The accompanying notes are an integral part of the Interim Condensed Consolidated Financial Statements.
The accompanying notes are an integral part of the Interim Condensed Consolidated Financial Statements.
The accompanying notes are an integral part of the Interim Condensed Consolidated Financial Statements.
The accompanying notes are an integral part of the Interim Condensed Consolidated Financial Statements.
The accompanying notes are an integral part of the Interim Condensed Consolidated Financial Statements.
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1:
BASIS OF PRESENTATION
a.
Company:
Arotech Corporation (“Arotech”) and its wholly-owned subsidiaries (the “Company”) provide defense and security products for the military, law enforcement, emergency services and homeland security markets, including advanced zinc-air and lithium batteries and chargers, and multimedia interactive simulators/trainers. The Company operates primarily through its wholly-owned subsidiaries FAAC Incorporated, a Michigan corporation located in Ann Arbor, Michigan (Training and Simulation Division) with a location in Orlando, Florida; Epsilor-Electric Fuel Ltd. (“Epsilor-EFL”), an Israeli corporation located in Beit Shemesh, Israel (between Jerusalem and Tel-Aviv) in Dimona, Israel (in Israel’s Negev desert area) and Sderot, Israel (near the Gaza Strip) (Power Systems Division); UEC Electronics, LLC (“UEC”), a South Carolina limited liability company located in Hanahan, South Carolina (Power Systems Division).
b.
Asset Held for Sale and Discontinued Operations:
In August 2016, the Board approved a strategic shift to discontinue the Flow Battery segment (“the segment”) with an effective date of August 31, 2016. The principal activities of the Flow Battery segment were research and development related and were focused on developing a commercial application based upon the Iron Flow Storage concept. In connection with the discontinuance of the operations, management has developed a plan to sell the assets to a third party for future development. Management believes that the Company will be able to execute the plan in 2017.
The amounts presented in the consolidated statements of comprehensive income as discontinued operations represent research and development and general and administrative expenses. As the Flow Battery segment is reported within the Epsilor-EFL legal entity and the legal entity has tax net operating loss carryforwards for which the Company has recorded a valuation allowance, there is no tax impact.
The impact of the discontinued operations on operating and investing activities within the consolidated statements of cash flows for the three months ended March 31, 2016 was ($189,314) and ($124,883), respectively. There was no impact on the consolidated statements of cash flows for the three months ended March 31, 2017.
The assets of the Flow Battery segment consist of property and equipment and are classified as held for sale. The carrying value of the assets as of March 31, 2017 and December 31, 2016, is $270,139.
Unless otherwise indicated, discontinued operations are not included in the reported results. The Notes to the Consolidated Financial Statements relate to the Company’s continuing operations.
c.
Basis of presentation:
The accompanying interim condensed consolidated financial statements have been prepared by Arotech Corporation in accordance with generally accepted accounting principles for interim financial information, with the instructions to Form 10-Q and with Article 10 of Regulation S-X, and include the accounts of Arotech Corporation and its subsidiaries. Certain information and footnote disclosures, normally included in complete financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted. In the opinion of the Company, the unaudited financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of its financial position at March 31, 2017, its operating results for the three-month periods ended March 31, 2017 and 2016, and its cash flows for the three-month periods ended March 31, 2017 and 2016.
The results of operations for the three months ended March 31, 2017 are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year ending December 31, 2017.
The balance sheet at December 31, 2016 has been derived from the audited financial statements at that date but does not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. These condensed consolidated financial statements should be read in conjunction with the audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.
d.
Goodwill and other long-lived assets:
Goodwill and indefinite-lived intangible assets are tested for impairment at least annually and between annual tests in certain circumstances, and written down when impaired. Goodwill is tested for impairment by comparing the fair value of the Company’s reporting units with the carrying value. The Training and Simulation and the Power Systems reporting units have goodwill.
As of its last annual impairment test at December 31, 2016, the Company determined that the goodwill for both reporting units was not impaired.
Consistent with previous interim reporting periods, the Company monitors qualitative and quantitative factors, including internal projections, periodic forecasts, and actual results of the reporting unit. Based upon this interim review, the Company does not believe that goodwill or its indefinite-lived intangible assets related to either reporting unit is impaired.
e.
Reclassification:
Certain comparative data in these financial statements may have been reclassified to conform to the current year’s presentation.
f.
Contingencies
The Company is from time to time involved in legal proceedings and other claims. The Company is required to assess the likelihood of any adverse judgments or outcomes to these matters, as well as potential ranges of probable losses. The Company has not made any material changes in the accounting methodology used to establish its self-insured liabilities during the past three fiscal years.
