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 consolidated 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 including its consolidated
subsidiary, OPS LLC, use the equity method to account for its investment in OPSA Ltd. 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 September 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 $8,104 and $70,229 for stock based compensation have been recorded for the six months ended September
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 $8.0 million,
or 23.1%, to $42.4 million for the three months ended September 30, 2016 from $34.4 million in the corresponding period of the
prior year. The increase in revenues for the three months ended September 30, 2016 was due mainly to the commencement of work under
the contracts with the USPS in June 2016 and a large on-line retailer in April 2016. In addition, revenues from a major transportation
company increased by approximately $0.6 million and revenues from financial and banking institutions increased by approximately
$0.3 million. These increases were partly offset by reductions in revenues of approximately $0.7 million from residential and retail
customers, approximately $0.7 million from temporary airport construction related services and from California based technology
companies of approximately $0.6 million.
Our revenues increased by $10.6 million,
or 15.6%, to $78.7 million for the six months ended September 30, 2016 from $68.1 million in the corresponding period of the prior
year. The increase in revenues for the six months ended September 30, 2016 was due mainly to the commencement of work under the
contracts with the USPS in June 2016 and a large on-line retailer in April 2016. In addition, revenues from a major transportation
company increased by approximately $0.9 million, revenues from New York based healthcare facilities increased by approximately
$0.5 million and revenues from financial and banking institutions increased by approximately $0.5 million. These increases were
partially offset by reductions in revenues of approximately $1.5 million from temporary airport construction related services,
approximately $1.5 million from California based technology companies and approximately $1.2 million from residential and retail
customers.
Gross Profit
Our gross profit increased by $0.6 million,
or 13.2%, to $5.2 million (12.2% of revenues) for the three months ended September 30, 2016, from $4.6 million (13.2% of revenues)
in the corresponding period of the prior year. The increase in gross profit was due mainly to the commencement of work under the
contracts with the USPS and the large on-line retailer as discussed above, partly offset by a decline in gross profit from temporary
airport construction related security services.
Our gross profit increased by $0.3 million,
or 3.5%, to $9.7 million (12.3% of revenues) for the six months ended September 30, 2016, from $9.4 million, (13.8% of revenues)
in the corresponding period of the prior year. The increase in gross profit was due mainly to the commencement of work under the
contracts with the USPS and the large on-line retailer, an increase in gross profit from financial institutions and an increase
in equipment sales. These increases were partially offset by a decrease in profits following the decline in revenues from temporary
airport construction related services, California based technology companies and various residential and retail customers.
The decline in gross profit margins for
the three and six months ended September 30, 2016, was primarily due to the decline in revenues from temporary airport construction
related security services and certain start-up costs incurred in connection with the above-mentioned new contracts.
General
and Administrative Expenses
Our general and administrative expenses
decreased by $0.2 million, or 4.1%, to $4.4 million (10.3% of revenues) for the three months ended September 30, 2016, from $4.6
million (13.3% of revenues) in the corresponding period of the prior year. The decrease in general and administrative expenses
for the three months ended September 30, 2016 was driven primarily by lower legal and consulting fees, partly offset by higher
employee compensation benefits costs, information technology and communications costs.
Our general and administrative expenses
decreased by $0.2 million, or 2.4%, to $8.5 million (10.8% of revenues) for the six months ended September 30, 2016, from $8.7
million (12.8% of revenues) in the corresponding period of the prior year. The decrease in general and administrative expenses
for the six months ended September 30, 2016 was driven primarily by lower legal fees, partly offset by higher employee compensation,
benefits costs, information technology and communications costs.
Provision for Doubtful Accounts
The provision for doubtful accounts for
the three months ended September 30, 2016, net of recoveries, decreased by $244,944 to net recoveries of $33,052 as compared with
net expense of $211,892 in the corresponding period of the prior year. The decrease in the net provision for doubtful accounts
for the three months ended September 30, 2016 was driven primarily by the recovery of approximately $45,600 of specific accounts
previously considered uncollectible and a reduction in past due accounts.
The provision for doubtful accounts for
the six months ended September 30, 2016, net of recoveries, decreased by $480,443 to net recoveries of $107,913 as compared with
net expense of $372,530 in the corresponding period of the prior year. The decrease in the net provision for doubtful accounts
for the six months ended September 30, 2016 was driven primarily by recovery of approximately $75,462 of specific accounts previously
deemed uncollectible and a reduction in past due 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.
Operating Income (Loss)
Our operating income increased by
$2.4 million, or 149%, to $0.8 million (1.9% of revenues) for the three months ended September 30, 2016, from an operating
loss of $1.6 million (4.7% of revenues) in the corresponding period of the prior year. The increase in operating income was
driven primarily by the absence of a $1.4 million settlement charge, the $0.6 improvement in gross
profit mentioned above, the $0.2 million reduction to general and administrative expenses and the $0.2 million increase in
recoveries of specific accounts receivable previously considered uncollectable.
Our operating income increased by
$2.4 million, or 223%, to $1.3 million (1.7% of revenues) for the six months ended September 30, 2016, as compared with an
operating loss of $1.1 million (1.6% of revenues) in the corresponding period of the prior year. The increase in operating
income was driven primarily by the absence of a $1.4 million settlement charge, the $0.5 million reduction in the
provision for doubtful accounts mentioned above, the $0.2 million reduction to general and administrative expenses and the
$0.3 million improvement in gross profit.
