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
three months ended June 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 June 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 June 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 of $76,161 and
$18,225 for stock based compensation have been recorded for the three months ended June 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.
Results
of Operations
Revenues
Our
revenues increased by $0.3 million, or 0.7%, to $44.1 million for the three months ended June 30, 2018, from $43.8 million in
the corresponding period of the prior year. The increase in revenues was due mainly to the commencement of work under new contracts
with a large on-line retailer and its web services division in June and July 2017 and 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. These increases were partly
offset by reductions in revenues from a major transportation company of approximately $5.3 million following the Company’s
decision to terminate its relationship with this customer effective August 31, 2017.
Gross
Profit
Our
gross profit increased by $0.5 million, or 9.0%, to $5.5 million (12.5% of revenues) for the three months ended June 30, 2018,
from $5.0 million (11.5% of revenues) in the corresponding period of the prior year. The increase in gross profit was due mainly
to the above-mentioned changes in revenue, a reduction in overhead costs associated with the above mentioned terminated contract,
a decrease in workers compensation expense and a decrease in general liability claims expense.
General
and Administrative Expenses
Our
general and administrative expenses decreased by $0.5 million, or 10.7%, to $4.3 million (9.7% of revenues) for the three months
ended June 30, 2018, from $4.8 million (10.9% of revenues) in the corresponding period of the prior year. The decrease in general
and administrative expenses was driven primarily by a reduction in administrative costs associated with the above mentioned terminated
contract, partly offset by start-up costs incurred in connection with the above mentioned new contract to provide security services
in Honduras for the U.S. Department of State.
Provision
for Doubtful Accounts
The
provision for doubtful accounts for the three months ended June 30, 2018, net of recoveries, increased by $21,672 to $24,160 as
compared with $2,488 in the corresponding period of the prior year. The increase in the net provision for doubtful accounts was
primarily due to 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 increased by $75,645, or 82.3%, to $167,572 for the three months ended June 30, 2018, from $91,927 in the corresponding
period of the prior year. The increase in interest expense for the three months ended June 30, 2018 was due mainly to higher average
outstanding borrowings in support of higher revenues and higher average interest rates under our credit agreement with Wells Fargo,
described below
.
Provision
for income taxes
The
provision for income taxes increased by $235,000 to $319,000 for the three months ended June 30, 2018, compared with $84,000 in
the corresponding period of the prior year. The Company’s effective tax rate decreased by 23.7% to 30.4% for the three months
ended June 30, 2018 compared with 54.1% in the corresponding period of the prior year. The difference between the Company’s
effective tax rate of 30.4% for the three months ended June 30, 2018 and the Company’s statutory tax rate of approximately
29% is primarily attributable to certain expenses that are not deductible for income tax purposes.
Liquidity
and Capital Resources
We
pay approximately 80% of our employees on a bi-weekly basis with the remaining employees being paid on a weekly basis, while customers
pay for services generally within 60 days from the invoice date. We maintain a commercial revolving loan arrangement, currently
with Wells Fargo Bank, National Association (“Wells Fargo”). We fund our payroll and operations primarily through
borrowings under our $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. 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 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 June 30,
2018, the interest rate was 3.75% for LIBOR loans and 4.125% for revolving loans. At June 30, 2018 we had approximately $1.4 million
of cash on hand, $13.0 million of LIBOR loans outstanding, $3.6 million of revolving loans outstanding and $0.3 million
outstanding under our letters of credit sub-line under the Credit Agreement, representing approximately 64% 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 July 30, 2018, we had total short term borrowings, net of cash,
of approximately $11.0 million, representing approximately 60% 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 three months ended June 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 $1.0 million, or 9.0%, to $11.8 million as of June 30, 2018, from $10.8 million as of March 31, 2018.
We
had checks drawn in advance of future deposits of $0.6 million at June 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:
|
|
●
|
Improved
performance through better systems, procedures and training;
|
|
|
|
|
|
|
●
|
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;
|
|
|
|
|
|
|
●
|
Dedicated
marketing and sales efforts in specific industry sectors that complement our core capabilities,
geographic presence and operational expertise; and,
|
|
|
|
|
|
|
●
|
Attention
to details and discipline that will drive operating efficiencies, and enhance enterprise value.
|
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 three months ended June 30, 2018 to 12.5% of revenues, compared with 11.5% 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 three months ended June 30, 2018,
our security services division generated approximately $28.4 million or 64% of our total revenues and our aviation
services division generated approximately $15.7 million or 36% of our total revenues.
In
the three months ended June 30, 2018, the Company had six customers, who represented approximately 60% of the Company’s
total revenues. These six customers included two 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 22% and 16% of total
revenue, respectively, for the three months ended June 30, 2018. The scope of work with the large online retailer representing
14% of total revenues was terminated effective May 31, 2018. Total revenues from the remaining five largest customers represent
approximately 45% of the Company’s total revenues for the three months ended June 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 July 30, 2018, we had total short term borrowings, net of cash, of
approximately $11.0 million, representing approximately 60% 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.