A determination of the amount of reserves required, if any, for any contingencies is made after careful analysis of each individual issue. The required reserves may change due to future developments in each matter or changes in approach, such as a change in the settlement strategy in dealing with any contingencies, which may result in higher net loss.
g.
Certain relationships and related transactions
On February 2, 2016, the Company entered into a three-year consulting agreement with a business controlled by a member of the Board of Directors. In exchange, the Company pays an annual fee equal to the Board member in the amount of the difference between total accrued compensation of the Board member and $125,000.
In December 2016, the Company and its former Chief Executive Officer (“former Executive”) agreed to terms whereby the Company and its former Executive agreed to early termination of the former Executive’s employment agreement. As of December 31, 2016, the amount due to the estate of the former Executive was approximately $2.6 million. The Company paid approximately $1.8 million to the estate of the former Executive in March 2017. The remainder of $0.8 million payable to the local taxing authorities was remitted in April 2017.
h.
Accounting for stock-based compensation:
For the three months ended March 31, 2017 and 2016 the compensation expense recorded related to restricted stock units and restricted shares was $106,833 and $116,806, respectively. The remaining total compensation cost related to share awards not yet recognized in the income statement as of March 31, 2017 was $307,801. The weighted average period over which this compensation cost is expected to be recognized is approximately one and one-half years. Income tax expense was not impacted since the Company is in a net operating loss position.
On February 2, 2016, the Company and an investor (the “Investor”) entered into a Stock Purchase Agreement (the “Investment Agreement”) providing for the sale to the Investor of a total of 1,500,000 shares of the Company’s common stock at a price valued at $1.99 per share. As the Investor was also given the right to nominate a member of the Board of Directors pursuant to the terms of the Investment Agreement, and the shares were issued at a discount to the then market price, this resulted in additional stock compensation expense in the first quarter of 2016 of $375,000.
i.
Basic and diluted net income per share:
Basic net income per share is computed based on the weighted average number of shares of common stock and participating securities outstanding during each year. Diluted net income per share includes the dilutive effect of additional potential common stock issuable under our share-based compensation plans, using the “treasury stock” method. Unvested restricted stock issued to our employees and directors are “participating securities” and as such, are included, net of estimated forfeitures, in the total shares used to calculate the Company’s basic and diluted net income per share. In the event of a net loss, unvested restricted stock awards are excluded from the calculation of both basic and diluted net loss per share. The total weighted average number of shares related to the outstanding common stock equivalents excluded from the calculations of diluted net loss per share for the three-month period ended March 31, 2017 and 2016, were none and 602,740, respectively.
NOTE 2:
FAIR VALUE MEASUREMENT
The carrying value of short term assets and liabilities in the accompanying condensed consolidated balance sheets for cash and cash equivalents, restricted collateral deposits, trade receivables, unbilled receivables, inventories, prepaid and other assets, trade payables, accrued expenses, deferred revenues and other liabilities as of March 31, 2017 and December 31, 2016, approximate fair value because of the short maturity of these instruments. The carrying amounts of long term debt approximates the estimated fair values at March 31, 2017, based upon the Company’s ability to acquire similar debt at similar maturities.
NOTE 3:
INVENTORIES
Inventories are stated at the lower of cost or market value. Cost is determined using the average cost method or the FIFO method. The Company periodically evaluates the quantities on hand relative to current and historical selling prices and historical and projected sales volume. Based on these evaluations, provisions are made in each period to write down inventory to its net realizable value. Inventory write-offs are provided to cover risks arising from slow-moving items, technological obsolescence, excess inventories, and for market prices lower than cost. Inventories in the Training and Simulation Division decreased $151,000 from December 31, 2016 and decreased $368,000 in the Power Systems Division in that same time period:
|
|
March 31, 2017
|
|
|
December 31, 2016
|
|
|
|
(Unaudited)
|
|
|
|
|
Raw and packaging materials
|
|
$
|
8,439,929
|
|
|
$
|
8,512,006
|
|
Work in progress
|
|
|
707,051
|
|
|
|
917,582
|
|
Finished products
|
|
|
651,577
|
|
|
|
888,433
|
|
Total:
|
|
$
|
9,798,557
|
|
|
$
|
10,318,021
|
|
NOTE 4:
SEGMENT INFORMATION
a.
