10-Q 1 arotech-063019x10q.htm 10-Q Document
OMB APPROVAL
OMB Number:                      3235-0070
Expires:                  October 31, 2021
Estimated average burden
hours per response                       190.42
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED June 30, 2019.
Commission file number: 0-23336
AROTECH CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
 
95-4302784
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
1229 Oak Valley Drive, Ann Arbor, Michigan
 
48108
(Address of principal executive offices)
 
(Zip Code)
800 281-0356
(Registrant’s telephone number, including area code)
______________________________________________________________________________________
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.01 par value
ARTX
The Nasdaq Stock Market LLC
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨
Indicate by check mark whether the registrant is large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” accelerated filer” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer: ¨
Accelerated filer: x
Non-accelerated filer: ¨
(Do not check if a smaller reporting company)
Smaller reporting company: x
Emerging growth company: ¨
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨   No x
The number of shares outstanding of the issuer’s common stock as of August 6, 2019 was 26,665,240.
SEC 1296 (05-19)
Potential persons who are to respond to the collection of information contained in this form are not
required to respond unless the form displays a currently valid OMB control number.



TABLE OF CONTENTS
Item
 
Page
PART I - FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART II - OTHER INFORMATION
 
 
 
 
 
 
 




PART I
ITEM 1.    FINANCIAL STATEMENTS (UNAUDITED)
AROTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(U.S. Dollars)
 
June 30, 2019
 
December 31, 2018
 
(Unaudited)
 
 
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
3,732,159

 
$
4,222,246

Restricted collateral deposits
154,058

 
222,712

Trade receivables, net
15,572,079

 
16,259,809

Contract assets
25,442,771

 
17,867,896

Other accounts receivable and prepaid expenses
3,628,432

 
5,989,263

Inventories, net
9,236,969

 
9,912,748

Total current assets
57,766,468

 
54,474,674

LONG TERM ASSETS:
 
 
 
Contractual and Israeli statutory severance pay fund
3,727,353

 
3,427,705

Other long term receivables
539,073

 
543,205

Property and equipment, net
9,398,550

 
8,914,247

Right of use asset
5,879,845

 

Other intangible assets, net
4,857,478

 
4,465,778

Goodwill
46,138,036

 
46,138,036

Total long term assets
70,540,335

 
63,488,971

Total assets
$
128,306,803

 
$
117,963,645

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Trade payables
$
7,303,070

 
$
6,442,919

Other accounts payable and accrued expenses
5,115,437

 
6,498,045

Current portion of lease obligations
634,005

 

Current portion of long term debt
2,397,206

 
2,204,653

Short term bank credit
12,052,008

 
5,500,416

Contract liabilities
6,430,106

 
7,054,779

Total current liabilities
33,931,832

 
27,700,812

LONG TERM LIABILITIES:
 
 
 
Contractual and accrued Israeli statutory severance pay
4,509,731

 
4,125,675

Long term portion of lease obligations
5,551,511

 

Long term portion of debt
5,273,595

 
6,360,569

Deferred income tax liability
3,078,859

 
2,863,098

Other long term liabilities
43,817

 
137,774

Total long-term liabilities
18,457,513

 
13,487,116

Total liabilities
52,389,345

 
41,187,928

STOCKHOLDERS’ EQUITY:
 
 
 
Share capital –
 
 
 
Common stock – $0.01 par value each;
Authorized: 50,000,000 shares as of June 30, 2019 and December 31, 2018;
Issued and outstanding: 26,665,240 shares and 26,486,152 shares as of
June 30, 2019 and December 31, 2018, respectively
266,653

 
264,862

Preferred shares – $0.01 par value each;
Authorized: 1,000,000 shares as of June 30, 2019 and December 31, 2018;
No shares issued or outstanding as of June 30, 2019 and December 31, 2018

 

Additional paid-in capital
251,638,418

 
251,551,001

Accumulated deficit
(177,512,794
)
 
(176,498,057
)
Notes receivable from stockholders
(908,054
)
 
(908,054
)
Accumulated other comprehensive income
2,433,235

 
2,365,965

Total stockholders’ equity
75,917,458

 
76,775,717

Total liabilities and stockholders’ equity
$
128,306,803

 
$
117,963,645

The accompanying notes are an integral part of the Interim Condensed Consolidated Financial Statements.

3


AROTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
(U.S. Dollars, except share data)
 
Six months ended June 30,
 
Three months ended June 30,
 
2019
 
2018
 
2019
 
2018
Revenues
$
44,045,203

 
$
49,123,118

 
$
23,266,564

 
$
21,874,609

 
 
 
 
 
 
 
 
Cost of revenues
30,587,522

 
34,812,163

 
15,628,411

 
15,275,082

Research and development expenses
2,095,922

 
1,764,995

 
1,021,858

 
728,293

Selling and marketing expenses
4,343,461

 
3,809,461

 
2,190,904

 
1,931,388

General and administrative expenses
6,385,960

 
6,211,813

 
3,215,569

 
2,985,879

Amortization of intangible assets
650,865

 
906,742

 
280,662

 
391,831

Total operating costs and expenses
$
44,063,730

 
$
47,505,174

 
$
22,337,404

 
$
21,312,473

 
 
 
 
 
 
 
 
Operating income (loss)
(18,527
)
 
1,617,944

 
929,160

 
562,136

 
 
 
 
 
 
 
 
Other income (expense), net
(9,091
)
 
7,399

 
(9,077
)
 
7,396

Financial expense, net
(669,857
)
 
(522,887
)
 
(371,426
)
 
(309,779
)
Total other expense
(678,948
)
 
(515,488
)
 
(380,503
)
 
(302,383
)
Income (loss) before income tax expense
(697,475
)
 
1,102,456

 
548,657

 
259,753

 
 
 
 
 
 
 


Income tax expense
317,262

 
423,385

 
156,381

 
176,271

Net income (loss)
(1,014,737
)
 
679,071

 
392,276

 
83,482

 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of income tax:
 
 
 
 
 
 
 
Foreign currency translation adjustment
67,270

 
(79,262
)
 
24,378

 
(55,002
)
Comprehensive income (loss)
$
(947,467
)
 
$
599,809

 
$
416,654

 
$
28,480

 
 
 
 
 
 
 
 
Income (loss) per share of common stock:
 
 
 
 
 
 
 
Basic net income (loss) per share
$
(0.04
)
 
$
0.03

 
$
0.01

 
$
0.00

Diluted net income (loss) per share
$
(0.04
)
 
$
0.03

 
$
0.01

 
$
0.00

Weighted average number of shares used in computing basic net income (loss) per share
26,522,553

 
26,457,133

 
26,551,466

 
26,432,094

Weighted average number of shares used in computing diluted net income (loss) per share
26,522,553

 
26,457,133

 
26,551,466

 
26,432,094

The accompanying notes are an integral part of the Interim Condensed Consolidated Financial Statements.
                                                                                                

4


AROTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(U.S. Dollars)
 
Six months ended June 30,
 
2019
 
2018
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income (loss)
$
(1,014,737
)
 
$
679,071

Adjustments required to reconcile net income (loss) to net cash (used in) provided by operating activities:
 
 
 
Depreciation
1,011,904

 
960,557

Amortization of intangible assets
650,865

 
906,742

Stock based compensation
202,129

 
190,269

Deferred tax provision
215,761

 
361,834

Changes in operating assets and liabilities:
 
