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ARTX > SEC Filings for ARTX > Form 10-Q on 14-Nov-2013All Recent SEC Filings

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Form 10-Q for AROTECH CORP


14-Nov-2013

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, as amended 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, including our Soldier Wearable Integrated Power Equipment System (SWIPES)™ power hubs, and other military applications (our Battery and Power Systems Division).


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Between 2002 and December 2011, we were also engaged in the production of armored vehicles and 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. We completed the sale of our Armor Division in June 2012.

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 in the first nine months of 2013. 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.

We incurred non-cash charges for amortization of intangible assets in the first nine months of 2013 and 2012 in the amount of $821,097 and $893,743, respectively.

Restricted Shares, Restricted Stock Units and Options

In accordance with FASB ASC 505-50, we incurred, for the nine months ended September 30, 2013 and 2012, compensation expense related to restricted stock units and restricted shares of approximately $394,000 and $171,000, respectively. Our directors received their annual restricted stock grants on April 3, 2013 in accordance with the terms of the directors' stock compensation plan.

Overview of Operating Performance and Backlog

Overall, our pre-tax income from continuing operations before income tax expense for the nine months ended September 30, 2013 was $3.6 million on revenues of $67.6 million, compared to a loss of $1.4 million on revenues of $57.9 million in the nine months ended September 30, 2012. As of September 30, 2013, our overall backlog totaled $74.4 million, compared to $90.0 million at the end of the third quarter of 2012.

In our Training and Simulation Division, revenues increased from approximately $43.8 million in the first nine months of 2012 to $48.1 million in the first nine months of 2013. As of September 30, 2013, our backlog for our Training and Simulation Division totaled $58.9 million, compared to $78.5 million in the third quarter of 2012.

In our Battery and Power Systems Division, revenues increased from approximately $14.1 million in the first nine months of 2012 to approximately $19.5 million in the first nine months of 2013. As of September 30, 2013, our backlog for our Battery and Power Systems Division totaled $15.5 million, compared to $11.5 million in the third quarter of 2012.

The table below details the percentage of total recognized revenue by type of arrangement for the nine months ended September 30, 2013 and 2012:

                                               Nine months ended September 30,
             Type of Revenue                    2013                     2012
  Sale of products                                    95.4 %                   97.0 %
  Maintenance and support agreements                   3.1 %                    2.8 %
  Long term research and development
  contracts                                            1.5 %                    0.2 %
  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, 2013, we repurchased 638,611 shares for a total of $869,931. The repurchase program is subject to the discretion of our management. During 2013, no activity has occurred.


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Common Stock Offering

In September 2013, we sold an aggregate of 3,428,571 shares of our common stock in a public offering for an aggregate of $6.0 million (before underwriting discounts and commissions and expenses of the offering).

In October 2013, we sold an additional 514,285 shares in this public offering for an aggregate of $900,000 (before underwriting discounts and commissions and expenses of the offering).

Casualty Loss

In September of 2013, we sustained a personal property loss at our Training and Simulation Division's leased Royal Oak, Michigan location as a result of an overnight electrical fire. We are fully operational in a temporary near-by location. All intellectual property and data were fully backed up on servers at an off-site location. We carried full replacement cost insurance and business interruption coverage. Management does not anticipate any financial losses associated with this casualty other than a minor insurance policy deductible.

Property Transfer of Discontinued Operations

In September 2013, as part of the wind-down of our discontinued operations, we transferred the ownership title and mortgage associated with the discontinued Armor Division building located in Auburn, Alabama to the Corporate continuing operations of Arotech. During the third quarter of 2013, $922,000 of debt was transferred to the Corporate Division associated with this transaction. The building is currently leased to a third party and has been listed for sale with a local real estate agent. Additionally, the carrying value of this property was written down to zero as part of the Armor Division impairment.

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 income/loss in stockholders' equity.

Results of Operations

Three months ended September 30, 2013, compared to the three months ended September 30, 2012.

Revenues. Revenues for the three months ended September 30, 2013 totaled $23.2 million, compared to $21.4 million in the third quarter of 2012, an increase of $1.8 million, or 8.2%. In the third quarter of 2013, revenues were $17.7 million for the Training and Simulation Division (compared to $16.4 million in the third quarter of 2012, an increase of $1.3 million, or 7.4%, due primarily to the Boom Operator Simulator System contract (BOSS)); and $5.5 million for the Battery and Power Systems Division (compared to $5.0 million in the third quarter of 2012, an increase of $528,000, or 10.6%, due to increased sales volume in the U.S. and Israel).

