ITEM 1.
FINANCIAL STATEMENTS (UNAUDITED)
CONDENSED CONSOLIDATED
BALANCE SHEETS
(U.S. Dollars)
|
|
|
September 30,
2017
|
|
|
December 31,
2016
|
|
|
|
|
(Unaudited)
|
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
CURRENT ASSETS:
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
4,335,017
|
|
|
$
|
7,130,983
|
|
|
Restricted collateral deposits
|
|
|
327,041
|
|
|
|
268,980
|
|
|
Trade receivables
|
|
|
13,827,915
|
|
|
|
16,821,737
|
|
|
Unbilled receivables
|
|
|
15,010,930
|
|
|
|
10,981,577
|
|
|
Other accounts receivable and prepaid expenses
|
|
|
2,519,266
|
|
|
|
2,156,896
|
|
|
Inventories
|
|
|
10,060,720
|
|
|
|
10,318,021
|
|
|
Total
current assets
|
|
|
46,080,889
|
|
|
|
47,678,194
|
|
|
LONG TERM ASSETS:
|
|
|
|
|
|
|
|
|
|
Contractual and Israeli statutory severance pay fund
|
|
|
3,581,316
|
|
|
|
3,177,238
|
|
|
Other long term receivables
|
|
|
146,209
|
|
|
|
56,662
|
|
|
Property and equipment, net
|
|
|
8,484,577
|
|
|
|
5,915,240
|
|
|
Other intangible assets, net
|
|
|
5,225,559
|
|
|
|
6,823,346
|
|
|
Goodwill
|
|
|
46,022,141
|
|
|
|
45,489,517
|
|
|
Long term assets of discontinued operations
|
|
|
270,139
|
|
|
|
270,139
|
|
|
Total long term assets
|
|
|
63,729,941
|
|
|
|
61,732,142
|
|
|
Total assets
|
|
$
|
109,810,830
|
|
|
$
|
109,410,336
|
|
The accompanying notes are an integral part of the Interim Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED BALANCE SHEETS
(U.S. Dollars, except share data)
|
|
|
September 30,
2017
|
|
|
December 31,
2016
|
|
|
|
|
(Unaudited)
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
CURRENT LIABILITIES:
|
|
|
|
|
|
|
|
Trade payables
|
|
$
|
6,095,039
|
|
|
$
|
4,362,804
|
|
|
Other accounts payable and accrued expenses
|
|
|
5,243,990
|
|
|
|
5,597,558
|
|
|
Current portion of long term debt
|
|
|
2,248,417
|
|
|
|
1,828,840
|
|
|
Short term bank credit
|
|
|
3,077,959
|
|
|
|
2,973,032
|
|
|
Severance payable
|
|
|
–
|
|
|
|
2,577,472
|
|
|
Deferred revenues
|
|
|
4,590,088
|
|
|
|
6,421,271
|
|
|
Total current liabilities
|
|
|
21,255,493
|
|
|
|
23,760,977
|
|
|
LONG TERM LIABILITIES:
|
|
|
|
|
|
|
|
|
|
Contractual and accrued Israeli statutory severance pay
|
|
|
4,530,550
|
|
|
|
3,891,710
|
|
|
Long term portion of debt
|
|
|
9,131,490
|
|
|
|
8,703,736
|
|
|
Deferred income tax liability
|
|
|
8,554,033
|
|
|
|
7,868,125
|
|
|
Other long term liabilities
|
|
|
99,782
|
|
|
|
100,742
|
|
|
Total long-term liabilities
|
|
|
22,315,855
|
|
|
|
20,564,313
|
|
|
Total liabilities
|
|
|
43,571,348
|
|
|
|
44,325,290
|
|
|
STOCKHOLDERS’ EQUITY:
|
|
|
|
|
|
|
|
|
|
Share capital –
|
|
|
|
|
|
|
|
|
|
Common stock – $0.01 par value each;
Authorized: 50,000,000 shares as of September 30, 2017 and December 31, 2016;
Issued and outstanding: 26,395,048 shares and 26,438,234 shares as of
September 30, 2017 and December 31, 2016, respectively
|
|
|
263,951
|
|
|
|
264,382
|
|
|
Preferred shares – $0.01 par value each;
Authorized: 1,000,000 shares as of September 30, 2017 and December 31, 2016;
No shares issued or outstanding as of September 30, 2017 and December 31, 2016
|
|
|
–
|
|
|
|
–
|
|
|
Additional paid-in capital
|
|
|
250,714,497
|
|
|
|
250,405,012
|
|
|
Accumulated deficit
|
|
|
(185,977,610
|
)
|
|
|
(185,402,893
|
)
|
|
Notes receivable from stockholders
|
|
|
(908,054
|
)
|
|
|
(908,054
|
)
|
|
Accumulated other comprehensive income
|
|
|
2,146,698
|
|
|
|
726,599
|
|
|
Total stockholders’ equity
|
|
|
66,239,482
|
|
|
|
65,085,046
|
|
|
Total liabilities and stockholders’ equity
|
|
$
|
109,810,830
|
|
|
$
|
109,410,336
|
|