 
 
Trade receivables
687,730

 
4,840,684

Contract assets
(7,574,875
)
 
(384,226
)
Other accounts receivable and prepaid expenses
2,670,634

 
(250,515
)
Inventories
676,863

 
(1,157,602
)
Severance pay, net
110,288

 
(26,425
)
Trade payables
860,165

 
(719,743
)
Other accounts payable and accrued expenses
(1,466,402
)
 
(2,022,522
)
Contract liabilities
(624,673
)
 
270,362

Net cash (used in) provided by operating activities
$
(3,594,348
)
 
$
3,648,486

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of property and equipment
$
(1,496,207
)
 
$
(652,156
)
Additions to capitalized software
(1,042,565
)
 
(244,324
)
Net cash used in investing activities
$
(2,538,772
)
 
$
(896,480
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from long term debt
220,264

 

Repayment of long term debt
(1,114,685
)
 
(1,129,505
)
Other financing activities
(118,649
)
 
(54,155
)
Change in short term bank credit
6,551,592

 
478,936

Net cash provided by (used in) financing activities
$
5,538,522

 
$
(704,724
)
(DECREASE) INCREASE IN CASH, RESTRICTED CASH, AND CASH EQUIVALENTS
$
(594,598
)
 
$
2,047,282

CASH DIFFERENCES DUE TO EXCHANGE RATE DIFFERENCES
$
35,857

 
$
132,419

CASH, RESTRICTED CASH AND CASH EQUIVALENTS AT THE BEGINNING OF THE PERIOD
$
4,444,958

 
$
5,488,754

CASH, RESTRICTED CASH AND CASH EQUIVALENTS AT THE END OF THE PERIOD
$
3,886,217

 
$
7,668,455

The accompanying notes are an integral part of the Interim Condensed Consolidated Financial Statements.


5


AROTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)
(U.S. Dollars)
 
Common stock
 
Additional
paid-in capital
 
Accumulated deficit
 
Notes
receivable
from stockholders
 
Accumulated
other
comprehensive income
 
Total
stockholders’ equity
 
Shares
 
Amount
 
 
 
 
 
Balance as of January 1, 2019
26,486,152

 
$
264,862

 
$
251,551,001

 
$
(176,498,057
)
 
$
(908,054
)
 
$
2,365,965

 
$
76,775,717

Stock based compensation

 

 
202,129

 

 

 

 
202,129

Restricted stock issued
71,780

 
718

 
(718
)
 

 

 

 

Restricted stock units vested, net of taxes
112,775

 
1,128

 
(114,049
)
 

 

 

 
(112,921
)
Restricted stock forfeitures
(5,467
)
 
(55
)
 
55

 

 

 

 

Foreign currency translation adjustment

 

 

 

 

 
67,270

 
67,270

Net Loss

 

 

 
(1,014,737
)
 

 

 
(1,014,737
)
Balance as of June 30, 2019
26,665,240

 
$
266,653

 
$
251,638,418

 
$
(177,512,794
)
 
$
(908,054
)
 
$
2,433,235

 
$
75,917,458

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of April 1, 2019
26,617,460

 
$
266,175

 
$
251,572,736

 
$
(177,905,070
)
 
$
(908,054
)
 
$
2,408,857

 
$
75,434,644

Stock based compensation

 

 
66,160

 

 

 

 
66,160

Restricted stock issued
47,780

 
478

 
(478
)
 

 

 

 

Restricted stock units vested, net of taxes

 

 

 

 

 

 

Restricted stock forfeitures

 

 

 

 

 

 

Foreign currency translation adjustment

 

 

 

 

 
24,378

 
24,378

Net Income

 

 

 
392,276

 

 

 
392,276

Balance as of June 30, 2019
26,665,240

 
$
266,653

 
$
251,638,418

 
$
(177,512,794
)
 
$
(908,054
)
 
$
2,433,235

 
$
75,917,458

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of January 1, 2018
26,395,048

 
$
263,951

 
$
250,826,873

 
$
(181,568,757
)
 
$
(908,054
)
 
$
2,479,205

 
$
71,093,218

Stock based compensation
 
 
 
 
190,269

 
 
 
 
 
 
 
190,269

Restricted stock issued
86,900

 
869

 
(869
)
 
 
 
 
 
 
 

Restricted stock units vested, net of taxes
50,247

 
502

 
(54,657
)
 
 
 
 
 
 
 
(54,155
)
Restricted stock forfeitures
(46,043
)
 
(460
)
 
460

 
 
 
 
 
 
 

Foreign currency translation adjustment
 
 
 
 
 
 
 
 
 
 
(79,262
)
 
(79,262
)
Net Income
 
 
 
 
 
 
679,071

 
 
 
 
 
679,071

Balance as of June 30, 2018
26,486,152

 
$
264,862

 
$
250,962,076

 
$
(180,889,686
)
 
$
(908,054
)
 
$
2,399,943

 
$
71,829,141

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of April 1, 2018
26,452,462

 
$
264,525

 
$
250,880,639

 
$
(180,973,168
)
 
$
(908,054
)
 
$
2,454,945

 
$
71,718,887

Stock based compensation
 
 
 
 
81,774

 
 
 
 
 
 
 
81,774

Restricted stock issued
45,900

 
459

 
(459
)
 
 
 
 
 
 
 

Restricted stock units vested, net of taxes
500

 
5

 
(5
)
 
 
 
 
 
 
 

Restricted stock forfeitures
(12,710
)
 
(127
)
 
127

 
 
 
 
 
 
 

Foreign currency translation adjustment
 
 
 
 
 
 
 
 
 
 
(55,002
)
 
(55,002
)
Net Income
 
 
 
 
 
 
83,482

 
 
 
 
 
83,482

Balance as of June 30, 2018
26,486,152

 
$
264,862

 
$
250,962,076

 
$
(180,889,686
)
 
$
(908,054
)
 
$
2,399,943

 
$
71,829,141

The accompanying notes are an integral part of the consolidated financial statements.

