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 that are being amortized on a straight-line basis over a period
of ten years, and goodwill, which is reviewed annually for impairment. The life assigned to customer lists acquired 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 December 31, 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 $11,443 and $99,171 for stock based compensation have
been recorded for the nine months ended December 31, 2016 and 2015, respectively.
Reclassifications
Certain
amounts previously reported for prior periods have been reclassified to conform to the current year presentation in the accompanying
condensed financial statements. Such reclassifications had no effect on the results of operations or shareholders’ equity
as previously recorded.
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 $9.1 million, or 27.2%, to $42.7 million for the three months ended December 31, 2016 from $33.5
million in the corresponding period of the prior year. The increase in revenues 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 and revenues from New York based healthcare facilities increased by approximately
$0.2 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 approximately $0.2 million
from aviation related services.
Our
revenues increased by $19.8 million, or 19.4%, to $121.4 million for the nine months ended December 31, 2016 from $101.7
million in the corresponding period of the prior year. The increase in revenues 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 $1.8 million, revenues from New York based healthcare facilities increased by approximately
$0.8 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 $2.2 million from temporary airport construction related services,
approximately $1.9 million from residential and retail customers and approximately $1.5 million from California based technology
companies.
Gross
Profit
Our
gross profit increased by $1.3 million, or 38.9%, to $4.7 million (11.0% of revenues) for the three months ended December 31,
2016, from $3.4 million (10.1% of revenues) in the corresponding period of the prior year. The increase in gross profit was due
mainly to a decrease in workers’ compensation expense of approximately $1.0 million, 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 aviation
related services and temporary airport construction related security services.
Our
gross profit increased by $1.6 million, or 12.9%, to $14.4 million (11.9% of revenues) for the nine months ended December 31,
2016, from $12.8 million, (12.6% 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, a decrease in workers’
compensation expense of approximately $0.6 million, an increase in gross profit from New York based healthcare facilities, equipment
sales, and financial institutions. These increases were partially offset by a decrease in profits following the decline in revenues
from temporary airport construction related services, various residential and retail customers, and California based technology
companies.
The
decline in gross profit margins for the nine months ended December 31, 2016, was primarily due to the decline in revenues from
temporary airport construction related security services and certain start-up and hiring related costs incurred in connection
with the above-mentioned new contracts.
General
and Administrative Expenses
Our
general and administrative expenses increased by $0.7 million, or 15.3%, to $5.0 million (11.7% of revenues) for the three months
ended December 31, 2016, from $4.3 million (12.9% of revenues) in the corresponding period of the prior year. The increase in
general and administrative expenses was driven primarily by higher legal expenses and labor settlement costs, employee compensation
and benefit costs, and information technology and communications costs, partly offset by lower consulting fees.
Our
general and administrative expenses decreased by $0.9 million, or 6.6%, to $13.5 million (11.1% of revenues) for the nine months
ended December 31, 2016, from $14.4 million (14.2% of revenues) in the corresponding period of the prior year. The decrease in
general and administrative expenses was driven primarily by lower legal expenses and labor settlement costs, consulting fees and
depreciation and amortization. These decreases were partly offset by higher employee compensation and benefit costs and information
technology and communication costs.
Provision
for Doubtful Accounts
The
provision for doubtful accounts for the three months ended December 31, 2016, net of recoveries, decreased by $6,336 to net expense
of $78,459 as compared with net expense of $84,795 in the corresponding period of the prior year. The decrease in the net provision
for doubtful accounts was driven primarily by the recovery of approximately $8,285 of specific accounts previously considered
uncollectible.
The
provision for doubtful accounts for the nine months ended December 31, 2016, net of recoveries, decreased by $486,778 to net recoveries
of $29,454 as compared with net expense of $457,324 in the corresponding period of the prior year. The decrease in the net provision
for doubtful accounts for the nine months ended December 31, 2016 was driven primarily by recovery of approximately $83,746 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.