The accompanying notes are an integral part of the Interim Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE
INCOME
(UNAUDITED)
(U.S. Dollars, except share data)
|
|
|
Nine months ended September 30,
|
|
|
Three months ended September 30,
|
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
Revenues
|
|
$
|
69,726,579
|
|
|
$
|
71,486,478
|
|
|
$
|
25,930,441
|
|
|
$
|
24,300,120
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues
|
|
|
50,007,949
|
|
|
|
48,933,171
|
|
|
|
18,673,955
|
|
|
|
16,436,276
|
|
|
Research and development expenses
|
|
|
2,791,519
|
|
|
|
2,367,964
|
|
|
|
1,031,669
|
|
|
|
752,847
|
|
|
Selling and marketing expenses
|
|
|
5,674,653
|
|
|
|
4,913,076
|
|
|
|
1,707,209
|
|
|
|
1,458,622
|
|
|
General and administrative expenses
|
|
|
8,588,759
|
|
|
|
11,149,640
|
|
|
|
2,732,171
|
|
|
|
3,122,853
|
|
|
Amortization of intangible assets
|
|
|
1,728,956
|
|
|
|
2,164,937
|
|
|
|
509,303
|
|
|
|
698,297
|
|
|
Total operating costs and expenses
|
|
|
68,791,836
|
|
|
|
69,528,788
|
|
|
|
24,654,307
|
|
|
|
22,468,895
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
934,743
|
|
|
|
1,957,690
|
|
|
|
1,276,134
|
|
|
|
1,831,225
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense), net
|
|
|
(13,498
|
)
|
|
|
49,913
|
|
|
|
(23,758
|
)
|
|
|
3,481
|
|
|
Financial expense, net
|
|
|
(749,967
|
)
|
|
|
(769,328
|
)
|
|
|
(200,923
|
)
|
|
|
(227,474
|
)
|
|
Total other expense
|
|
|
(763,465
|
)
|
|
|
(719,415
|
)
|
|
|
(224,681
|
)
|
|
|
(223,993
|
)
|
|
Income from continuing operations before income tax expense
|
|
|
171,278
|
|
|
|
1,238,275
|
|
|
|
1,051,453
|
|
|
|
1,607,232
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense
|
|
|
745,995
|
|
|
|
684,272
|
|
|
|
263,235
|
|
|
|
101,992
|
|
|
Income (loss) from continuing operations
|
|
|
(574,717
|
)
|
|
|
554,003
|
|
|
|
788,218
|
|
|
|
1,505,240
|
|
|
Loss from discontinued operations
|
|
|
–
|
|
|
|
(1,361,787
|
)
|
|
|
–
|
|
|
|
(869,302
|
)
|
|
Net income (loss)
|
|
|
(574,717
|
)
|
|
|
(807,784
|
)
|
|
|
788,218
|
|
|
|
635,938
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income (loss), net of income tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency translation adjustment
|
|
|
1,420,099
|
|
|
|
406,892
|
|
|
|
(166,075
|
)
|
|
|
344,837
|
|
|
Comprehensive income (loss)
|
|
$
|
845,382
|
|
|
$
|
(400,892
|
)
|
|
$
|
622,143
|
|
|
$
|
980,775
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) per share of common stock:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic – continuing operations
|
|
$
|
(0.02
|
)
|
|
$
|
0.02
|
|
|
$
|
0.03
|
|
|
$
|
0.06
|
|
|
Basic – discontinued operations
|
|
$
|
–
|
|
|
$
|
(0.05
|
)
|
|
$
|
–
|
|
|
$
|
(0.04
|
)
|
|
Basic net income (loss) per share
|
|
$
|
(0.02
|
)
|
|
$
|
(0.03
|
)
|
|
$
|
0.03
|
|
|
$
|
0.02
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted – continuing operations
|
|
$
|
(0.02
|
)
|
|
$
|
0.02
|
|
|
$
|
0.03
|
|
|
$
|
0.06
|
|
|
Diluted – discontinued operations
|
|
$
|
–
|
|
|
$
|
(0.05
|
)
|
|
$
|
–
|
|
|
$
|
(0.04
|
)
|
|
Diluted net income (loss) per share
|
|
$
|
(0.02
|
)
|
|
$
|
(0.03
|
)
|
|
$
|
0.03
|
|
|
$
|
0.02
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of shares used in computing basic net income (loss) per share
|
|
|
26,202,386
|
|
|
|
25,410,494
|
|
|
|
26,394,613
|
|
|
|
26,215,049
|
|
|
Weighted average number of shares used in computing diluted net income (loss) per share
|
|
|
26,202,386
|
|
|
|
25,410,494
|
|
|
|
26,394,613
|
|
|
|
26,215,049
|
|
The accompanying notes are an integral part of the Interim Condensed Consolidated Financial Statements.
