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 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.
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, 2018, 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.
Principles
of Consolidation
The
consolidated financial statements include the accounts of Command Security Corporation and its consolidated subsidiaries. All
intercompany balances and transactions are eliminated upon consolidation. The Company’s revenues and expenses transacted
in foreign currencies are translated based on the monthly average exchange rate for the month in which each transaction occurred.
Realized gains and losses on foreign currency transactions are recorded in general and administrative expenses on the Company’s
consolidated statements of operations. Amounts recorded as foreign currency exchange gains and losses were not material for the
six months ended September 30, 2018. Assets and liabilities of the Company denominated in foreign currencies are translated at
the exchange rate in effect as of the balance sheet date. Amounts recorded as a result of translation adjustments are not material
as of September 30, 2018 and therefore we did not present the translation adjustments as a separate component of accumulated other
comprehensive income in the stockholders’ equity section of the consolidated balance sheets.
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.
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
Estimated
accrued liabilities related to our general liability claims are calculated on an undiscounted basis and are based on actual claim
data and estimates of incurred but unreported claims developed utilizing historical claim trends. Projected settlements and incurred
but unreported 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 will be recorded as selling,
general and administrative expense. We did not have any unrecognized tax benefits as of September 30, 2018 and 2017.
Stock
Based Compensation
FASB
ASC 718, Stock Compensation, requires all share-based payments to employees, including grants of stock options and restricted
stock units (“RSUs”) 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. Non-cash charges for stock based
compensation of $86,034 and $124,875 have been recorded in the three months ended September 30, 2018 and 2017, respectively, and
$162,194 and $143,101 have been recorded in the six months ended September 30, 2018 and 2017, 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 18 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 or external conflicts and technology.
As
has been previously disclosed, on September 18, 2018, the Company entered into an Agreement and Plan of Merger (the “Merger
Agreement”) with Prosegur SIS (USA) Inc., a Florida corporation (“Parent”), and Crescent Merger Sub, Inc., a
New York corporation and a wholly owned subsidiary of Parent (“Merger Sub”). The Merger Agreement provides that, subject
to the terms and conditions set forth therein, Merger Sub will merge with and into the Company (the “Merger”), with
the Company surviving the Merger and becoming a wholly owned subsidiary of Parent.
Under
the Merger Agreement, at the effective time of the Merger, each issued and outstanding share of the Company’s common stock
(other than (i) shares owned by Parent, Merger Sub or any other direct or indirect wholly owned subsidiary of Parent or (ii) shares
owned by any direct or indirect wholly owned subsidiary of the Company, and, in each case, not held on behalf of third parties)
will be cancelled and automatically converted into the right to receive $2.85 per share in cash (the “Merger Consideration”).
Under
the Merger Agreement, at the effective time of the Merger, each outstanding option to purchase shares, outstanding restricted
shares and outstanding restricted stock units, in each case, whether vested or unvested, will be cancelled. A holder of an outstanding
option to purchase shares will be entitled to receive an amount in cash equal to (x) the total number of shares subject to such
Company option, whether vested or unvested, immediately prior to the effective time of the Merger multiplied by (y) the excess,
if any, of the Merger Consideration over the exercise price per share under each Company option, less applicable taxes. A holder
of an outstanding restricted share or outstanding restricted stock unit will be entitled to receive an amount in cash equal to
(x) the total number of such restricted shares and restricted stock units, whether vested or unvested, immediately prior to the
effective time multiplied by (y) the Merger Consideration, less applicable taxes.
The
Company has made customary representations, warranties and covenants in the Merger Agreement, including covenants not to, during
the pendency of the Merger, solicit alternative transactions or, subject to certain exceptions, not to enter into discussions
concerning, or provide confidential information in connection with, an alternative transaction. Each of Parent and Merger Sub
also has made customary representations, warranties and covenants in the Merger Agreement.
