be required to
obtain alternative or additional financing to maintain and expand our existing operations through the sale of our securities,
an increase in the amount of available borrowings under our Credit Agreement, obtaining additional financing from
other financial institutions or otherwise. The financial markets generally, and the credit markets in particular, continue to
be volatile, both in the United States and in other markets worldwide. The current market situation has resulted generally
in substantial reductions in available loans to a broad spectrum of businesses, increased scrutiny by lenders of
the credit-worthiness of borrowers, more restrictive covenants imposed by lenders upon borrowers under credit and
similar agreements and, in some cases, increased interest rates under commercial and other loans. If we require alternative
or additional financing at this or any other time, we cannot assure you that such financing will be available
upon commercially acceptable terms or at all. If we fail to obtain additional financing when and if required by us, our
business, financial condition and results of operations would be materially adversely affected.