CONSOLIDATED STATEMENT OF
CASH FLOWS (UNAUDITED)
(U.S. Dollars)
|
|
|
Nine months ended September 30,
|
|
|
|
|
2017
|
|
|
2016
|
|
|
CASH FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(574,717
|
)
|
|
$
|
(807,784
|
)
|
|
Adjustments required to reconcile net loss to net cash provided by (used in) operating activities:
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
1,277,985
|
|
|
|
1,322,595
|
|
|
Amortization of intangible assets
|
|
|
1,728,956
|
|
|
|
2,164,937
|
|
|
Stock based compensation
|
|
|
309,053
|
|
|
|
785,738
|
|
|
Deferred tax provision
|
|
|
685,908
|
|
|
|
607,925
|
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
Trade receivables
|
|
|
3,416,571
|
|
|
|
372,779
|
|
|
Unbilled receivables
|
|
|
(4,008,309
|
)
|
|
|
433,010
|
|
|
Other accounts receivable and prepaid expenses
|
|
|
(391,646
|
)
|
|
|
(1,420,274
|
)
|
|
Inventories
|
|
|
620,751
|
|
|
|
(819,411
|
)
|
|
Severance pay, net
|
|
|
(1,981,943
|
)
|
|
|
436,682
|
|
|
Trade payables
|
|
|
1,815,709
|
|
|
|
(1,166,222
|
)
|
|
Other accounts payable and accrued expenses
|
|
|
(223,856
|
)
|
|
|
(341,418
|
)
|
|
Deferred revenues
|
|
|
(1,831,183
|
)
|
|
|
(1,071,511
|
)
|
|
Net cash provided by operating activities
|
|
|
843,279
|
|
|
|
497,046
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
Decrease in restricted collateral deposits
|
|
|
(33,398
|
)
|
|
|
(139,192
|
)
|
|
Purchase of property and equipment
|
|
|
(3,733,323
|
)
|
|
|
(1,108,356
|
)
|
|
Additions to capitalized software
|
|
|
(131,169
|
)
|
|
|
(27,951
|
)
|
|
Net cash used in investing activities
|
|
$
|
(3,897,890
|
)
|
|
$
|
(1,275,499
|
)
|
The accompanying notes are an integral part of the Interim Condensed Consolidated Financial Statements.
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(U.S. Dollars)
|
|
|
Nine months ended September 30,
|
|
|
|
|
2017
|
|
|
2016
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
Proceeds from long term debt
|
|
$
|
2,150,000
|
|
|
$
|
11,000,000
|
|
|
Repayment of long term debt
|
|
|
(1,284,278
|
)
|
|
|
(16,380,225
|
)
|
|
Proceeds from the issuance of common stock
|
|
|
–
|
|
|
|
2,952,999
|
|
|
Change in short term bank credit
|
|
|
104,927
|
|
|
|
3,349,208
|
|
|
Net cash provided by financing activities
|
|
|
970,649
|
|
|
|
921,982
|
|
|
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
|
|
|
(2,083,962
|
)
|
|
|
143,529
|
|
|
CASH DIFFERENCES DUE TO EXCHANGE RATE DIFFERENCES
|
|
|
(712,004
|
)
|
|
|
(429,371
|
)
|
|
CASH AND CASH EQUIVALENTS AT THE BEGINNING OF THE PERIOD
|
|
|
7,130,983
|
|
|
|
10,608,420
|
|
|
CASH AND CASH EQUIVALENTS AT THE END OF THE PERIOD
|
|
$
|
4,335,017
|
|
|
$
|
10,322,578
|
|
|
SUPPLEMENTARY CASH FLOW INFORMATION:
|
|
|
|
|
|
|
|
|
|
Interest paid during the period
|
|
$
|
531,210
|
|
|
$
|
574,547
|
|
|
Taxes paid on income during the period
|
|
$
|
152,444
|
|
|
$
|
111,441
|
|
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”) is a defense and security products and services company, engaged in two business areas: interactive simulation for military, law enforcement and commercial markets; and mobile power systems for the military, commercial and medical markets. 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 was 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 statement of cash flows for the nine months ended September 30, 2016 was $511,366 and $11,186, respectively. There was no impact on the consolidated statement of cash flows for the nine months ended September 30, 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 September 30, 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 September 30, 2017, its operating results for the nine and three-month periods ended September 30, 2017 and 2016, and its cash flows for the nine-month periods ended September 30, 2017 and 2016.
The results of operations for the nine and three months ended September 30, 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. The resulting reclassifications have not resulted in a change to total assets, net income, or stockholders’ equity.
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 $800,000 payable to the local taxing authorities was remitted in April 2017.
h. Accounting for stock-based compensation:
For the three months ended September 30, 2017 and 2016 the compensation expense recorded related to restricted stock units and restricted shares was $116,127 and $137,252, respectively. For the nine months ended September 30, 2017 and 2016 the compensation expense recorded related to restricted stock units and restricted shares was $309,053 and $410,738, respectively. The remaining total compensation cost related to share awards not yet recognized in the income statement as of September 30, 2017 was $250,946. The weighted average period over which this compensation cost is expected to be recognized is approximately one and one-half years. As the Company is in a net operating loss position, the Company has recorded a full valuation allowance on the deferred tax impact of its stock based compensation.
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 nine months 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 and nine month periods ended September 30, 2017 and 2016, were none and 172,793; and none and 715,325, 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 September 30, 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 September 30, 2017, based upon the Company’s ability to acquire similar debt at similar maturities.