Interest Expense
Interest expense increased by $45,666,
or 111%, to $86,786 for the three months ended September 30, 2016, from $41,120 in the corresponding period of the prior year.
The increase in interest expense for the three months ended September 30, 2016 was due to higher average outstanding borrowings
and higher interest rates under our credit agreement with Wells Fargo, described below.
Interest expense increased by $67,601,
or 92.4%, to $140,771 for the six months ended September 30, 2016, from $73,170 in the corresponding period of the prior year.
The increase in interest expense for the six months ended September 30, 2016 was due primarily to higher average outstanding borrowings
and higher interest rates 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 Acquisitions Ltd. (“OPSA”). 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.
The Company’s proportionate share
of the net loss of OPSA for the three months ended September 30, 2016 was $30,000 as compared with net income of $74,804 in the
corresponding period of the prior year. The decrease in the Company’s proportionate share of net income of OPSA was due
to a reduction in revenues driven by a decrease in total missions during the three months ended September 30, 2016 as compared
to the three months ended September 30, 2015, as well as changes in the number and composition of assigned security personnel.
In addition, during the three months ended September 30, 2016, OPSA recognized approximately $122,000 of legal and other costs
incurred in connection with recent changes in its ownership structure.
The Company’s proportionate
share of the net loss of OPSA for the six months ended September 30, 2016 was $130,000 as compared with net income of $136,304
in the corresponding period of the prior year. The decrease in the Company’s proportionate share of net income of OPSA
was due to a reduction in revenues driven by a decrease in total missions during the six months ended September 30, 2016 as
compared to the six months ended September 30, 2015, as well as changes in the number and composition of assigned security
personnel. In addition, during the six months ended September 30, 2016, OPSA recognized approximately $767,000 of costs
incurred in connection with certain strategic growth initiatives and other costs incurred in connection with recent changes
in the ownership of OPSA.
During the past two fiscal years ended
December 31, 2015 and 2014, and continuing into the first nine months of 2016, OPSA 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%.
OPSA revenues for the six months
ended September 30, 2016 and 2015 were $4.3 million and $6.1 million, respectively. Gross profit margins for the same periods
were 32.7% and 32.9%, respectively.
The above-mentioned decline in revenues
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 nine months ended
September 30, 2016, OPSA 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. And, during
the three months ended September 30, 2016, OPSA incurred $122,000 of costs in connection with recent changes in the ownership of
OPSA.
The combination of the above-mentioned decline in revenues and increased costs has resulted in short-term liquidity pressures
that may impact OPSA’s ability to remain current in its obligations under its senior debt. However, the Company and OPSA
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 OPSA 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 OPSA to more stable and
predictable levels of profitability. Management performed an impairment analysis as of March 31, 2016 and concluded its investment
in OPSA was not impaired at that time. The Company has and will continue to closely monitor the operations of OPSA 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 (benefit from) income
taxes
The provision for income taxes increased
by $888,000 to a net tax provision of $251,000 for the three months ended September 30, 2016 compared with a net tax benefit of
$637,000 in the corresponding period of the prior year. The Company’s effective tax rate decreased by 3.5% to 36.5% for the
three months ended September 30, 2016 compared with 40.0% in the corresponding period of the prior year.
The provision for income taxes increased
by $857,000 to a net tax provision of $465,000 for the six months ended September 30, 2016 compared to a net tax benefit of $392,000
in the corresponding period of the prior year. The Company’s effective tax rate increased by 5.3% to 43.7% for the six months
ended September 30, 2016 compared with 38.4% in the corresponding period of the prior year.
Liquidity and Capital Resources
We pay approximately 81% 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 October 2016 (see below) and matures March 31, 2017, 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.
On October 12, 2016, we entered into a
seventh amendment (the “Seventh Amendment” to our Credit Agreement). The Seventh Amendment amends the Credit Agreement
to extend the existing agreement from October 16, 2016 to March 31, 2017 and amend the terms of the “Minimum Excess Availability”
covenant. 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 September 30, 2016, we were in compliance
with all covenants under the Credit Agreement.
Under the Credit Agreement, as of September
30, 2016, the interest rate was 2.375% for LIBOR loans and 2.6250% for revolving loans. At September 30, 2016, we had approximately
$0.5 million of cash on hand. We also had $8.0 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 69% 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 $1.4 million,
or 12.8%, to $12.0 million as of September 30, 2016, from $10.7 million as of March 31, 2016.
We had checks drawn in advance of future
deposits of $0.5 million at September 30, 2016, and 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 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. 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 six
months ended September 30, 2016 was 12.3%. 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 $48.8 million or 62.0% of our total revenues in the six months ended September 30, 2016. Our aviation services division
generated approximately $29.9 million or 38.0% of our total revenues in the six months ended September 30, 2016.
In the six months ended September 30, 2016,
the Company had seven customers who, in the aggregate, represented approximately 54% of the Company’s revenues for the six
months ended September 30, 2016, with two of those customers representing 13% and 11% of total revenues, respectively. These customers
include one domestic and one international airline, three major transportation & logistics companies, 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 October 2016, as described
above. As of the close of business on October 24, 2016, 2016, our total outstanding borrowings under the Credit Agreement were
approximately $10.0 million and our total availability was approximately $7.5 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.