Interest
Expense
Interest
expense increased by $30,997, or 66%, to $78,060 for the three months ended December 31, 2016, from $47,063 in the corresponding
period of the prior year. The increase in interest expense for the three months ended December 31, 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 $98,594, or 82%, to $218,831 for the nine months ended December 31, 2016, from $120,237 in the corresponding
period of the prior year. The increase in interest expense for the nine months ended December 31, 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 income of OPSA for the three months ended December 31, 2016 was $73,000 as compared
with net loss of $24,304 in the corresponding period of the prior year. The increase in the Company’s proportionate share
of net income of OPSA was due to a reduction in
legal and consulting expenses incurred in connection with certain strategic
initiatives and changes in the Company’s ownership partly offset by lower gross profits following the decline in revenues.
The
Company’s proportionate share of the net loss of OPSA for the nine months ended December 31, 2016 was $57,000 as compared
with net income of $112,000 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 nine months
ended December 31, 2016 as compared to the nine months ended December 31, 2015, as well as changes in the
number and composition of assigned security personnel.
During
the nine months ended December 31, 2016 and 2015, OPSA has experienced a decline in revenues and net income from continuing operations.
Specifically, for the nine months ended December 31, 2016, revenues declined 26.4% as compared to the nine months ended December
31, 2015, gross profits declined by 24.6% and net income from continuing operations declined from $554,699 to a net loss from
continuing operations of $310,959. During the same periods, gross profit as a percent of revenues increased from 28.9% to 29.7%.
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.
The above-mentioned decline in revenues and reduced profits 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 $266,000 to a net tax benefit of $152,000 for the three months ended December 31, 2016
compared with a net tax benefit of $418,000 in the corresponding period of the prior year. The Company’s effective tax rate
increased by 3.9% to 42.3% for the three months ended December 31, 2016 compared with 38.3% in the corresponding period of the
prior year.
The
provision for income taxes increased by $1.1 million to a net tax provision of 313,000 for the nine months ended December 31,
2016 compared to a net tax benefit of $810,000 in the corresponding period of the prior year. The Company’s effective tax
rate increased by 6.1% to 44.5% for the nine months ended December 31, 2016 compared with 38.4% in the corresponding period of
the prior year.
Liquidity
and Capital Resources
We
pay approximately 82% 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 amends the
terms of the “Minimum Excess Availability” covenant. The Company is currently in discussions to renew the agreement
before March 31, 2017. 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 December 31, 2016, the interest rate was 2.625% for LIBOR loans and 2.75% for revolving loans. At
December 31, 2016, we had approximately $1.3 million of cash on hand. We also had $7.0 million in LIBOR loans outstanding, $8.7
million of revolving loans outstanding and $0.5 million outstanding under our letters of credit sub-line under the Credit Agreement,
representing 83% 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 $0.3 million, or 2.9%, to $11.0 million as of December 31, 2016, from $10.7
million as of March 31, 2016.
We
had checks drawn in advance of future deposits of $1.2 million and $0.5 million at December 31, 2016, and March 31, 2016, respectively.
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. As a result of these efforts, we re-entered the U.S. federal government market
with the award of the U.S. Postal Service (“USPS”) contract.
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 the consolidation of the industry,
the Company will face fewer very large competitors and is also being invited into more large opportunities than in previous years.
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 nine months ended December 31, 2016 was 11.9%. 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 $76.9 million or 63.0% of our total revenues in the nine months ended December
31, 2016. Our aviation services division generated approximately $44.5 million or 37.0% of our total revenues in the nine months
ended December 31, 2016.
In
the nine months ended December 31, 2016, the Company had six customers who, in the aggregate, represented approximately 55% of
the Company’s revenues for the nine months ended December 31, 2016, with two of those customers representing 13% and 12%
of total revenues, respectively. These customers include three major transportation & logistics customers, one domestic and
one international airline and a northeast U.S. based healthcare facility. 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 February 6, 2017, our total outstanding borrowings
under the Credit Agreement were approximately $9.7 million and our total availability was approximately $5.3 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.