NOTE 3:
INVENTORIES
Inventories are stated at net realizable 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 $147,000 from December 31, 2016 to September 30, 2017 and decreased $110,000 in the Power Systems Division in that same time period:
|
|
|
September 30,
2017
|
|
|
December 31,
2016
|
|
|
|
|
(Unaudited)
|
|
|
|
|
|
Raw and packaging materials
|
|
$
|
8,031,884
|
|
|
$
|
8,512,006
|
|
|
Work in progress
|
|
|
1,322,200
|
|
|
|
917,582
|
|
|
Finished products
|
|
|
706,636
|
|
|
|
888,433
|
|
|
Total:
|
|
$
|
10,060,720
|
|
|
$
|
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’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 and for the periods ended September 30, 2017 and 2016:
|
|
|
Training and
Simulation
Division
|
|
|
Power Systems
Division
|
|
|
Corporate
Expenses
|
|
|
Total
Company
|
|
|
Nine months ended September 30, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from outside customers
|
|
$
|
35,139,969
|
|
|
$
|
34,586,610
|
|
|
$
|
–
|
|
|
$
|
69,726,579
|
|
|
Depreciation and amortization expense
(1)
|
|
|
(772,736
|
)
|
|
|
(2,230,750
|
)
|
|
|
(3,455
|
)
|
|
|
(3,006,941
|
)
|
|
Direct expenses
(2)
|
|
|
(29,723,546
|
)
|
|
|
(33,425,392
|
)
|
|
|
(2,649,455
|
)
|
|
|
(65,798,393
|
)
|
|
Segment operating income (loss)
|
|
$
|
4,643,687
|
|
|
$
|
(1,069,532
|
)
|
|
$
|
(2,652,910
|
)
|
|
$
|
921,245
|
|
|
Financial income (expense)
|
|
|
(77,975
|
)
|
|
|
(170,381
|
)
|
|
|
(501,611
|
)
|
|
|
(749,967
|
)
|
|
Income tax expense
|
|
|
(105,000
|
)
|
|
|
44,913
|
|
|
|
(685,908
|
)
|
|
|
(745,995
|
)
|
|
Income (loss) from continuing operations
|
|
$
|
4,460,712
|
|
|
$
|
(1,195,000
|
)
|
|
$
|
(3,840,429
|
)
|
|
$
|
(574,717
|
)
|
|
Segment assets
(3)
|
|
$
|
48,550,296
|
|
|
$
|
57,675,628
|
|
|
$
|
3,314,767
|
|
|
$
|
109,540,691
|
|
|
Additions to long-lived assets
|
|
$
|
2,454,099
|
|
|
$
|
1,410,393
|
|
|
$
|
–
|
|
|
$
|
3,864,492
|
|
|
Nine months ended September 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from outside customers
|
|
$
|
36,519,124
|
|
|
$
|
34,967,354
|
|
|
$
|
–
|
|
|
$
|
71,486,478
|
|
|
Depreciation and amortization expense
(1)
|
|
|
(825,178
|
)
|
|
|
(2,649,545
|
)
|
|
|
(12,809
|
)
|
|
|
(3,487,532
|
)
|
|
Direct expenses
(2)
|
|
|
(29,218,054
|
)
|
|
|
(32,217,155
|
)
|
|
|
(4,556,134
|
)
|
|
|
(65,991,343
|
)
|
|
Segment operating income (loss)
|
|
$
|
6,475,892
|
|
|
$
|
100,654
|
|
|
$
|
(4,568,943
|
)
|
|
$
|
2,007,603
|
|
|
Financial income (expense)
|
|
|
(29,593
|
)
|
|
|
(58,858
|
)
|
|
|
(680,877
|
)
|
|
|
(769,328
|
)
|
|
Income tax expense
|
|
|
51,285
|
|
|
|
(127,632
|
)
|
|
|
(607,925
|
)
|
|
|
(684,272
|
)
|
|
Income (loss) from continuing operations
|
|
$
|
6,497,584
|
|
|
$
|
(85,836
|
)
|
|
$
|
(5,857,745
|
)
|
|
$
|
554,003
|
|
|
Segment assets
(3)
|
|
$
|
46,650,797
|
|
|
$
|
61,131,101
|
|
|
$
|
8,681,031
|
|
|
$
|
116,462,929
|
|
|
Additions to long-lived assets
|
|
$
|
236,866
|
|
|
$
|
668,854
|
|
|
$
|
–
|
|
|
$
|
905,720
|
|
|
Three months ended September 30, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from outside customers
|
|
$
|
14,596,967
|
|
|
$
|
11,333,474
|
|
|
$
|
–
|
|
|
$
|
25,930,441
|
|
|
Depreciation and amortization expense
(1)
|
|
|
(224,611
|
)
|
|
|
(698,939
|
)
|
|
|
(1,183
|
)
|
|
|
(924,733
|
)
|
|
Direct expenses
(2)
|
|
|
(11,672,943
|
)
|
|
|
(11,269,961
|
)
|
|
|
(810,428
|
)
|
|
|
(23,753,332
|
)
|
|
Segment operating income (loss)
|
|
$
|
2,699,413
|
|
|
$
|
(635,426
|
)
|
|
$
|
(811,611
|
)
|
|
$
|
1,252,376
|
|
|
Financial income (expense)
|
|
|
(40,706
|
)
|
|
|
7,367
|
|
|
|
(167,584
|
)
|
|
|
(200,923
|
)
|
|
Income tax expense
|
|
|
(35,000
|
)
|
|
|
401
|
|
|
|
(228,636
|
)
|
|
|
(263,235
|
)
|
|
Income (loss) from continuing operations
|
|
$
|
2,623,707
|
|
|
$
|
(627,658
|
)
|
|
$
|
(1,207,831
|
)
|
|
$
|
788,218
|
|
|
Three months ended September 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues from outside customers
|
|
$
|
11,871,987
|
|
|
$
|
12,428,133
|
|
|
$
|
–
|
|
|
$
|
24,300,120
|
|
|
Depreciation and amortization expense
(1)
|
|
|
(276,151
|
)
|
|
|
(874,163
|
)
|
|
|
(2,552
|
)
|
|
|
(1,152,866
|
)
|
|
Direct expenses
(2)
|
|
|
(8,795,338
|
)
|
|
|
(11,451,439
|
)
|
|
|
(1,065,771
|
)
|
|
|
(21,312,548
|
)
|
|
Segment operating income (loss)
|
|
$
|
2,800,498
|
|
|
$
|
102,531
|
|
|
$
|
(1,068,323
|
)
|
|
$
|
1,834,706
|
|
|
Financial income (expense)
|
|
|
(14,782
|
)
|
|
|
(23,830
|
)
|
|
|
(188,862
|
)
|
|
|
(227,474
|
)
|
|