6


NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1:    BASIS OF PRESENTATION
a.    Company:
Arotech Corporation (“Arotech”) and its wholly-owned subsidiaries (the “Company”) provide defense and security products for the military, law enforcement, emergency services and homeland security markets, including multimedia interactive simulators/trainers, and lithium batteries and chargers. 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) and in Dimona, Israel (in Israel’s Negev desert area) (Power Systems Division); UEC Electronics, LLC (“UEC”), a South Carolina limited liability company located in Hanahan, South Carolina (Power Systems Division).
b.    Basis of Presentation:
The Company prepared the accompanying unaudited condensed consolidated financial statements of Arotech Corporation and all wholly-owned, majority owned or otherwise controlled subsidiaries on the same basis as its annual audited financial statements. The Company condensed or omitted certain information and footnote disclosures normally included in its annual audited financial statements, which it prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP), 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. The Company’s quarterly financial statements should be read in conjunction with its Annual Report on Form 10-K for the year ended December 31, 2018. 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 June 30, 2019, its operating results for the three and six months ended June 30, 2019 and 2018, its cash flows for the six months ended June 30, 2019 and 2018, and its statement of stockholders’ equity for the three and six months ended June 30, 2019 and 2018.
The results of operations for the three and six months ended June 30, 2019 are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year ending December 31, 2019.
The condensed consolidated balance sheet at December 31, 2018 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, 2018.
c.    Reclassification:
From time to time the Company may reclassify amounts from prior periods to conform to the current year’s presentation.
d.    Commitments and contingencies:
The Company is involved in litigation from time to time in the regular course of its business. There are no material legal proceedings pending or known by the Company to be contemplated to which the Company is a party or to which any of its property is subject.  In addition, the Company believes that adequate provisions for resolution of all contingencies have been made for probable losses that are reasonably estimable. These contingencies are subject to uncertainties, and, as a result, the Company is unable to estimate the amount or range of loss, if any, in excess of amounts accrued. The Company does not believe that these contingencies will have a material adverse effect on the Company’s balance sheets, statements of operations and comprehensive income or statements of cash flows for the three and six months ended June 30, 2019
e.    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 October 1, 2018, 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.
f.    Government Termination for Convenience:
On October 3, 2018, the Company’s U.S. Power Systems Division subsidiary was informed by its customer, SAIC, that the United States Marine Corps (“USMC”) had discontinued its efforts to upgrade the Assault Amphibious Vehicle (“AAV”) fleet that was undergoing survivability and electrical upgrades under a prime contract with Science Applications International Corporation (“SAIC”). As a result

7


of this termination for the USMC’s convenience, the Company presented its costs related to this program for reimbursement by SAIC and the USMC in December 2018. The amounts of and time frame for resolution have not yet been determined.

In July 2019, we received a $2.0 million partial payment towards the AAV program costs.

g.    New accounting pronouncements:
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The new standard, effective January 1, 2019, requires virtually all leases to be recognized on the Consolidated Balance Sheets. Effective January 1, 2019, the Company adopted the standard using the modified retrospective method, under which it elected the package of practical expedients and transition provisions allowing it to bring its existing operating leases onto the Condensed Consolidated Balance Sheet without adjusting comparative periods.
The Company has operating leases for facilities and equipment, which are recorded as assets and liabilities for those leases with terms greater than 12 months. Lease-related assets, or right-of-use assets (“ROU”), are recognized at the lease commencement date at amounts equal to the respective lease liabilities, adjusted for prepaid lease payments, initial direct costs, and lease incentives received. Lease-related liabilities are recognized at the present value of the remaining contractual fixed lease payments, discounted using our incremental borrowing rate. Operating lease expense is recognized on a straight-line basis over the lease term, while variable lease payments are expensed as incurred.
Upon adoption of the standard, the Company recorded approximately $6.3 million of ROU assets and $6.5 million of current and long term lease obligations in its Condensed Consolidated Balance Sheet. Refer to Note 2 “Significant Accounting Policy Update” for additional information.
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 early adopted this standard and it did not have an impact on its consolidated financial statements.
In February 2018, the FASB issued ASU No. 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220), Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (“AOCI”). The accounting standard allows for the optional reclassification of stranded tax effects within accumulated other comprehensive income to retained earnings that arise due to the enactment of the Tax Cuts and Jobs Act of 2017 (the “Tax Act”). The amount of the reclassification would reflect the effect of the change in the U.S. federal corporate income tax rate on the gross deferred tax amounts and related valuation allowances, if any, at the date of enactment of the Tax Act and other income tax effects of the Tax Act on items remaining in accumulated other comprehensive income. The Company adopted the requirements of the new standard in the first quarter of 2019, as required by the new standard. The adoption of this ASU did not have a material impact on the consolidated financial statements.
In August 2018, the SEC issued Release No. 33-10532 that amends and clarifies certain financial reporting requirements. The principal change to the Company’s financial reporting is the inclusion of the annual disclosure requirement of changes in stockholders’ equity in Rule 3-04 of Regulation S-X to interim periods.
NOTE 2:    SIGNIFICANT ACCOUNTING POLICIES UPDATE
The Company’s significant accounting policies are detailed in “Note 2:  Significant Accounting Policies” of its Form 10-K for the year ended December 31, 2018.  Significant changes to the Company’s accounting policies as a result of adopting Accounting Standards Codification (“ASC”) 842 are discussed below:
Leases:
The Company determines if an arrangement is a lease at inception. Leases with an initial term of 12 months or less are not recorded in the Condensed Consolidated Balance Sheets and the Company recognizes lease expense for these leases on a straight line basis over the lease term. Operating leases are included in operating lease ROU asset, current portion of lease obligations and long term portion of lease obligations on its Condensed Consolidated Balance Sheet. Finance leases are included in property and equipment, other current liabilities, and other long-term liabilities on its Condensed Consolidated Balance Sheet. As of June 30, 2019, the Company does not have any non-cancelable operating lease commitments that have not yet commenced.
Operating lease ROU assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. If a lease does not implicitly state a rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. The operating lease ROU asset also includes any lease payments made in advance, any initial direct costs incurred and excludes any lease incentives. The lease terms may include options to extend or terminate the lease when it is reasonably assured that the Company will exercise that option. Lease expense for minimum lease payments are recognized on a straight-line basis over the lease term.
The Company has lease agreements with lease and non-lease components, which are generally accounted for separately.

8


The Company has operating leases for its production and office facilities and certain office equipment. These leases have remaining lease terms of 2 years to 15 years, some of which include options to extend for up to 5 years. These options have been included in the Company’s calculation of the ROU asset and lease liability based upon the Company’s assessment of whether the option will be exercised.
The Company’s lease agreements do not contain any residual value guarantees or material restrictive covenants.
The Company rents or subleases certain real estate to third parties. The Company’s sublease portfolio consists of an operating lease within one of its facilities, resulting in approximately $25,000 and $52,000 of sublease income for the three and six months ended June 30, 2019.
The components of lease expense were as follows:
 
 
Six months ended June 30,
 
Three months ended June 30,
 
 
2019
 
2019
Operating lease cost
 
$
560,492

 
$
280,246

 
 
 
 
 
Finance lease cost:
 
 
 
 
Amortization of right-of-use assets
 
$
6,332

 
$
3,166

Interest on lease liabilities
 
1,604

 
876

Total finance lease costs
 
$
7,936

 
$
4,042

 
 
 
 
 
Right-of-use assets obtained in exchange for lease obligations:
 
 
 
 
Operating leases
 
$
2,785,444

 
$

Finance leases
 
31,386

 

Supplemental balance sheet information related to leases was as follows:
 
 
June 30, 2019
Operating Leases:
 
 
Right of use asset
 
$
5,879,845

 
 
 
Current portion of lease obligations
 
634,005

Long term portion of lease obligations
 
5,551,511

Total operating lease obligations
 
6,185,516

 
 
 
Financing Leases:
 
 
Property and Equipment, at cost
 
56,933

Accumulated depreciation
 
(6,332
)
Property and Equipment, net
 
50,601

 
 
 
Other accounts payable and accrued expenses
 
11,638

Other long term liabilities
 
37,546

Total financing lease liabilities
 
$
49,184

 
 
 
Weighted Average Remaining Lease Term
 
 
Operating leases
 
11 years

Finance leases
 
4 years

 
 
 
Weighted Average Discount Rate
 
 
Operating leases
 
7.47
%
Finance leases
 
6.86
%

9


Supplemental Cash Flows information related to leases was as follows:
 
