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ARTX > SEC Filings for ARTX > Form 10-Q on 14-Nov-2012All Recent SEC Filings

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Form 10-Q for AROTECH CORP


14-Nov-2012

Quarterly Report


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.

Arotech™ is a trademark and Electric Fuel® is a registered trademark of Arotech Corporation. All company and product names mentioned may be trademarks or registered trademarks of their respective holders. Unless the context requires otherwise, all references to us refer collectively to Arotech Corporation and its subsidiaries.

We make available through our internet website free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to such reports and other filings made by us with the SEC, as soon as practicable after we electronically file such reports and filings with the SEC. Our website address is www.arotech.com. The information contained in this website is not incorporated by reference in this report.

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 batteries and charging systems for the military. We operate in two business units:

††† we develop, manufacture and market advanced high-tech multimedia and interactive digital solutions for use-of-force training and driving training of military, law enforcement, security and other personnel (our Training and Simulation Division); and

††† we manufacture and sell lithium and Zinc-Air batteries for defense and security products, Soldier Wearable Integrated Power Equipment System (SWIPES) and other military applications (our Battery and Power Systems Division).

Between 2002 and December 2011, we were also engaged in utilizing advanced engineering concepts to manufacture military and paramilitary armored vehicles, and employing sophisticated lightweight materials to produce aviation armor, through our Armor Division. In December 2011, our Board of Directors approved management's plan to sell our Armor Division in order to focus on the more profitable and growth-oriented aspects of our business.

The discontinuation and subsequent asset sale of the Armor Division resulted in a one-time, pre-tax charge during the fourth quarter of 2011 of approximately $3.9 million, reflecting an impairment of goodwill and intangibles ($1.8 million), an impairment of other long-lived assets ($1.5 million), a write-off of a joint venture investment ($269,000), and costs associated with change of control provisions and other non-statutory severance expenses ($302,000). Also, during the second quarter of 2012, we incurred additional expenses of $1.1 million related to the sale of Armor Division assets. Almost all of these charges are non-cash impacting items.

Overview of Results of Operations

Acquisitions

In the acquisition of subsidiaries, part of the purchase price is allocated to intangible assets and goodwill. Amortization of definite-lived intangible assets related to acquisition of subsidiaries is recorded based on the estimated expected life of the assets. Accordingly, for a period of time following an acquisition, we incur a non-cash charge related to amortization of definite-lived intangible assets in the amount of a fraction (based on the useful life of the definite-lived intangible assets) of the amount recorded as intangible assets. Such amortization charges continued during the first nine months of 2012. We are required to review long-lived intangible assets and goodwill for impairment at least annually or whenever events or changes in circumstances indicate that carrying amount of the assets may not be recoverable. If we determine, through the impairment review process, that the carrying amount of these assets has been impaired, we must record the impairment charge in our statement of operations.


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Financings and Issuances of Warrants

The non-cash charges that relate to our financings occurred in connection with our issuance of convertible securities with warrants, and in connection with our repricing of certain warrants and grants of new warrants. When we issue convertible securities, we record a discount for a beneficial conversion feature that is amortized ratably over the life of the debenture.

During the third quarter of 2008 and pursuant to the terms of a Securities Purchase Agreement dated August 14, 2008, we issued and sold to a group of institutional investors 10% senior convertible notes in the aggregate principal amount of $5.0 million due August 15, 2011. These notes were convertible at any time prior to August 15, 2011 at a conversion price of $2.24 per share. As part of our analysis of the convertible debt and related warrants, we reviewed and followed the guidance of FASB ASC 718-10, ASC 815-40-15, ASC 470-20-30 and ASC 105-10-05.

As part of the securities purchase agreement, we issued to the purchasers of our 10% senior convertible notes due August 15, 2011, warrants to purchase an aggregate of 558,036 shares of common stock at any time prior to August 15, 2011 at a price of $2.24 per share. As of August 15, 2011, the Notes were paid in full and all associated warrants had expired.

Restricted Shares, Restricted Stock Units and Options

In accordance with FASB ASC 505-50, we incurred, for the nine months ended September 30, 2012 and 2011, compensation expense related to restricted stock units and restricted shares of approximately $171,000 and $245,000, respectively. Our directors received their annual restricted stock grants on April 3, 2012 in accordance with the terms of the directors' stock compensation plan.