Income tax expense
|
|
|
144,915
|
|
|
|
(18,271
|
)
|
|
|
(228,636
|
)
|
|
|
(101,992
|
)
|
|
Income (loss) from continuing operations
|
|
$
|
2,930,631
|
|
|
$
|
60,430
|
|
|
$
|
(1,485,821
|
)
|
|
$
|
1,505,240
|
|
|
(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 $24,435,641 and $21,586,500, respectively, as of September 30, 2017 and $24,435,641 and $21,191,580, respectively, as of September 30, 2016.
|
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 (“Term Loan A”), (iii) a $1,358,000 Mortgage Loan (“Term Loan B”) and (iv) a $1,730,895 Mortgage Loan (“Term Loan C”); collectively referred to as the “Credit Facilities.”
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 September 30, 2017 was 4.75%. The balance at September 30, 2017 and December 31, 2016 was $3.1 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 September 30, 2017 was 4.75%. The balance at September 30, 2017 and December 31, 2016 was $8.2 million and $9.3 million, respectively.
During the quarter ended June 30, 2017, the Company purchased land and a building, previously leased by our Training and Simulation Division, in Ann Arbor, Michigan. As a result, the Company now maintains two Mortgage Loans (“Term Loans B and C”). The maturities of Term Loans B and C are June 1, 2024 and maintain an interest rate on a scale identical to Term Loan A. The monthly payments on Term Loan B and Term Loan C are $7,212 and $5,660, respectively, in principal plus accrued interest, with balloon payments due on the maturity date. The effective interest rate for the Mortgage Loans at September 30, 2017 was 5.0%. The balance of both loans at September 30, 2017 and December 31, 2016 was $3.0 million 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 September 30, 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”) 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. Additionally, the new standard requires enhanced disclosures about the nature, amount, timing, and uncertainty of revenue and cash flows arising from customer contracts, including revenue recognition policies to identify performance obligations, assets recognized from costs incurred to obtain and fulfill a contract, and significant judgments in measurement and recognition. The Company’s task force has identified significant contracts with customers and the promised goods and/or services associated with the revenue streams for each segment. The Company is evaluating the distinct performance obligations and the pattern of revenue recognition of these significant contracts in advance of the implementation of the standard
. It is also determining the impact of adopting the standard on its control framework and may require changes to its system and other controls process.
The standard, as amended, will be effective for annual periods beginning after December 15, 2017, including interim periods within that reporting period. The Company will 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 March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The new standard introduces targeted amendments intended to simplify the accounting for stock compensation. Among other things, the ASU requires all excess tax benefits and tax deficiencies to be recognized as income tax expense or benefit in the income statement. The amendments are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The adoption of this new standard was not material to the consolidated financial statements.
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.
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report contains forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements involve inherent risks and uncertainties. When used in this discussion, the words “believes,” “anticipated,” “expects,” “estimates” and similar expressions are intended to identify such forward-looking statements. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors including, but not limited to, those set forth elsewhere in this report. Please see “Risk Factors” in our Annual Report on Form 10-K and in our other filings with the Securities and Exchange Commission.
The following discussion and analysis should be read in conjunction with the interim financial statements and notes thereto appearing elsewhere in this Quarterly Report. We have rounded amounts reported here to the nearest thousand, unless such amounts are more than $1.0 million, in which event we have rounded such amounts to the nearest hundred thousand.