Cost of revenues. Cost of revenues totaled $16.8 million in the third quarter of 2013, compared to $16.5 million in the third quarter of 2012, an increase of $341,000, or 2.1% due primarily to increased revenues and improved margins. Cost of revenues were $12.4 million for the Training and Simulation Division (compared to $12.5 million in the third quarter of 2012, a decrease of $118,000, or 0.9%, due primarily to improved margins; and $4.4 million for the Battery and Power Systems Division (compared to $4.0 million in the third quarter of 2012, an increase of $459,000, or 11.5%, due primarily to an increase in revenue).


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Research and development expenses. Research and development expenses for the third quarter of 2013 were $808,000, compared to $610,000 in the third quarter of 2012, an increase of $198,000, or 32.4%, due primarily to increased spending related to new product development in both our Training and Simulation and Battery and Power Systems Division.

Selling and marketing expenses. Selling and marketing expenses for the third quarter of 2013 were $1.2 million, compared to $1.3 million in the third quarter of 2012, a decrease of $26,000, or 2.1%, due to a slight decrease of expenses in our Training and Simulation Division offset by a slight increase in our Battery and Power Division.

General and administrative expenses. General and administrative expenses for the third quarter of 2013 were $2.7 million, compared to $2.1 million in the third quarter of 2012, an increase of $621,000, or 30.1%, due primarily to increased expenses in our Corporate Division primarily associated with stock compensation expense and other compensation accruals, along with increases in staffing and other expenses in the Battery and Power Systems Division to facilitate the significant growth in this division.

Amortization of intangible assets. Amortization of intangible assets totaled $271,000 in the third quarter of 2013, compared to $292,000 in the third quarter of 2012, a decrease of $21,000, or 7.3%, due primarily to decreased charges for fully amortized capitalized software in our Training and Simulation Division.

Financial expense, net. Financial expense totaled $173,000 in the third quarter of 2013, compared to financial expense of $186,000 in the third quarter of 2012, a decrease of $13,000, due primarily to exchange rate differences.

Income taxes. We recorded $337,000 in tax expense in the third quarter of 2013, compared to $127,000 in tax expense in the third quarter of 2012, an increase of $210,000, or 165.5%, mainly associated with increased profits in our Training and Simulation Division. This amount includes the required adjustment of taxes due to the deduction of goodwill "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) for U.S. federal taxes, which totaled $150,000 in non-cash expenses in both the third quarter of 2013 and 2012.

Net income. Due to the factors cited above, we went from a net income of $433,000 in the third quarter of 2012 to a net income of $861,000 in the third quarter of 2013, an improvement of $428,000.

Nine months ended September 30, 2013, compared to the nine months ended September 30, 2012.

Revenues. Revenues for the nine months ended September 30, 2013 totaled $67.6 million, compared to $57.9 million in the comparable period in 2012, an increase of $9.7 million, or 16.8%. In the first nine months of 2013, revenues were $48.1 million for the Training and Simulation Division (compared to $43.8 million in the first nine months of 2012, an increase of $4.3 million, or 9.8%, due primarily to several significant new contracts); and $19.5 million for the Battery and Power Systems Division (compared to $14.1 million in the first nine months of 2012, an increase of $5.4 million, or 38.5%, due primarily to increased revenue in the U.S. of the SWIPES™ system along with increased revenues from other battery products).

Cost of revenues. Cost of revenues totaled $49.7 million in the first nine months of 2013, compared to $45.3 million in the first nine months of 2012, an increase of $4.4 million, or 9.7%, due primarily to increased revenue in both our divisions. Cost of revenues were $33.8 million for the Training and Simulation Division (compared to $33.6 million in the first nine months of 2012, an increase of $191,000, or 0.6%); and $15.9 million for the Battery and Power Systems Division (compared to $11.7 million in the first nine months of 2012, an increase of $4.2 million, or 35.7%, due primarily to increased sales of the SWIPES™ system).

Research and development expenses. Research and development expenses for the first nine months of 2013 were $1.9 million, compared to $1.6 million in the first nine months of 2012, an increase of $279,000, or 16.8%, due primarily to increased spending in both divisions for continuing research on new products.


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Selling and marketing expenses. Selling and marketing expenses for the first nine months of 2013 were $3.9 million, compared to $3.9 million in the first nine months of 2012, a decrease of $19,000, or 0.5%.