The Company and its subsidiaries operate in two business segments. The two segments are also treated by the Company as reporting units for goodwill impairment evaluation purposes. The goodwill amounts associated with the Training and Simulation Division and the Power Systems Division were determined and valued when the specific businesses were purchased. The Company and its subsidiaries operate in two continuing business segments and follow the requirements of FASB ASC 280-10.
The Company’s reportable segments have been determined in accordance with the Company’s internal management structure, which is organized based on operating activities. The accounting policies of the reportable segments are the same as those used by the Company in the preparation of its annual financial statements. The Company evaluates performance based on two primary factors, one is the segment’s operating income and the other is the segment’s contribution to the Company’s future strategic growth.
b.
The following is information about reported segment revenues, income (losses) from continuing operations, and total assets as of March 31, 2017 and 2016:
|
|
Training and
Simulation
Division
|
|
|
Power Systems
Division
|
|
|
Corporate
Expenses
|
|
|
Total
Company
|
|
Three months ended March 31, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from outside customers
|
|
$
|
10,351,189
|
|
|
$
|
11,996,256
|
|
|
$
|
–
|
|
|
$
|
22,347,445
|
|
Depreciation, amortization and impairment expenses
(1)
|
|
|
(270,663
|
)
|
|
|
(845,711
|
)
|
|
|
(1,088
|
)
|
|
|
(1,117,462
|
)
|
Direct expenses
(2)
|
|
|
(9,377,698
|
)
|
|
|
(11,091,332
|
)
|
|
$
|
(975,464
|
)
|
|
|
(21,444,494
|
)
|
Segment operating income (loss)
|
|
$
|
702,828
|
|
|
$
|
59,213
|
|
|
$
|
(976,552
|
)
|
|
$
|
(214,511
|
)
|
Financial expense
|
|
|
(12,668
|
)
|
|
|
(150,147
|
)
|
|
|
(171,042
|
)
|
|
|
(333,857
|
)
|
Income tax expense (benefit)
|
|
|
(35,000
|
)
|
|
|
43,696
|
|
|
|
(228,636
|
)
|
|
|
(219,940
|
)
|
Income (loss) from continuing operations
|
|
$
|
655,160
|
|
|
$
|
(47,238
|
)
|
|
$
|
(1,376,230
|
)
|
|
$
|
(768,308
|
)
|
Segment assets
(3)(4)
|
|
$
|
43,049,400
|
|
|
$
|
60,776,389
|
|
|
$
|
6,186,003
|
|
|
$
|
110,011,792
|
|
Additions to long-lived assets
|
|
$
|
155,234
|
|
|
$
|
528,941
|
|
|
$
|
–
|
|
|
$
|
684,175
|
|
Three months ended March 31, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from outside customers
|
|
$
|
13,300,842
|
|
|
$
|
12,105,639
|
|
|
$
|
–
|
|
|
$
|
25,406,481
|
|
Depreciation, amortization and impairment expenses
(1)
|
|
|
(272,660
|
)
|
|
|
(900,891
|
)
|
|
|
(1,487
|
)
|
|
|
(1,175,038
|
)
|
Direct expenses
(2)
|
|
|
(10,927,734
|
)
|
|
|
(11,101,609
|
)
|
|
$
|
(2,033,120
|
)
|
|
|
(24,062,463
|
)
|
Segment operating income (loss)
|
|
$
|
2,100,448
|
|
|
$
|
103,139
|
|
|
$
|
(2,034,607
|
)
|
|
$
|
168,980
|
|
Financial expense
|
|
|
(11,061
|
)
|
|
|
(29,054
|
)
|
|
|
(297,543
|
)
|
|
|
(337,658
|
)
|
Income tax expense
|
|
|
(62,800
|
)
|
|
|
–
|
|
|
|
(150,653
|
)
|
|
|
(213,453
|
)
|
Income (loss) from continuing operations
|
|
$
|
2,026,587
|
|
|
$
|
74,085
|
|
|
$
|
(2,482,803
|
)
|
|
$
|
(382,131
|
)
|
Segment assets
(3)(4)
|
|
$
|
51,101,611
|
|
|
$
|
60,327,299
|
|
|
$
|
2,470,729
|
|
|
$
|
113,899,639
|
|
Additions to long-lived assets
|
|
$
|
150,411
|
|
|
$
|
283,466
|
|
|
$
|
–
|
|
|
$
|
433,877
|
|
(1)
|
Includes depreciation of property and equipment and amortization expenses of intangible assets.
|
(2)
|
Including,
inter alia
, sales and marketing, general and administrative.