Executive Summary
We are a defense and security products and services company, engaged in two business areas: interactive simulation for military, law enforcement and commercial markets; and mobile power systems for the military, commercial and medical markets. We operate in two business units:
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We develop, manufacture and market advanced high-tech multimedia and interactive digital solutions for engineering, use-of-force training and operator training of military, law enforcement, security, emergency services and other personnel through our
Training and Simulation Division
.
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We provide advanced battery solutions, innovative energy management and power distribution technologies and world-class product design and manufacturing services for the aerospace, defense, law enforcement and homeland security markets, and we manufacture and sell primary rechargeable batteries, for defense and security products and medical and industrial applications through our
Power Systems Division
.
Discontinued Operations
During the quarter ended September 30, 2016, the Board of Directors approved a plan to discontinue the Flow Battery segment. The discontinuance was a strategic shift that had a major effect on the Company’s operations and financial results; therefore, the results of the Flow Battery segment have been reclassified as discontinued operations for all periods presented.
The financial results of the Company are presented as continuing operations in the Consolidated Financial Statements for all periods presented. See Note 1.b. – Asset Held for Sale and Discontinued Operations. The loss from discontinued operations reported for the nine and three month periods ended September 30, 2016 was $1.4 million and $869,000, respectively. The impact of the discontinued operations on operating and investing activities within the consolidated statements of cash flows for the nine months ended September 30, 2016 was $511,000 and $11,000, respectively. There was no impact on the consolidated statements of income and cash flows for the nine months ended September 30, 2017.
The absence of the losses from the Flow Battery segment has improved financial results, liquidity, and loan covenants.
Overview of Pre-Tax Results of Continuing Operations
Through the first nine months of 2017 as compared to 2016, our revenues decreased by $1.8 million to $69.7 million. This was principally as a result of revenue contraction in our Simulation Division that is related to the timing of the award of new contracts. For the first nine months of 2017, we reported income from continuing operations of $171,000 as compared to income from continuing operations of $1.2 million for the first nine months of 2016. Included in the income from operations in 2016 is incremental stock compensation expense of $375,000 related to a non-recurring issuance of common stock during the first nine months of 2016.
Overview of Operating Performance and Backlog
Overall, our pre-tax income from continuing operations for the nine months ended September 30, 2017 was $171,000 on revenues of $69.7 million, compared to pre-tax income from continuing operations of $1.2 million on revenues of $71.5 million during the nine months ended September 30, 2016. Our overall backlog at the end of the third quarter of 2017 totaled $69.5 million, compared to $55.0 million at the end of the third quarter of 2016.
In our Training and Simulation Division, revenues for the nine months ended September 30, 2017 were $35.1 million, compared to $36.5 million during the nine months ended September 30, 2016. As of September 30, 2017, our backlog for our Training and Simulation Division totaled $41.5 million, compared to $22.0 million at the end of the third quarter of 2016.
In our Power Systems Division, revenues for the nine months ended September 30, 2017 were $34.6 million, compared to $35.0 million during the nine months ended September 30, 2016. As of September 30, 2017, our backlog for our Power Systems Division totaled $28.0 million, compared to $33.0 million at the end of the third quarter of 2016.
The table below details the percentage of total recognized revenue by type of arrangement for the nine months ended September 30, 2017 and 2016:
|
|
|
Nine months ended September 30,
|
|
|
Type of Revenue
|
|
2017
|
|
|
2016
|
|
|
Sale of products
|
|
|
96.7
|
%
|
|
|
95.3
|
%
|
|
Maintenance and support agreements
|
|
|
3.3
|
%
|
|
|
4.4
|
%
|
|
Long term research and development contracts
|
|
|
–
|
|
|
|
0.3
|
%
|
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
Functional Currency
We consider the United States dollar to be the currency of the primary economic environment in which we and EFL operate and, therefore, both we and EFL have adopted and are using the United States dollar as our functional currency. Transactions and balances originally denominated in U.S. dollars are presented at the original amounts. Gains and losses arising from non-dollar transactions and balances are included in net income.
The majority of financial transactions of Epsilor is in New Israeli Shekels (“NIS”) and a substantial portion of Epsilor’s costs is incurred in NIS. Management believes that the NIS is the functional currency of Epsilor. Accordingly, the financial statements of Epsilor have been translated into U.S. dollars. All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. Statement of comprehensive income amounts have been translated using the average exchange rate for the period. The resulting translation adjustments are reported as a component of accumulated other comprehensive loss in stockholders’ equity.
Results of Operations
Three months ended September 30, 2017 compared to the three months ended September 30, 2016.
Revenues
.
Revenues totaled $25.9 million during the third quarter of 2017, compared to $24.3 million in the third quarter of 2016, an increase of $1.6 million, or 6.7%. In the third quarter of 2017, revenues were $14.6 million for the Training and Simulation Division, compared to $11.9 million in the third quarter of 2016, an increase of $2.7 million, or 23.0% due primarily to higher revenue in our Use of Force and our Air Warfare Simulation product areas; and $11.3 million for the Power Systems Division, compared to $12.4 million in the third quarter of 2016, a decrease of $1.1 million, or 8.8%, due primarily to lower revenues in the U.S. operations of our Power Systems Division.
Cost of revenues.