Consummation
of the Merger is subject to the satisfaction or waiver of customary closing conditions, including adoption of the Merger Agreement
by the Company’s stockholders and receipt of the Committee on Foreign Investment in the United States (CFIUS) approval.
The transaction is not subject to any financing condition.
The
Merger Agreement contains certain customary termination rights for Parent and the Company, including a right to terminate the
Merger Agreement if the Merger is not completed by March 18, 2019, unless otherwise extended pursuant to the terms of the Merger
Agreement. The Merger Agreement further provides that, upon termination of the Merger Agreement under certain specified circumstances,
the Company will be obligated to pay Parent a termination fee of approximately $1.2 million.
On
November 2, 2018, the Company filed a definitive proxy statement with the U.S. Securities and Exchange Commission relating to
a special meeting of the Company’s shareholders to be held to enable the Company’s shareholders to consider and vote
on a proposal to approve the Merger Agreement and certain other related matters.
Results
of Operations
Revenues
Our
revenues decreased by $9.7 million, or 19.3%, to $40.5 million for the three months ended September 30, 2018, from $50.2 million
in the corresponding period of the prior year. The decrease in revenues was due mainly to the cessation of services at fulfillment
centers of a large on-line retailer and reductions in revenues from a major transportation company following the Company’s
decision to terminate its relationship with this customer effective August 31, 2017. These decreases were partly offset by increases
in security services with various airlines, an increase in security services with the web services division of a large on-line
retailer in July 2017, the commencement of work under a new contract with LaGuardia Gateway Partners for LaGuardia airport’s
new central terminal in June 2018, the commencement of work under a new contract with the United States Department of State at
the U.S. Mission Tegucigalpa, Honduras in February 2018 and an increase in services with the U.S. Postal Service.
Our
revenues decreased by $9.3 million, or 9.9%, to $85.0 million for the six months ended September 30, 2018, from $94.3 million
in the corresponding period of the prior year. The decrease in revenues was due mainly to reductions in revenues from a major
transportation company following the Company’s decision to terminate its relationship with this customer effective August
31, 2017 and the cessation of services with the fulfillment centers division of a large on-line retailer. These decreases were
partly offset by an increase in security services with the web services division of a large on-line retailer, increases in services
with various airlines, the commencement of work under a new contract with the United States Department of State at the U.S. Mission
Tegucigalpa, Honduras in February 2018, the commencement of work under a new contract with LaGuardia Gateway Partners for LaGuardia
airport’s new central terminal in June 2018 and an increase in services with the U.S. Postal Service.
Gross
Profit
Our
gross profit decreased by $0.7 million, or 13.7%, to $4.7 million (11.7% of revenues) for the three months ended September 30,
2018, from $5.4 million (10.9% of revenues) in the corresponding period of the prior year. The decrease in gross profit was due
mainly to the above-mentioned changes in revenue, an increase in workers’ compensation expense of approximately $0.5 million,
and startup costs of approximately $0.1 million in preparation for the commencement of work under a new contract with the U.S.
Department of State at the U.S. Consulate in Hong Kong, China.
Our
gross profit decreased by $0.3 million, or 2.8%, to $10.2 million (12.0% of revenues) for the six months ended September 30, 2018,
from $10.5 million (11.2% of revenues) in the corresponding period of the prior year. The decrease in gross profit was due mainly
to the above-mentioned changes in revenue, an increase in workers’ compensation expense of approximately $0.9 million, and
startup costs of approximately $0.1 million in preparation for the commencement of work under a new contract with the U.S. Department
of State at the U.S. Consulate in Hong Kong, China.
General
and Administrative Expenses
Our
general and administrative expenses decreased by $0.1 million, or 2.6%, to $4.7 million (11.6% of revenues) for the three months
ended September 30, 2018, from $4.8 million (9.6% of revenues) in the corresponding period of the prior year. The decrease in
general and administrative expenses was driven primarily by lower employee compensation and benefits as a result of the reductions
in revenue noted above, partly offset by legal and other due diligence costs of approximately $0.3 million specifically attributable
to merger and acquisition related activities in connection with the Merger.