Overview of Operating Performance and Backlog for Continuing Operations

Overall, our loss from continuing operations before income tax expense for the nine months ended September 30, 2012 was $1.4 million on revenues of $57.9 million, compared to a loss of $3.1 million on revenues of $44.2 million during the nine months ended September 30, 2011. As of September 30, 2012, our overall backlog totaled $90.0 million compared to $89.1 million in the third quarter of 2011.

In our Training and Simulation Division, revenues increased from approximately $31.4 million in the first nine months of 2011 to $43.8 million in the first nine months of 2012. As of September 30, 2012, our backlog for our Training and Simulation Division totaled $78.5 million compared to $77.2 million in the third quarter of 2011.

In our Battery and Power Systems Division, revenues increased from approximately $12.8 million in the first nine months of 2011 to approximately $14.1 million in the first nine months of 2012. As of September 30, 2012, our backlog for our Battery and Power Systems Division totaled $11.5 million compared to $11.9 million in the third quarter of 2011.

The table below details the percentage of total recognized revenue by type of arrangement for the nine months ended September 30, 2012 and 2011:

                                               Nine months ended September 30,
             Type of Revenue                    2012                     2011
  Sale of products                                    97.0 %                   92.8 %
  Maintenance and support agreements                   2.8 %                    4.6 %
  Long term research and development
  contracts                                            0.2 %                    2.6 %
  Total                                              100.0 %                  100.0 %

Common Stock Repurchase Program

In February of 2009, we authorized the repurchase in the open market or in privately negotiated transactions of up to $1.0 million of our common stock. Through September 30, 2012, we repurchased 638,611 shares for a total of $869,931. The repurchase program is subject to the discretion of our management.


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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 operations 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, 2012 compared to the three months ended September 30, 2011.

Revenues. Revenues for the three months ended September 30, 2012 totaled $21.4 million, compared to $21.1 million in the comparable period in 2011, an increase of $297,000, or 1.4%. In the third quarter of 2012, revenues were $16.4 million for the Training and Simulation Division (compared to $16.7 million in the third quarter of 2011, a decrease of $240,000, or 1.4%,); and $5.0 million for the Battery and Power Systems Division (compared to $4.5 million in the third quarter of 2011, an increase of $537,000, or 12.1%, due primarily to increased sales of our SWIPES product in the U.S.).

Cost of revenues. Cost of revenues totaled $16.5 million during the third quarter of 2012, compared to $17.0 million in the third quarter of 2011, a decrease of $544,000, or 3.2%. Cost of revenues were $12.5 million for the Training and Simulation Division (compared to $13.2 million in the third quarter of 2011, a decrease of $760,000, or 5.7%, due primarily to an improvement in margins in the division); and $4.0 million for the Battery and Power Systems Division (compared to $3.8 million in the third quarter of 2011, an increase of $216,000, or 5.7%, due primarily to an increase in revenue).

Research and development expenses. Research and development expenses for the third quarter of 2012 were $610,000, compared to $436,000 during the third quarter of 2011, an increase of $174,000, or 40.0%, due primarily to increased spending in the Battery and Power Systems Division for continuing research on the SWIPES system, offset by a slight reduction of expenses in the Training and Simulation Division.

Selling and marketing expenses. Selling and marketing expenses for the third quarter of 2012 were $1.3 million, compared to $1.3 million in the third quarter of 2011, an increase of $3,000, or 0.3%.

General and administrative expenses. General and administrative expenses for the third quarter of 2012 were $2.1 million, compared to $2.8 million in the third quarter of 2011, a decrease of $716,000, or 25.8%, due primarily to a reduction of $270,000 in corporate consulting and legal expenses related to transactional activities along with a reduction of $159,000, in compensation and incentive accruals compared to 2011. We have continued with our initiative to reduce general and administrative expense in all categories.


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Amortization of intangible assets. Amortization of intangible assets totaled $292,000 in the third quarter of 2012, compared to $478,000 in the third quarter of 2011, a decrease of $185,000, or 38.8%, due primarily to decreased charges for fully amortized capitalized software in our Training and Simulation Division.