Cost of revenues totaled $18.7 million during the third quarter of 2017, compared to $16.4 million in the third quarter of 2016, an increase of $2.3 million or 13.6%, due primarily to an increase in revenues in our Training and Simulation Division as well as an increase in project-related investments within our Power Systems Division. Cost of revenues were $8.8 million for the Training and Simulation Division, compared to $6.1 million in the third quarter of 2016, an increase of $2.7 million, or 44.5%, due primarily to higher costs associated with higher revenues; and $9.9 million for the Power Systems Division, compared to $10.4 million in the third quarter of 2016, a decrease of $468,000, or 4.5%, due primarily to lower revenues and increased investment by the U.S. operations of our Power Division.
Research and development expenses
.
Research and development expenses totaled $1.0 million during the third quarter of 2017, compared to $753,000 for the third quarter of 2016, an increase of $279,000, or 37.0%, due primarily to increased development activities in our Vehicle Simulation product area offset by an increase in project-related investment in our U.S. operations of our Power Systems Division.
Selling and marketing expenses
.
Selling and marketing expenses for the third quarter of 2017 were $1.7 million, compared to $1.5 million in the third quarter of 2016, an increase of $249,000, or 17.0%, due primarily to increase selling and marketing efforts in our domestic and international businesses through increased staffing and other business development activities.
General and administrative expenses
.
General and administrative expenses for the third quarter of 2017 were $2.7 million, compared to $3.1 million in the third quarter of 2016, a decrease of $391,000, or 12.5%, due primarily to lower salaries resulting from the separation of the former Chief Executive Officer, as well as other measures taken to reduce expenses in third quarter of 2017.
Amortization of intangible assets
.
Amortization of intangible assets totaled $509,000 in the third quarter of 2017, compared to $698,000 in the third quarter of 2016, a decrease of $189,000, or 27.1%, due primarily to higher amortization expense recognized in 2016 pertaining to shorter lived intangible assets.
Other expense, net
.
Other expense totaled $225,000 in the third quarter of 2017, compared to other expense of $224,000 in the third quarter of 2016.
Income taxes.
We recorded $263,000 in tax expense in the third quarter of 2017, compared to $102,000 in tax expense in the third quarter of 2016, an increase of $161,000. This expense includes “naked” credits (“naked” credits occur when deferred tax liabilities that are created by indefinite-lived assets such as goodwill cannot be used as a source of taxable income to support the realization of deferred tax assets) of $228,000 in non-cash expenses in the third quarter of 2017 and 2016, respectively. The 2016 expense amount was offset by income tax benefits recorded in our domestic subsidiaries.
Income from continuing operations.
Due to the factors cited above, we went from an income from continuing operations of $1.5 million in the third quarter of 2016 to income from continuing operations of $790,000 in the third quarter of 2017, a decrease of $710,000.
Nine months ended September 30, 2017 compared to the nine months ended September 30, 2016.
Revenues
.
Revenues for the nine months ended September 30, 2017 totaled $69.7 million, compared to $71.5 million in the comparable period in 2016, a decrease of $1.8 million, or 2.5%. In the first nine months of 2017, revenues were $35.1 million for the Training and Simulation Division, compared to $36.5 million in the first nine months of 2016, a decrease of $1.4 million, or 3.8% due primarily to lower revenue in our Vehicle Simulation product area; and $34.6 million for the Power Systems Division, compared to $35.0 million in the first nine months of 2016, a decrease of $381,000, or 1.1%.
Cost of revenues.
Cost of revenues totaled $50.0 million during the first nine months of 2017, compared to $48.9 million in the first nine months of 2016, an increase of $1.1 million, or 2.2%, due primarily to an increase in project related investments of our U.S. operations of our Power Systems Division. Cost of revenues were $20.2 million for the Training and Simulation Division, compared to $20.7 million in the first nine months of 2016, a decrease of $507,000, or 2.5%, due primarily to lower costs associated with lower revenues; and $29.8 million for the Power Systems Division, compared to $28.3 million in the first nine months of 2016, an increase of $1.5 million, or 5.6%, due primarily to an increase in project-related investments within our Power Systems Division.
Research and development expenses
.
Research and development expenses totaled $2.8 million during the first nine months of 2017, compared to $2.4 million for the first nine months of 2016, an increase of $424,000, or 17.9% due primarily to increased development activities in our Vehicle Simulation product area offset by an increase in project-related investment in our U.S. operations of our Power Systems Division.
Selling and marketing expenses
.
Selling and marketing expenses for the first nine months of 2017 were $5.7 million, compared to $4.9 million in the first nine months of 2016, an increase of $762,000, or 15.5%, due primarily to increase selling and marketing efforts in our Vehicle Simulation product area as well as increased efforts in our Use-of-Force product areas.
General and administrative expenses
.
General and administrative expenses for the first nine months of 2017 were $8.6 million, compared to $11.1 million in the first nine months of 2016, a decrease of $2.6 million, or 23.0%, due primarily to lower stock compensation resulting from a share issuance to a member of the Board of Directors, lower salaries resulting from the separation of the former Chairman of the Board of Directors and the former Chief Executive Officer, and lower performance-based bonuses recognized in the first nine months of 2017.