Our
general and administrative expenses decreased by $0.6 million, or 6.6%, to $9.0 million (10.5% of revenues) for the six months
ended September 30, 2018, from $9.6 million (10.2% of revenues) in the corresponding period of the prior year. The decrease in
general and administrative expenses was driven primarily by lower employee compensation and benefits as a result of the reductions
in revenue noted above, partly offset by legal and other due diligence costs of approximately $0.3 million specifically attributable
to merger and acquisition related activities in connection with the Merger.
Provision
for Doubtful Accounts
The
provision for doubtful accounts for the three months ended September 30, 2018, net of recoveries, increased by $124,629 to $4,523
as compared with net recoveries of $120,106 in the corresponding period of the prior year. The increase in the net provision for
doubtful accounts was primarily due to a decrease in recoveries of specific accounts previously deemed uncollectible and an increase
in reserves for specific accounts considered uncollectible.
The
provision for doubtful accounts for the six months ended September 30, 2018, net of recoveries, increased by $146,301 to $28,683
as compared with net recoveries of $117,618 in the corresponding period of the prior year. The increase in the net provision for
doubtful accounts was primarily due to a decrease in recoveries of specific accounts previously deemed uncollectible and an increase
in reserves for specific accounts considered uncollectible.
We
periodically evaluate the requirement to provide 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 decreased by $6,673, or 5.1%, to $123,807 for the three months ended September 30, 2018, from $130,480 in the corresponding
period of the prior year. The decrease in interest expense for the three months ended September 30, 2018 was due mainly to lower
average outstanding borrowings partly offset by higher average interest rates under our credit agreement with Wells Fargo, described
below.
Interest
expense increased by $68,971, or 31.0%, to $291,379 for the six months ended September 30, 2018, from $222,408 in the corresponding
period of the prior year. The increase in interest expense for the six months ended September 30, 2018 was due almost entirely
to higher average interest rates under our credit agreement with Wells Fargo, described below.
Provision
for income taxes
The
provision for income taxes decreased by $185,000 to $91,000 for the three months ended September 30, 2018, compared with $276,000
in the corresponding period of the prior year. The Company’s effective tax rate increased to 95.7% for the three months
ended September 30, 2018 compared with 44.6% in the corresponding period of the prior year. The difference between the Company’s
effective tax rate of 95.7% for the three months ended September 30, 2018 and the Company’s statutory tax rate of approximately
29.0% is primarily attributable to certain expenses related to the expiration of stock options that are not deductible for income
tax purposes.
The
provision for income taxes increased by $50,000 to $410,000 for the six months ended September 30, 2018, compared with $360,000
in the corresponding period of the prior year. The Company’s effective tax rate decreased to 43.0% for the six months ended
September 30, 2018 compared with 46.5% in the corresponding period of the prior year. The difference between the Company’s
effective tax rate of 43.0% for the six months ended September 30, 2018 and the Company’s statutory tax rate of approximately
29% is primarily attributable to certain expenses related to the expiration of stock options that are not deductible for income
tax purposes.
Liquidity
and Capital Resources
We
pay approximately 80% of our employees on a bi-weekly basis and we pay the remaining employees on a weekly basis, while customers
pay for services generally within 45 to 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 $35.0 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. 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 credit facility (the “Credit Agreement”) with Wells Fargo Bank, National Association
(“Wells Fargo”). This credit facility, which was most recently amended in March 2018 (see below) and matures March
31, 2020, 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 $1.5 million. The Credit Agreement also
provides for interest to be calculated on the outstanding principal balance of the revolving loans at the floating 90 day LIBOR
rate plus 1.75%. For LIBOR loans, interest will be calculated on the outstanding principal balance of the LIBOR loans at the 30
day LIBOR rate plus 1.75%.