Financial income (expense), net. Financial expense totaled $186,000 in the third quarter of 2012, compared to financial expense of $153,000 in the third quarter of 2011, an increase of $34,000, due primarily to exchange rate differences of $(258,000), offset by an increase in corporate bank charges of $55,000 and by $237,000 decrease in charges related to expenses recorded in 2011 for warrants.

Income taxes. We recorded $127,000 in tax expense in the third quarter of 2012, compared to a total of less than $1,000 in tax expense in the third quarter of 2011 due to a 2011 adjustment to the tax liability in Israel, an increase of $127,000, mainly concerning "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). This amount includes the required adjustment of taxes due to the deduction of goodwill "naked" credits for U.S. federal taxes, which totaled $150,000 and $137,000, respectively, in non-cash expenses in the third quarter of 2012 and 2011.

Net income. Due to the factors cited above, we went from a net loss of $977,000 in the third quarter of 2011 to a net income of $433,000 in the third quarter of 2012, an improvement of $1.4 million.

Discontinued operations. As noted above, we have discontinued our Armor Division, which generated net profit of $65,000 in the third quarter of 2012 due to adjustments of accruals relating to the closure of the Division.

Nine months ended September 30, 2012 compared to the nine months ended September 30, 2011.

Revenues. Revenues for the nine months ended September 30, 2012 totaled $57.9 million, compared to $44.2 million in the comparable period in 2011, an increase of $13.7 million, or 31.1%. In the first nine months of 2012, revenues were $43.8 million for the Training and Simulation Division (compared to $31.4 million in the first nine months of 2011, an increase of $12.5 million, or 39.7%, due primarily to a major new contract (VCTS)); and $14.1 million for the Battery and Power Systems Division (compared to $12.8 million in the first nine months of 2011, an increase of $1.3 million, or 10.1%, due primarily to increased sales in the U.S. of the SWIPES system).

Cost of revenues. Cost of revenues totaled $45.3 million during the first nine months of 2012, compared to $33.0 million in the first nine months of 2011, an increase of $12.3 million, or 37.1%, due primarily to increased revenue and the higher costs associated with the new VCTS contract. Cost of revenues were $33.6 million for the Training and Simulation Division (compared to $21.6 million in the first nine months of 2011, an increase of $12.0 million, or 55.6%, due primarily to an increase in revenue and the higher costs associated with the new VCTS contract); and $11.7 million for the Battery and Power Systems Division (compared to $11.4 million in the first nine months of 2011, an increase of $259,000, or 2.3%, due primarily to increased sales in the U.S. of the SWIPES system).

Research and development expenses. Research and development expenses for the first nine months of 2012 were $1.7 million, compared to $1.3 million during the first nine months of 2011, an increase of $366,000, or 28.4%, due primarily to increased spending in the Battery and Power Systems Division for continuing research on the SWIPES system, offset by a reduction of expenses in the Training and Simulation Division due to the capitalization of $160,000 in software development costs.

Selling and marketing expenses. Selling and marketing expenses for the first nine months of 2012 were $3.9 million, compared to $3.7 million in the first nine months of 2011, an increase of $214,000, or 5.9%, due primarily to an increase in the sales force and increases in the demonstration of new products to the military in the Battery and Power Systems Division.

General and administrative expenses. General and administrative expenses for the first nine months of 2012 were $7.1 million, compared to $7.7 million in the first nine months of 2011, a decrease of $679,000, or 8.8%, due primarily to reductions in corporate and division compensation of $541,000 and a $217,000 reduction in corporate compensation and incentive accruals compared to 2011.

Amortization of intangible assets. Amortization of intangible assets totaled $894,000 in the first nine months of 2012, compared to $1.4 million in the first nine months of 2011, a decrease of $539,000, or 37.6%, due primarily to decreased charges for fully amortized capitalized software in our Training and Simulation Division.


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Financial income (expense), net. Financial expense totaled $565,000 in the first nine months of 2012, compared to financial expense of $163,000 in the first nine months of 2011, an increase of $402,000, due primarily to an increase in corporate interest and bank charges of $275,000 along with a $139,000 decrease in credits recorded in 2011 for warrants.