 
Six months ended June 30,
 
 
2019
Supplemental Cash Flows Information
 
 
Cash paid for amounts included in the measurement of lease liabilities:
 
 
Operating cash flows from operating leases
 
$
378,086

Operating cash flows from finance leases
 
1,604

Financing cash flows from finance leases
 
5,728

The undiscounted annual future minimum lease payments are summarized by year in the table below:
Year Ending December 31,
 
Operating Leases
 
Finance Leases
2019 (excluding the six months ended June 30, 2019)
 
$
551,123

 
$
7,332

2020
 
1,106,961

 
14,664

2021
 
891,447

 
14,664

2022
 
805,503

 
12,276

2023
 
697,277

 
7,500

Thereafter
 
5,555,115

 

Total future minimum lease payments
 
9,607,426

 
56,436

Less imputed interest
 
(3,421,910
)
 
(7,252
)
Total:
 
$
6,185,516

 
$
49,184

NOTE 3:    REVENUES
Revenue recognition:
The Company recognized revenues from (i) the sale and customization of interactive training systems (Training and Simulation Division); (ii) maintenance services in connection with such systems (Training and Simulation Division); (iii) the sale of batteries, chargers and adapters, and custom power solutions (Power Systems Division); and (iv) the sale of lifejacket lights (Power Systems Division).
The Company determines its revenue recognition through the following steps:
Identification of the contract, or contracts, with a customer
Identification of the performance obligations within the contract
Determination of the transaction price
Allocation of the transaction price to the performance obligations within the contract
Recognition of revenue when, or as the performance obligation has been satisfied
Performance Obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in Accounting Standards Codification (“ASC”) Topic 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. In assessing the recognition of revenue, the Company evaluates whether two or more contracts should be combined and accounted for as one contract and if the combined or single contract should be accounted for as multiple performance obligations which could change the amount of revenue and profit (loss) recorded in a period. The majority of the Company’s contracts with customers are accounted for as one performance obligation, as the majority of tasks and services is part of a single project or capability. As these contracts are typically a customized customer-specific solution, the Company uses the expected cost plus margin approach to estimate the standalone selling price of each performance obligation.  For contracts with multiple performance obligations, the Company allocates the contract’s transaction price to each performance obligation using its best estimate of the standalone selling price of each distinct good or service in the contract.
The Company also offers maintenance and support agreements (“warranties”) for many of its products.  The specific terms and conditions of those warranties vary depending upon the product sold and country in which the product was sold.  The warranty revenue is recognized on a straight-line basis over the term of the maintenance and support services.   The standalone selling price is determined based on the price charged when sold separately or upon renewal.

10


The Company’s performance obligations are satisfied over time as work progresses or at a point in time. Revenue from products and services transferred to customers over time accounted for 91% and 93% of its revenue for the six months ended June 30, 2019 and 2018, respectively. Revenue from products and services transferred to customers over time accounted for 91% and 92% of its revenue for the three months ended June 30, 2019 and 2018, respectively. Substantially all of the Company’s revenue in the Training and Simulation Division and the U.S. Power Systems Division is recognized over time. Typically, revenue is recognized over time using an input measure (e.g., costs incurred to date relative to total estimated costs at completion) to measure progress. Contract costs include labor, material, and overhead.
As of June 30, 2019, the Company had $70.3 million of expected future revenue relating to performance obligations that that are currently under contract, which it also refers to as total backlog. The Company expects to recognize approximately 58.4% of its backlog as revenue in 2019, and the remaining 41.6% thereafter.
Contract Estimates. Accounting for long-term contracts and programs involves the use of various techniques to estimate total contract revenue and costs. For long-term contracts, the Company estimates the profit on a contract as the difference between the total estimated revenue and expected costs to complete a contract and recognizes that profit over the life of the contract.
Contract estimates are based on various assumptions to project the outcome of future events that can exceed a year. These assumptions include labor productivity and availability; the complexity of the work to be performed; the cost and availability of materials; the performance of subcontractors; and the availability and timing of funding from the customer.
As a significant change in one or more of these estimates could affect the profitability of its contracts, the Company reviews and updates its contract-related estimates quarterly. The Company recognizes adjustments in estimated profit on contracts under the cumulative catch-up method. Under this method, the impact of the adjustment on profit recorded to date is recognized in the period the adjustment is identified. Revenue and profit in future periods of contract performance is recognized using the adjusted estimate. If at any time the estimate of contract profitability indicates an anticipated loss on the contract, the Company recognizes the total loss in the quarter in which it is identified.
The aggregate impact of adjustments in contract estimates to net income (loss) is presented below:
 
Six months ended June 30,
 
2019
 
2018
 
Training and Simulation Division
 
Power Systems Division
 
Training and Simulation Division
 
Power Systems Division
Net income (loss)
$
690,376

 
$
233,950

 
$
588,596

 
$
(242,866
)
 
Three months ended June 30,
 
2019
 
2018
 
Training and Simulation Division
 
Power Systems Division
 
Training and Simulation Division
 
Power Systems Division
Net income (loss)
$
544,098

 
$
264,369

 
$
517,156

 
$
(123,088
)

11



Revenue by Category. As of June 30, 2019 and 2018 the Company’s portfolio of products and services consisted of 495 and 498 active contracts, respectively.
Revenue by major product line was as follows:
 
Six months ended June 30,
 
Three months ended June 30,
 
2019
 
2018
 
2019
 
2018
Product Revenue
 
 
 
 
 
 
 
Air Warfare Simulation
$
7,106,471

 
$
9,657,370

 
$
3,607,269

 
$
4,624,711

Vehicle Simulation
14,847,871

 
10,999,632

 
7,766,930

 
5,535,633

Use-of-Force
5,397,384

 
6,545,553

 
2,940,207

 
3,285,505

Service Revenue
 
 
 
 
 
 
 
Warranty
2,007,064

 
1,707,695

 
1,054,769

 
906,537

Total Training and Simulation Division
$
29,358,790

 
$
28,910,250

 
$
15,369,175

 
$
14,352,386

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contract Manufacturing
$
6,844,198

 
$
7,030,011

 
$
3,626,206

 
$
2,865,685

Power Distribution and Generation
330,785

 
4,281,921

 
80,085

 
1,006,541

Batteries
4,533,738

 
6,649,514

 
2,151,263

 
2,503,403

Engineering Services and Other
2,977,692

 
2,251,422

 
2,039,835

 
1,146,594

Total Power Division
$
14,686,413

 
$
20,212,868

 
$
7,897,389

 
$
7,522,223

The table below details the percentage of total recognized revenue by type of arrangement for the six and three months ended June 30, 2019 and 2018:
 
Six months ended June 30,
 
Three months ended June 30,
Type of Revenue
2019
 
2018
 
2019
 
2018
Sale of products
92.3
%
 
95.3
%
 
92.5
%
 
92.2
%
Maintenance and support agreements
4.6
%
 
3.4
%
 
4.5
%
 
4.1
%
Long term research and development contracts
3.1
%
 
1.3
%
 
3.0
%
 
3.7
%
Total
100
%
 
100
%
 
100
%
 
100
%

12


Revenue by contract type was as follows:
 
Training and
Simulation
Division
 
Power Systems
Division
Six months ended June 30, 2019
 
 
 