|
(3)
|
Out of those amounts, goodwill in the Company’s Training and Simulation and Power Systems Divisions totaled $24,435,640 and $21,402,711, respectively, as of March 31, 2017 and $24,435,640 and $21,178,653, respectively, as of March 31, 2016.
|
(4)
|
Cash balances previously reporting in the Training and Simulation Division in 2016 are now reported in Corporate in 2017.
|
NOTE 5:
BANK FINANCING
The Company maintains credit facilities with JPMorgan Chase Bank, N.A. (“Chase”), whereby Chase provides (i) a $15,000,000 revolving credit facility (“Revolver”), (ii) a $10,000,000 Term Loan (the “Term Loan”), and (iii) a $1,000,000 Mortgage Loan (the “Mortgage Loan” and, together with the Revolver and the Term Loan, the “Credit Facilities”) in respect of certain property located in Ann Arbor, Michigan.
The maturity of the Revolver is March 11, 2021. The Revolver maintains an interest rate on a scale ranging from LIBOR plus 1.75% up to LIBOR plus 3.00%. The effective interest rate for the revolver at March 31, 2017 was 4.25%. The balance at March 31, 2017 and December 31, 2016 was $5.8 million and $3.0 million, respectively.
The maturity of the Term Loan is March 11, 2021. The Term Loan maintains an interest rate on a scale ranging from LIBOR plus 2.0% up to LIBOR plus 3.25%. The repayment of the Term Loan consists of 60 consecutive monthly payments of principal plus accrued interest based on annual principal reductions of 10% during the first year, 20% during the second through fourth years, and 30% during the fifth year. The effective interest rate for the Term Loan at March 31, 2017 was 4.5%. The balance at March 31, 2017 and December 31, 2016 was $9.1 million and $9.3 million, respectively.
The maturity of the Mortgage Loan is March 11, 2021 and maintains an interest rate on a scale identical to the Term Loan. The monthly payments on the Mortgage Loan are $5,555 in principal plus accrued interest, with a balloon payment due at the end of month 60. The effective interest rate for the Mortgage Loan at March 31, 2017 was 4.5%. The balance at March 31, 2017 and December 31, 2016 was $950,000 and $967,000, respectively.
The Credit Facilities maintain certain reporting requirements, conditions precedent, affirmative covenants and financial covenants. The Company is required to maintain certain financial covenants that include a Maximum Debt to EBITDA ratio of 3.00 to 1.00 and a Minimum Fixed Charge Coverage Ratio of 1.20 to 1.00. The Company was in compliance with its covenants at March 31, 2017.
The Credit Facilities are secured by the Company’s assets and the assets of the Company’s domestic subsidiaries.
NOTE 6:
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, as a new Topic, Accounting Standards Codification (“ASC”) Topic 606. The new revenue recognition standard relates to revenue from contracts with customers, which, along with amendments issued in 2015 and 2016, will supersede nearly all current U.S. GAAP guidance on this topic and eliminate industry-specific guidance. The underlying principle is to use a five-step analysis of transactions to recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. The Company has formed a task force to review material contracts from our respective business segments. The task force is currently evaluating those contracts to determine the impact on the Company’s consolidated financial position or results of operations. The standard, as amended, will be effective for annual periods beginning after December 15, 2017, including interim periods within that reporting period. We expect to adopt the standard on a modified retrospective basis in 2018.
In February 2016, the FASB issued ASU No. 2016-02, Leases. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. Upon adoption, the Company expects that the ROU asset and lease liability will be recognized in the balance sheets in amounts that will be material.
In August 2016, the FASB issued ASU No. 2016-15 (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The amendments provide guidance on eight specific cash flow issues for which the current accounting framework does not provide specific guidance. The amendments are effective for annual periods beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. The Company is currently evaluating the impact of its pending adoption of the new standard on its consolidated financial statements.
In January 2017, the FASB issued ASU No. 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The new standard simplifies the subsequent measurement of goodwill and eliminates Step 2 from the goodwill impairment test and requires businesses to perform its annual goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognizing an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. The amendments are effective for annual periods beginning after December 15, 2019 with early adoption permitted for goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the impact of its pending adoption of the new standard on its consolidated financial statements.
In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The amendments provide a more robust framework to use in determining when a set of assets and activities is a business. The amendments are effective for annual periods beginning after December 15, 2017 with a limited scope of early adoption. The Company is currently evaluating the impact of its pending adoption of the new standard on its consolidated financial statements.
For information about previous new accounting pronouncements and the potential impact on the Company’s Consolidated Financial Statements, see Note 2 of the Notes to Consolidated Financial Statements in the Company’s 2016 Form 10-K.