Amortization of intangible assets
.
Amortization of intangible assets totaled $1.7 million in the first nine months of 2017, compared to $2.2 million in the first nine months of 2016, a decrease of $436,000, or 20.1%, due primarily to higher amortization expense recognized in 2016 pertaining to shorter lived intangible assets.
Other expense, net
.
Other expense totaled $763,000 in the first nine months of 2017, compared to other expense of $719,000 in the first nine months of 2016, an increase of $44,000, or 6.1%.
Income taxes.
We recorded $746,000 in tax expense in the first nine months of 2017, compared to $684,000 in tax expense in the first nine months of 2016, an increase of $62,000, or 9.0%. This expense includes “naked” credits (“naked” credits occur when deferred tax liabilities that are created by indefinite-lived assets such as goodwill cannot be used as a source of taxable income to support the realization of deferred tax assets) which totaled $686,000 and $608,000 in non-cash expenses in the first nine months of 2017 and 2016, respectively. The 2016 expense amount was offset by income tax benefits recorded in our domestic subsidiaries.
Income (loss) from continuing operations.
Due to the factors cited above, we went from an income from continuing operations of $554,000 in the first nine months of 2016 to a loss from continuing operations of $(574,000) in the first nine months of 2017, a decrease of $1.1 million.
Liquidity and Capital Resources
As of September 30, 2017, we had $4.3 million in cash and $327,000 in restricted collateral deposits, as compared to December 31, 2016, when we had $7.1 million in cash and $269,000 in restricted collateral deposits. We also had $8.5 million in available, unused bank lines of credit with our main bank as of September 30, 2017, under a $15.0 million credit facility.
We maintain 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 (“Term Loan A”), (iii) a $1,358,000 Mortgage Loan (“Term Loan B”) and (iv) a $1,730,895 Mortgage Loan (“Term Loan C”); collectively referred to as the “Credit Facilities.”
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 September 30, 2017 was 4.75%.
The maturity of Term Loan A is March 11, 2021. This Term Loan maintains an interest rate on a scale ranging from LIBOR plus 2.0% up to LIBOR plus 3.25%. The repayment of this 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 this Term Loan at September 30, 2017 was 4.75%.
During the quarter ended September 30, 2017, we purchased land and a building previously leased by our Training and Simulation Division in Ann Arbor, Michigan for $2.1 million. As a result, we now have two Mortgage Loans (“Term Loans B and C”). The maturities of the Mortgage Loans are June 1, 2024 and maintain an interest rate on a scale identical to the Term Loan. The monthly payments on the Mortgage Loans are $12,872 in principal plus accrued interest, with balloon payments due at the maturity date. The effective interest rate for the Mortgage Loans at September 30, 2017 was 5.0%.
The Credit Facilities maintain certain reporting requirements, conditions precedent, affirmative covenants and financial covenants. We are 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. We were in compliance with our covenants at September 30, 2017.
The Credit Facilities are secured by our assets and the assets of our domestic subsidiaries.
We used available funds in the nine months ended September 30, 2017 primarily for working capital needs, including the $2.6 million severance payment to our former Chief Executive Officer, and investment in fixed assets. We purchased the land and building referred to above for $2.2 million as well as $1.6 million of fixed assets during the nine months ended September 30, 2017. Our net fixed assets amounted to $8.5 million at quarter end.
Net cash provided by operating activities for the nine months ended September 30, 2017 was $843,000. Net cash provided by operating activities for the nine months ended September 30, 2016 was $497,000, representing a net change year over year of $346,000. The increase in cash provided by operations is primarily attributable to an increase in cash generated by net operating assets and liabilities of $4.0 million which was partially offset by severance paid to our
former Chief Executive Officer in the first quarter of 2017 of $2.6 million as well as a reduction in non-cash expenses of $1.0 million.
Net cash used in investing activities for the nine months ended September 30, 2017 was $3.9 million. Net cash used in investing activities for the nine months ended September 30, 2016 was $1.3 million, representing a year over year change of $2.6 million. This difference was due primarily to the $2.2 million building purchase and investments in fixed assets referred to above.
Net cash provided by financing activities for the nine months ended September 30, 2017 and 2016 was $1.0 million and $900,000, an increase of $100,000. In 2016, we refinanced our long-term debt resulting in a payment of $5.2 million as well as obtained an investment from a member of our Board of Directors of $3.0 million. In 2017, we obtained financing of $2.2 million for the building purchase, paid long-term debt of $1.3 million and increased the utilization on our line of credit by $100,000.
As of September 30, 2017, we had approximately $3.1 million in short-term bank debt under our credit facility and $11.4 million in long-term loans outstanding. This is in comparison to December 31, 2016, when we had $3.0 million in short-term bank debt under our credit facility and $10.5 million in long-term debt outstanding.
Subject to all of the reservations regarding “forward-looking statements” set forth above, we believe that our present cash position, anticipated cash flows from operations and availability under our lines of credit should be sufficient to satisfy our current estimated cash requirements through the next twelve months. In this connection, we note that from time to time our working capital needs are partially dependent on our and/or our subsidiaries’ lines of credit.