Fixed Price
$
23,554,301

 
$
13,890,756

Cost Reimbursement (Cost Plus)
2,777,113

 
433,581

Time and Materials
3,027,376

 
362,076

Total
$
29,358,790

 
$
14,686,413

Six months ended June 30, 2018
 
 
 
Fixed Price
$
24,026,993

 
$
18,434,482

Cost Reimbursement (Cost Plus)
2,609,275

 
1,254,891

Time and Materials
2,273,982

 
523,495

Total
$
28,910,250

 
$
20,212,868

Three months ended June 30, 2019
 
 
 
Fixed Price
$
12,583,199

 
$
7,721,099

Cost Reimbursement (Cost Plus)
1,427,768

 
2,531

Time and Materials
1,358,208

 
173,759

Total
$
15,369,175

 
$
7,897,389

Three months ended June 30, 2018
 
 
 
Fixed Price
$
11,817,023

 
$
6,362,314

Cost Reimbursement (Cost Plus)
1,270,325

 
866,142

Time and Materials
1,265,038

 
293,767

Total
$
14,352,386

 
$
7,522,223

Each of these contract types presents advantages and disadvantages. Typically, the Company assumes more risk with fixed-price contracts. However, these types of contracts offer additional profits when the Company completes the work for less than originally estimated. Cost-reimbursement contracts generally subject the Company to lower risk. Accordingly, the associated base fees are usually lower than fees earned on fixed-price contracts. Under time and materials contracts, the Company’s profit may fluctuate if actual labor-hour costs vary significantly from the negotiated rates.

13


Revenue by customer was as follows:
 
Training and
Simulation
Division
 
Power Systems
Division
Six months ended June 30, 2019
 
 
 
U.S. Government
 
 
 
Department of Defense (DoD)
$
9,614,371

 
$
479,994

Non-DoD
6,388,309

 

Foreign Military Sales (FMS)
1,580,495

 

Total U.S. Government
$
17,583,175

 
$
479,994

 
 
 
 
U.S. Commercial
$
10,008,874

 
$
6,982,356

Non-U.S. Government
467,988

 
457,974

Non-U.S. Commercial
1,298,753

 
6,766,089

Total Revenue
$
29,358,790

 
$
14,686,413

Six months ended June 30, 2018
 
 
 
U.S. Government
 
 
 
Department of Defense (DoD)
$
7,646,854

 
$
1,342,356

Non-DoD
4,382,879

 

Foreign Military Sales (FMS)
1,713,399

 

Total U.S. Government
13,743,132

 
1,342,356

 
 
 
 
U.S. Commercial
$
11,802,062

 
$
11,489,572

Non-U.S. Government
1,392,449

 
1,823,167

Non-U.S. Commercial
1,972,607

 
5,557,773

Total Revenue
$
28,910,250

 
$
20,212,868

Three months ended June 30, 2019
 
 
 
U.S. Government
 
 
 
Department of Defense (DoD)
$
4,720,568

 
$
38,961

Non-DoD
3,783,823

 

Foreign Military Sales (FMS)
938,226

 

Total U.S. Government
$
9,442,617

 
$
38,961

 
 
 
 
U.S. Commercial
$
5,237,832

 
$
3,815,135

Non-U.S. Government
226,435

 
166,009

Non-U.S. Commercial
462,291

 
3,877,284

Total Revenue
$
15,369,175

 
$
7,897,389

Three months ended June 30, 2018
 
 
 
U.S. Government
 
 
 
Department of Defense (DoD)
$
4,214,661

 
$
830,144

Non-DoD
1,644,072

 

Foreign Military Sales (FMS)
1,128,618

 

Total U.S. Government
$
6,987,351

 
$
830,144

 
 
 
 
U.S. Commercial
$
5,773,064

 
$
3,771,608

Non-U.S. Government
466,285

 
305,348

Non-U.S. Commercial
1,125,686

 
2,615,123

Total Revenue
$
14,352,386

 
$
7,522,223

Contract Balances. The timing of revenue recognition, billings and cash collections results in billed accounts receivable, unbilled receivables (contract assets), and customer advances and deposits (contract liabilities) on the Consolidated Balance Sheet. The majority of the Company’s contract amounts is billed as work progresses in accordance with agreed-upon contractual terms, either at

14


periodic intervals (e.g., biweekly or monthly) or upon achievement of contractual milestones. Billing sometimes occurs subsequent to revenue recognition, resulting in contract assets. However, the Company sometimes receives advances or deposits from its customers, particularly on its international contracts, before revenue is recognized, resulting in contract liabilities. These contract liabilities also include deferred warranty revenues from our Training and Simulation Division. These assets and liabilities are reported on the Consolidated Balance Sheet on a contract-by-contract basis at the end of each reporting period.
 
June 30, 2019
 
December 31, 2018
 
Training and Simulation Division
 
Power Systems Division
 
Total
 
Training and Simulation Division
 
Power Systems Division
 
Total
Contract Assets - Current
$
16,472,090

 
$
8,970,681

 
$
25,442,771

 
$
10,358,679

 
$
7,509,217

 
$
17,867,896

Contract Liabilities - Current
(6,188,910
)
 
(241,196
)
 
(6,430,106
)
 
(6,697,522
)
 
(357,257
)
 
(7,054,779
)
Net Contract Assets and Liabilities:
$
10,283,180

 
$
8,729,485

 
$
19,012,665

 
$
3,661,157

 
$
7,151,960

 
$
10,813,117

The $8.2 million increase in the Company’s net contract assets (liabilities) from December 31, 2018 to June 30, 2019 was due to the timing of milestone payments on certain U.S. Government and commercial contracts.
During the six months ended June 30, 2019 and 2018, the Company recognized $3.9 million and $3.8 million, respectively, in revenue related to the Company’s contract liabilities.
The Company did not record any provisions for impairment of its contract assets during the six months ended June 30, 2019 and 2018.
Trade Receivables
Trade receivables include amounts billed and currently due from customers. The amounts are recorded at net estimated realizable value.  The value of the Company’s trade receivables when appropriate includes an allowance for estimated uncollectible amounts.  The Company calculates an allowance based on its history of write-offs, the assessment of customer creditworthiness, and the age of the outstanding receivables.
As of June 30, 2019 and December 31, 2018, the Company’s trade receivables recorded in the consolidated balance sheets were $15.6 million and $16.3 million, respectively.  The Company had an immaterial provision for doubtful accounts at June 30, 2019 and December 31, 2018.  The Company believes its exposure to concentrations of credit risk is limited due to the nature of its operations, where a significant number of its contracts are typically a customized customer specific solution.
NOTE 4:    INVENTORIES
Inventories are stated at the lower of cost or net realizable value. The Company periodically evaluates the quantities on hand relative to current and historical selling prices and historical and projected sales volume and based on these evaluations, provisions are made in each period to write down inventory to its net realizable value. For the six months ended June 30, 2019 and 2018 the Company wrote off approximately $67,363 and $218,000, respectively, of obsolete inventory, which has been included in the cost of revenues.
Inventories by component are as follows:
 
June 30, 2019
 
December 31, 2018
Raw and packaging materials
$
7,654,479

 
$
7,912,883

Work in progress
1,163,272

 
1,626,960

Finished products
419,218

 
372,905

Total:
$
9,236,969

 
$
9,912,748

NOTE 5:    SEGMENT INFORMATION
The Company and its subsidiaries operate in two business segments. The two segments are also treated by the Company as reporting units for goodwill impairment evaluation purposes. The goodwill amounts associated with the Training and Simulation Division and the Power Systems Division were determined and valued when the specific businesses were purchased. The Company and its subsidiaries operate in two continuing business segments and follow the requirements of ASC 280-10.
The Company’s reportable segments have been determined in accordance with the Company’s internal management structure, which is organized based on operating activities. The accounting policies of the reportable segments are the same as those used by the Company in the preparation of its annual financial statements. The Company evaluates performance based on two primary factors, one of which is the segment’s operating income and the other of which is the segment’s contribution to the Company’s future strategic growth.