General and administrative expenses. General and administrative expenses for the first nine months of 2013 were $7.5 million, compared to $7.1 million in the first nine months of 2012, an increase of $473,000, or 6.7%, due primarily to a reduction of $751,000 in corporate consulting and legal expenses related to transactional activities offset by an increases in corporate stock compensation expense and other compensation accruals and an increase of $633,000 in expenses in our Battery and Power Systems Division, due primarily to increased staffing and other expenses to accommodate the significant growth in this division.

Amortization of intangible assets. Amortization of intangible assets totaled $821,000 in the first nine months of 2013, compared to $894,000 in the first nine months of 2012, a decrease of $73,000, or 8.1%, due primarily to decreased charges for fully amortized capitalized software in our Training and Simulation Division.

Financial expense, net. Financial expense totaled $475,000 in the first nine months of 2013, compared to financial expense of $565,000 in the first nine months of 2012, a decrease of $90,000, due primarily to exchange rate differences.

Income taxes. We recorded $766,000 in tax expense in the first nine months of 2013, compared to $524,000 in tax expense in the first nine months of 2012, an increase of $242,000, or 46.2%, mainly due to increased profits in our Training and Simulation Division. This amount includes the required adjustment of taxes due to the deduction of goodwill "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) for U.S. federal taxes, which totaled $449,000, in non-cash expenses in the first nine months of 2013 and 2012.

Net income. Due to the factors cited above, we went from a net loss of $2.0 million in the first nine months of 2012 to a net income of $2.8 million in the first nine months of 2013, an improvement of $4.8 million.

Liquidity and Capital Resources

As of September 30, 2013, we had $4.9 million in cash and $528,000 in restricted collateral deposits, as compared to December 31, 2012, when we had $1.6 million in cash and $186,000 in restricted collateral deposits. We have experienced fluctuations in available cash in the previous twelve months due to the funding requirements of our larger contracts. These fluctuations have not had a significant impact on our operations, due in part to the increase in our credit facility that was negotiated with our primary bank in 2013. We ended the quarter with $9.1 million in available, unused bank lines of credit with our main bank as of September 30, 2013, under a $15.0 million credit facility under our FAAC subsidiary, described below.

We and FAAC maintain a $15.0 million credit facility with FAAC's primary bank, which is secured by Arotech's assets and the assets of our other domestic subsidiaries and guaranteed by Arotech and our other domestic subsidiaries, at a rate of LIBOR plus 375 basis points and an unused line of credit fee of 0.35%. This credit facility expires May 31, 2015. The 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. At the end of the first nine months of 2013 and as of the filing date of this report, we met all required current covenants.

In September 2013, we sold an aggregate of 3,428,571 shares of our common stock in a public offering for an aggregate of $6.0 million (before underwriting discounts and commissions and expenses of the offering). After the close of the quarter, we sold an additional 514,285 shares in this public offering for an aggregate of $900,000 (before underwriting discounts and commissions and expenses of the offering) upon exercise by the underwriter of its overallotment option.

We used available funds in the nine months ended September 30, 2013 primarily for working capital, investment in fixed assets and repayment of short term debt. We purchased approximately $1.3 million of fixed assets in the nine months ended September 30, 2013. Our net fixed assets amounted to $4.9 million at September 30, 2013.


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Net cash provided by operating activities for the nine months ended September 30, 2013 was $6.1 million and net cash used in operating activities for the nine months ended September 30, 2012 was $5.9 million, a change of $12.0 million. This difference was due primarily to the profit from continuing operations along with changes in working capital. The timing of cash inflows and outflows has impacted us due to the substantial purchases of products to fulfill the contracts in the Simulation and Training Division and Battery and Power Systems Division.

Net cash used in investing activities for the nine months ended September 30, 2013 was $1.6 million and net cash provided by investing activities for the nine months ended September 30, 2012 was $946,000, a change of $2.5 million. This difference was due primarily to the purchase of capital equipment and changes in restricted collateral deposits.

Net cash used in financing activities for the nine months ended September 30, 2013 was $1.5 million and cash provided by financing activities was $3.4 million, in 2012, a change of $4.9 million. The change in 2013 of cash used in financing activities was due primarily to receipt of a net $5.4 million from a public offering that we conducted in September 2013, offset by a change in short term bank credit of $9.9 million.

As of September 30, 2013, we had approximately $3.7 million in short-term bank debt and $2.0 million in long-term debt outstanding. This is in comparison to $9.8 million in short-term bank debt and $1.9 million in long-term debt outstanding as of December 31, 2012. During the 3rd quarter of 2013, $922,000 of debt was transferred to the Corporate Division associated with the building in Auburn, Alabama that was previously held by the discontinued Armor Division.

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 lines of credit should be sufficient to satisfy our current estimated cash requirements through the next twelve months.

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