Income taxes. We recorded $524,000 in tax expense in the first nine months of 2012, compared to $281,000 in tax expense in the first nine months of 2011, an increase of $243,000, or 86.3%, mainly concerning state and local taxes along with "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). This amount includes the required adjustment of taxes due to the deduction of goodwill "naked" credits for U.S. federal taxes, which totaled $449,000 and $363,000, respectively, in non-cash expenses in the first nine months of 2012 and 2011.

Net loss. Due to the factors cited above, we improved to a net loss of $2.0 million in the first nine months of 2012 from a net loss of $3.4 million in the first nine months of 2011.

Discontinued operations. As noted above, we have discontinued our Armor Division, which generated a net loss of $1.5 million in the first nine months of 2012. During the second quarter of 2012, we had incurred additional expenses of $1.1 million related to the sale of the Armor Division. Almost all of these charges are non-cash impacting items.

Liquidity and Capital Resources

As of September 30, 2012, we had $758,000 in cash and $94,000 in restricted collateral deposits, as compared to December 31, 2011, when we had $2.3 million in cash and $1.7 million in restricted collateral deposits. We also had $289,000 in unused bank lines of credit with our main bank as of September 30, 2012, under a $10.0 million credit facility under our FAAC subsidiary, which is secured by our assets and the assets of our other subsidiaries and guaranteed by us. There was $289,000 of available credit on this line as of September 30, 2012, based on our borrowing base calculations.

Effective April 30, 2012, we and FAAC entered into an agreement with a different primary bank that has provided us with a replacement $10.0 million credit facility under our FAAC subsidiary, which is secured by our assets and the assets of our other domestic subsidiaries and guaranteed by us and our other domestic subsidiaries, at a rate of LIBOR plus 375 basis points. This credit facility expires May 2013. The new credit agreement contains certain covenants, including minimum Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA"), quarterly Maximum Increase in Net Advance to Affiliates of less than 90% of EBITDA and an annual Fixed Charge Coverage Ratio of not less than 1.1 to
1.0. For the nine months ended September 30, 2012, we met all required current covenants.

We used available funds in the nine months ended September 30, 2012 primarily for working capital and investment in fixed assets. We purchased approximately $511,000 of fixed assets during the nine months ended September 30, 2012. Our net fixed assets amounted to $4.3 million at quarter end.

Net cash used in operating activities for the nine months ended September 30, 2012 and 2011 was $5.9 million and $593,000, respectively, a net change in usage of $5.3 million. This increase in cash used was due primarily to the increased working capital funding requirements for our major projects at both the Simulation and Training Division (VCTS) and Battery and Power Systems Division (SWIPES). The timing of cash inflows and outflows has impacted our Company due to the substantial purchases of products to fulfill these contracts.

Net cash (used in)/provided by investing activities for the nine months ended September 30, 2012 and 2011 was $946,000 and $(2.2) million, a net change of $3.1 million. This difference was due primarily to the release of $1.6 million in restricted funds due to the completion of a significant contract by the Training and Simulation Division along with a reduction in property and equipment purchases.

Net cash (used in)/provided by financing activities for the nine months ended September 30, 2012 and 2011 was $3.4 million and $(1.8) million, respectively, a change of $5.2 million. The decrease in 2012 of cash used in financing activities was due primarily to changes in short term borrowing under our primary line of credit to support the timing differences associated with our major projects at the Training and Simulation Division and the Battery and Power Systems Division.

As of September 30, 2012, we had approximately $10.5 million in short-term bank debt and $1.1 million in long-term debt outstanding. This is in comparison to $6.6 million in short-term bank debt and $1.1 million in long-term debt outstanding as of December 31, 2011. Additionally, there is approximately $981,000 in long-term debt outstanding in the discontinued Armor Division for the mortgage on the building that was retained by Arotech.

Subject to all of the reservations regarding "forward-looking statements" set forth above, we believe that our present cash position, bolstered by the collection of current receivables from operations and lines of credit should be sufficient to satisfy our current estimated cash requirements through the remainder of the year. To increase our ongoing cash availability, we are meeting with our bank to discuss a credit line increase to accommodate our working capital needs through 2013 along with an extension of our credit line into 2014.


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