15


The following is information about reported segment revenues, income (losses) from operations, and total assets as of June 30, 2019 and 2018:
 
Training and
Simulation
Division
 
Power Systems
Division
 
Corporate
Expenses
 
Total
Company
Six months ended June 30, 2019
 
 
 
 
 
 
 
Revenues from outside customers
$
29,358,790

 
$
14,686,413

 
$

 
$
44,045,203

Depreciation and amortization(1)
(382,464
)
 
(1,280,305
)
 

 
(1,662,769
)
Direct expenses(2)
(23,897,563
)
 
(16,552,108
)
 
(1,951,290
)
 
(42,400,961
)
Segment operating income (loss)
$
5,078,763

 
$
(3,146,000
)
 
$
(1,951,290
)
 
$
(18,527
)
Total other expense
(119,373
)
 
(131,237
)
 
(428,338
)
 
(678,948
)
Income tax expense
(94,600
)
 

 
(222,662
)
 
(317,262
)
Net income (loss)
$
4,864,790

 
$
(3,277,237
)
 
$
(2,602,290
)
 
$
(1,014,737
)
Segment assets(3)(4)
$
60,569,922

 
$
63,956,333

 
$
3,780,548

 
$
128,306,803

Additions to long-lived assets
$
918,890

 
$
1,293,125

 
$
326,757

 
$
2,538,772

Six months ended June 30, 2018
 
 
 
 
 
 
 
Revenues from outside customers
$
28,910,250

 
$
20,212,868

 
$

 
$
49,123,118

Depreciation and amortization(1)
(397,140
)
 
(1,470,159
)
 

 
(1,867,299
)
Direct expenses(2)
(22,844,511
)
 
(20,928,851
)
 
(1,864,513
)
 
(45,637,875
)
Segment operating income (loss)
$
5,668,599

 
$
(2,186,142
)
 
$
(1,864,513
)
 
$
1,617,944

Total other expense
(132,145
)
 
(2,826
)
 
(380,517
)
 
(515,488
)
Income tax expense
(61,551
)
 

 
(361,834
)
 
(423,385
)
Net income (loss)
$
5,474,903

 
$
(2,188,968
)
 
$
(2,606,864
)
 
$
679,071

Segment assets(3)
$
52,169,769

 
$
58,798,604

 
$
3,404,904

 
$
114,373,277

Additions to long-lived assets
$
469,436

 
$
427,044

 
$

 
$
896,480

Three months ended June 30, 2019
 
 
 
 
 
 
 
Revenues from outside customers
$
15,369,175

 
$
7,897,389

 
$

 
$
23,266,564

Depreciation and amortization(1)
(194,634
)
 
(604,815
)
 

 
(799,449
)
Direct expenses(2)
(12,202,504
)
 
(8,290,181
)
 
(1,045,270
)
 
(21,537,955
)
Segment operating income (loss)
2,972,037

 
(997,607
)
 
(1,045,270
)
 
929,160

Total other expense
(76,366
)
 
(66,322
)
 
(237,815
)
 
(380,503
)
Income tax expense
(44,600
)
 

 
(111,781
)
 
(156,381
)
Net income (loss)
$
2,851,071

 
$
(1,063,929
)
 
$
(1,394,866
)
 
$
392,276

Three months ended June 30, 2018
 
 
 
 
 
 
 
Revenues from outside customers
$
14,352,386

 
$
7,522,223

 
$

 
$
21,874,609

Depreciation, amortization and impairment expenses(1)
(196,780
)
 
(674,117
)
 

 
(870,897
)
Direct expenses(2)
(10,966,284
)
 
(8,661,132
)
 
(814,160
)
 
(20,441,576
)
Segment operating income (loss)
$
3,189,322

 
$
(1,813,026
)
 
$
(814,160
)
 
$
562,136

Total other expense
(93,522
)
 
(12,298
)
 
(196,563
)
 
(302,383
)
Income tax expense
(41,750
)
 

 
(134,521
)
 
(176,271
)
Net income (loss)
$
3,054,050

 
$
(1,825,324
)
 
$
(1,145,244
)
 
$
83,482

(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 Division and Power Systems Division totaled $24,435,641 and $21,702,395, respectively, as of June 30, 2019 and 2018.
(4)
Out of those amounts, right-of-use assets for the Company’s Training and Simulation Division and Power Systems Division totaled $456,373 and $5,423,472, respectively, as of June 30, 2019.
NOTE 6:    FAIR VALUE MEASUREMENT
The carrying values of short term assets and liabilities in the accompanying Condensed Consolidated Balance Sheets for cash and cash equivalents, restricted collateral deposits, trade receivables, contract assets, inventories, prepaid and other assets, trade payables, accrued expenses, deferred revenues and other liabilities as of June 30, 2019 and December 31, 2018, approximate fair value because of the short

16


maturity of these instruments. The carrying amounts of long term debt approximate the estimated fair values at June 30, 2019, based upon the Company’s ability to acquire similar debt at similar maturities.
NOTE 7:    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 $6,000,000 revolving credit facility (“Revolver B”), (iii) a $10,000,000 Term Loan (“Term Loan A”), (iv) a $1,730,895 Mortgage Loan (“Term Loan B”), (v) a $1,358,000 Mortgage Loan (“Term Loan C”); collectively referred to as the “Credit Facilities.”
On July 24, 2019, we entered into a new amendment to the Credit Agreement (the “Ninth Amendment”), effective June 30, 2019. Pursuant to the terms of the Ninth Amendment, the parties have incorporated, among other changes, amended definitions of eligible unbilled accounts associated with certain long term contracts and borrowing base.
On April 22, 2019, the Company entered into a new amendment to the Credit Agreement (the “Eighth Amendment”), effective March 31, 2019. Pursuant to the terms of the Eighth Amendment, the parties have incorporated, among other changes, amended definitions of fixed charge coverage ratios and leverage ratios for specific quarters in 2019, and the Company has been given a second revolving line (“Revolver B”) in the amount of $6,000,000, reducing to $3,000,000 at the end of 2019 and due to be paid in full by February 28, 2020.
The Credit Facilities maintain certain reporting requirements, conditions precedent, affirmative covenants and financial covenants. The Company is required to maintain certain financial covenants. The Eighth Amendment to the credit facilities adjusted the financial covenant ratios for the Company’s reporting periods during fiscal year 2019. The amended Maximum Debt to EBITDA ratio of 3.75 to 1.00 for the period ended March 31, 2019, 5.50 to 1.00 for the period ended June 30, 2019, 6.25 to 1.00 for the period ended September 30, 2019, 4.00 to 1.00 for the period ended December 31, 2019 and 3.00 to 1.00 for periods ending after December 31, 2019. The amended Minimum Fixed Charge Coverage Ratio is 1.20 to 1.00 for the period ended March 31, 2019, 1.00 to 1.00 for the periods ended June 30, 2019 and September 30, 2019, and 1.20 to 1.00 for the periods ending after September 30, 2019. The Company was in compliance with its covenants at June 30, 2019.
The Credit Facilities are secured by the Company’s assets and the assets of the Company’s domestic subsidiaries.
A summary of our debt, including our debt under the Credit Agreement, is as follows:
 