On
March 14, 2018, we entered into a ninth amendment (the “Ninth Amendment”) to our Credit Agreement. The Ninth Amendment
increased the revolving line of credit from $27.5 million to $35.0 million.
Under
the Credit Agreement, as of September 30, 2018, the interest rate was 3.875% for LIBOR loans and 4.25% for revolving loans. At
September 30, 2018 we had approximately $1.7 million of cash on hand, $7.0 million of LIBOR loans outstanding, $3.5 million of
revolving loans outstanding and $0.4 million outstanding under our letters of credit sub-line under the Credit Agreement, representing
approximately 49% 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. As of the close of business October 26, 2018, we had total short term borrowings,
net of cash, of approximately $8.3 million, representing approximately 50% 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.
We
rely on our revolving loan from Wells Fargo which contains a fixed charge covenant and various other financial and non-financial
covenants. 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 six months ended September 30, 2018, we were in compliance
with all covenants under the Credit Agreement.
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 8.7%, to $11.7 million as of September 30, 2018, from $10.8 million as of March
31, 2018.
We
had checks drawn in advance of future deposits of $0.4 million at September 30, 2018 and $1.2 million at March 31, 2018. Cash
balances, book overdrafts and payroll and related expenses can fluctuate materially from day to day depending on such factors
as collections and timing of payroll payments.
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. The Company re-entered the U.S. federal government market with the commencement of
work for the U.S. Postal Service (“USPS”) and in February 2018, we commenced work on an armed security contract for
the U.S. Embassy in Honduras. More recently we were awarded a new contract to provide security services at the U.S. Embassy in
Hong Kong which is scheduled to commence in October 2018. With the contract to provide physical security for data centers for
the web services segment of the major on-line retailer, we have expanded our strategic focus to include the data center market
space. Our Aviation division has also expanded to include the addition of cargo screening for a major domestic airline. Despite
the recent loss of a significant scope of work with a major customer, we expect to continue to pursue similar large opportunities
in multiple end markets. These large service agreements provide significant opportunities to leverage operating and administrative
costs.
With
a strong foundation and a more effective organization, the Company remains 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 international
opportunities, the inclusion of a broad range of technology offerings to augment manned guarding and potential strategic opportunities;
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Dedicated
marketing and sales efforts in specific industry sectors that complement our core capabilities, geographic presence 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, 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.
We may pursue complementary acquisition opportunities to leverage our management structure and deliver accretive earnings with
acceptable collection terms. Our focus on larger, long-term service agreements provides another path to add significant additional
revenue similar to that of the U.S. Postal Service contract and other commercial and federal contract opportunities. 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 current focus is on increasing our revenues, as our sales
and marketing teams and branch managers work to develop new business and retain profitable contracts. Also, intense competition
from other security services companies impacts our ability to gain or maintain sales, gross margins and 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 increased during the six months ended September 30, 2018 to 12.0% of revenues, compared with 11.2%
during the corresponding period in the prior year. 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.
For
the six months ended September 30, 2018, our security services division generated approximately $52.4 million or 62% of our total
revenues and our aviation services division generated approximately $32.6 million or 38% of our total revenues.
In
the six months ended September 30, 2018, the Company had five customers, who represented approximately 50% of the Company’s
total revenues. These five customers included one domestic and one international airline, the USPS, an online retailer and web
services provider and a northeast U.S. based healthcare facility. Two of these six customers represented 17% and 16% of total
revenue, respectively, for the six months ended September 30, 2018. The scope of work with the large online retailer representing
7% of total revenues was terminated effective May 31, 2018. Total revenues from the remaining four largest customers represent
approximately 37% of the Company’s total revenues for the six months ended September 30, 2018.
As
noted earlier, on February 12, 2009, we entered into a Credit Agreement with Wells Fargo, which was most recently amended in March
2018, as described above. As of the close of business October 26, 2018, we had total short term borrowings, net of cash, of approximately
$8.3 million, representing approximately 50% 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, 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.