 
 
 
 
June 30, 2019
 
Maturity
 
Effective Interest Rate
 
Current
 
Long Term
Debt:
 
 
 
 
 
 
 
Revolver
March 11, 2021
 
6.25%
 
$
9,052,008

 
$

Revolver B
February 28, 2020
 
6.00%
 
3,000,000

 

Term Loan A
March 11, 2021
 
6.50%
 
2,166,667

 
2,489,625

Term Loan B & C
June 1, 2024
 
6.50%
 
154,464

 
2,612,631

Other Debt (1)
 
 
 
 
76,075

 
171,339

Total Debt
 
 
 
 
$
14,449,214

 
$
5,273,595

(1)
Other Debt includes various debt instruments that have maturities that range from July 22, 2019 to March 20, 2024 with varying interest rates between 2.75% and 3.6%.
 
 
 
 
 
December 31, 2018
 
Maturity
 
Effective Interest Rate
 
Current
 
Long Term
Debt:
 
 
 
 
 
 
 
Revolver
March 11, 2021
 
5.50%
 
$
5,500,416

 
$

Term Loan A
March 11, 2021
 
5.75%
 
2,000,000

 
3,656,291

Term Loan B & C
June 1, 2024
 
5.75%
 
154,464

 
2,689,863

Other Debt (1)
 
 
 
 
50,189

 
14,415

Total Debt
 
 
 
 
$
7,705,069

 
$
6,360,569

(1)
Other Debt includes various debt instruments that have maturities that range from February 3, 2019 to June 28, 2020 with an interest rate of 3.6%.

17


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 company engaged in two business areas: interactive simulation, and batteries and charging systems.
Ø    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.
Ø    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.
Overview of Operating Performance and Backlog
Overall, our pre-tax loss for the six months ended June 30, 2019 was $(697,000) on revenues of $44.0 million compared to pre-tax profit of $1.1 million on revenues of $49.1 million during the six months ended June 30, 2018. Our overall backlog at the end of the second quarter of 2019 totaled $70.3 million, compared to $64.8 million at the end of the second quarter of 2018.
In our Training and Simulation Division, revenues for the six months ended June 30, 2019 were $29.4 million compared to $28.9 million during the six months ended June 30, 2018. As of June 30, 2019, our backlog for our Training and Simulation Division totaled $49.2 million, compared to $47.3 million as of December 31, 2018.
In our Power Systems Division, revenues for the six months ended June 30, 2019 were $14.7 million compared to $20.2 million during the six months ended June 30, 2018. As of June 30, 2019, our backlog for our Power Systems Division totaled $21.2 million, compared to $17.6 million at the end of as of December 31, 2018.
The table below details the percentage of total recognized revenue by type of arrangement for the six and three months ended June 30, 2019 and 2018:
 
Six months ended
June 30,
 
Three months ended
June 30,
Type of Revenue
2019
 
2018
 
2019
 
2018
Sale of products
92.3
%
 
95.3
%
 
92.5
%
 
92.2
%
Maintenance and support agreements
4.6
%
 
3.4
%
 
4.5
%
 
4.1
%
Long term research and development contracts
3.1
%
 
1.3
%
 
3.0
%
 
3.7
%
Total
100
%
 
100
%
 
100
%
 
100
%
Critical Accounting Policies
Please refer to our Form 10-K for the year ended December 31, 2018, for a discussion on our critical accounting policies and to Note 2 “Basis of Presentation” for an update to our critical accounting policies as of June 30, 2019.
Results of Operations
Three months ended June 30, 2019 compared to the three months ended June 30, 2018
Revenues. Revenues for the three months ended June 30, 2019 totaled $23.3 million compared to $21.9 million in the comparable period in 2018, an increase of $1.4 million or 6.4%, due to higher revenues in our Training and Simulation Division and our Power Systems Division. In the second quarter of 2019, revenues were $15.4 million for the Training and Simulation Division as compared to

18


$14.4 million in the second quarter of 2018, an increase of $1.0 million, or 7.1% driven by its larger military contracts. Revenues for the second quarter of 2019 in the Power Systems Division increased by $375,000, or 5.0%, from $7.5 million in the second quarter of 2018 to $7.9 million in the second quarter of 2019, due primarily to increased revenue in our Israeli operations related to increased battery and charger sales offset by lower revenue in our U.S. subsidiary due to the termination of our Amphibious Assault Vehicle program (“AAV”) by our customer Science Applications International Corporation (“SAIC”) as a result of the United States Marine Corps (“Marines”) termination for convenience with SAIC on October 3, 2018.
Cost of revenues. Cost of revenues totaled $15.6 million during the second quarter of 2019 as compared to $15.3 million in the second quarter of 2018, an increase of $300,000, or 2.2%, consistent with our increased sales. Cost of revenues for the second quarter of 2019 was $8.9 million for the Training and Simulation Division as compared to $8.0 million in the second quarter of 2018, an increase of $900,000, or 11.4% primarily due to the increase in revenue; and $6.7 million for the Power Systems Division in the second quarter of 2019 as compared to $7.3 million in the second quarter of 2018, a decrease of $600,000, or 7.7%, primarily due to lower revenues in the second quarter of 2019 related to the termination of the AAV contract in the fourth quarter of 2018, partially offset by an increase in the manufacturing of certain batteries in our Israeli operations.
Research and development expenses. Research and development expenses totaled $1.0 million during the second quarter of 2019 as compared to $728,000 for the second quarter of 2018, an increase of $294,000, or 40.3%, relating to the timing of research and development projects.
Selling and marketing expenses. Selling and marketing expenses for the second quarter of 2019 were $2.2 million, compared to $1.9 million in the second quarter of 2018, an increase of $260,000, or 13.4%, due primarily to increased marketing efforts in our Power Systems Division.
General and administrative expenses. General and administrative expenses for the second quarter of 2019 were $3.2 million, compared to $3.0 million for the second quarter of 2018, an increase of $230,000, or 7.7%, due to costs associated with a new enterprise resource planning system (“ERP”) undergoing implementation.
Amortization of intangible assets. Amortization of intangible assets totaled $281,000 in the second quarter of 2019, compared to $392,000 in the second quarter of 2018, a decrease of $111,000, or 28.4%, due primarily to the higher amortization expense recognized in 2018 pertaining to shorter-lived intangible assets.
Other income (expense), net. Other expense in the second quarter of 2019 was $(9,000) compared to income of $7,000 for the second quarter of 2018, an increase of $16,000 in expense.
Financial expense, net. Financial expense totaled $371,000 in the second quarter of 2019, compared to financial expense of $310,000 in the second quarter of 2018, an increase of $62,000, or 19.9%, due primarily to higher draws on our lines of credit.
Income taxes. We recorded $156,000 in tax expense in the second quarter of 2019, compared to $176,000 of tax expense in the second quarter of 2018, a decrease of $20,000, or 11.3%. 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). This amount includes the required adjustment of taxes due to the deduction of goodwill “naked” credits for U.S. federal taxes, which totaled $108,000 and $135,000 in non-cash expenses in the second quarter of 2019 and 2018, respectively.
Net income. Due to the factors cited above, we went from income of $83,000 in the second quarter of 2018 to income of $392,000 in the second quarter of 2019, an increase of $309,000.
Six months ended June 30, 2019 compared to the six months ended June 30, 2018
Revenues. Revenues for the six months ended June 30, 2019 totaled $44.0 million as compared to $49.1 million in the comparable period in 2018, a decrease of $5.1 million or 10.3%. In the first six months of 2019, revenues were $29.4 million for the Training and Simulation Division as compared to $28.9 million in the first six months of 2018, an increase of $449,000, or 1.6%, primarily due to increased sales. Revenues for the first six months of 2019 in the Power Systems Division decreased by $5.5 million, or 27.3%, from $20.2 million in the first six months of 2018 to $14.7 million in the first six months of 2019, due primarily to the termination of our AAV program by our customer SAIC as a result of the Marines termination for convenience with SAIC on October 3, 2018 and the decline in battery orders from the Israel Defense Forces.
Cost of revenues. Cost of revenues totaled $30.6 million during the first six months of 2019 as compared to $34.8 million in the first six months 2018, a decrease of $4.2 million, or 12.1%, consistent with lower sales in our Power Systems Division. Cost of revenues for the first six months of 2019 were $17.5 million for the Training and Simulation Division as compared to $16.8 million in the first six months of 2018, an increase of $725,000, or 4.3% , primarily due to the increase in revenue; and $13.0 million for the Power Systems Division in the first six months of 2019 as compared to $18.0 million in the first six months of 2018, a decrease of $5.0 million, or 27.5%, due to lower sales primarily related to the termination of the AAV contract in the fourth quarter of 2018.
Research and development expenses. Research and development expenses totaled $2.1 million during the first six months of 2019 as compared to $1.8 million for the first six months of 2018, an increase of $331.000, or 18.7%, due to the timing of research and development projects.

19


Selling and marketing expenses. Selling and marketing expenses for the first six months of 2019 were $4.3 million, compared to $3.8 million in the first six months of 2018, an increase of $534,000, or 14.0%, due primarily to increased marketing efforts in our Power Systems Division.
General and administrative expenses. General and administrative expenses were $6.4 million for the first six months of 2019, compared to $6.2 million for the first six months of 2018, an increase of $174,000, primarily due to costs associated with a new ERP system undergoing implementation.
Amortization of intangible assets. Amortization of intangible assets totaled $651,000 in the first six months of 2019, compared to $907,000 in the first six months of 2018, a decrease of $256,000, or 28.2%, due primarily to the higher amortization expense recognized in 2018 pertaining to shorter-lived intangible assets.
Other income (expense), net. Other expense totaled $(9,000) the first six months 2019, compared to income of $7,000 the first six months of 2018, an increase of expense of $16,000.
Financial expense, net. Financial expense totaled $670,000 in the second quarter of 2019, compared to financial expense of $523,000 in the first six months of 2018, an increase of $147,000, or 28.1%, primarily due to higher utilization of the lines of credit in 2019.
Income taxes. We recorded $317,000 in tax expense in the first six months 2019, compared to $423,000 of tax expense in the first six months 2019, a decrease of $106,000, or 25.1%. 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). This amount includes the required adjustment of taxes due to the deduction of goodwill “naked” credits for U.S. federal taxes, which totaled $216,000 and $362,000 in non-cash expenses in the first six months of 2019 and 2018, respectively.
Net income (loss). Due to the factors cited above, we went from income of $679,000 in the first six months of 2018 to a net loss of $(1.0) million in the first six months 2019, a decrease of $1.7 million.
Liquidity and Capital Resources
On July 24, 2019, we entered into a new amendment to the Credit Agreement (the “Ninth Amendment”), effective June 30, 2019. Pursuant to the terms of the Ninth Amendment, the parties have incorporated, among other changes, amended definitions of eligible unbilled accounts associated with certain long term contracts and borrowing base.
On April 22, 2019, we entered into a new amendment to the Credit Agreement (the “Eighth Amendment”), effective March 31, 2019. Pursuant to the terms of the Eighth Amendment, the parties have incorporated, among other changes, amended definitions of fixed charge coverage ratios and leverage ratios for specific quarters in 2019, and we have been given a second revolving line (“Revolver B”) in the amount of $6,000,000, reducing to $3,000,000 at the end of 2019 and due to be paid in full by February 28, 2020.
We maintain credit facilities with JPMorgan Chase Bank, N.A. (“Chase”), whereby Chase provides (i) a $15,000,000 revolving line (“Revolver”) and a second revolving line (“Revolver B”) in the amount of $6,000,000, reducing to $3,000,000 at the end of 2019 and due to be paid in full by February 28, 2020, (ii) a $10,000,000 Term Loan (“Term Loan A”), (iii) a $1,730,895 Mortgage Loan (“Term Loan B”), and (iv) a $1,358,000 Mortgage Loan (“Term Loan C”); collectively referred to as the “Credit Facilities.”
As of June 30, 2019, we had $3.7 million in cash and $154,000 in restricted collateral deposits, as compared to December 31, 2018, when we had $4.2 million in cash and $223,000 in restricted collateral deposits. We also had $5.9 million in available, unused bank lines of credit with our main bank as of June 30, 2019, under a $15.0 million credit facility. In addition, we had $3.0 million in available, unused bank credit as of June 30, 2019 under a $6.0 million line of credit under Revolver B.
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 June 30, 2019 was 6.25%.
The maturity of the Revolver B is February 28, 2020. The Revolver B maintains an interest rate on a scale ranging from LIBOR plus 1.75% up to LIBOR plus 3.50%. The effective interest rate for the Revolver B at June 30, 2019 was 6.00%.
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 June 30, 2019 was 6.50%.
We 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 June 30, 2019 was 6.50%.
The Credit Facilities maintain certain reporting requirements, conditions precedent, affirmative covenants and financial covenants. We are required to maintain certain financial covenants. The Eighth Amendment to the credit facilities adjusted the financial covenant ratios for the Company’s reporting periods during fiscal year 2019. The amended Maximum Debt to EBITDA ratio of 3.75 to 1.00 for the period ended March 31, 2019, 5.50 to 1.00 for the period ended June 30, 2019, 6.25 to 1.00 for the period ended September 30, 2019, 4.00 to 1.00 for the period ended December 31, 2019 and 3.00 to 1.00 for periods ending after December 31, 2019. The amended

20


Minimum Fixed Charge Coverage Ratio is 1.20 to 1.00 for the period ended March 31, 2019, 1.00 to 1.00 for the periods ended June 30, 2019 and September 30, 2019, and 1.20 to 1.00 for the periods ending after September 30, 2019. We were in compliance with our covenants at June 30, 2019.
The Credit Facilities are secured by our assets and the assets of our domestic subsidiaries.
We used available funds in the six months ended June 30, 2019 primarily for working capital needs and investment in fixed assets. Our net fixed assets amounted to $9.4 million at quarter end.
Net cash used in operating activities for the six months ended June 30, 2019 was $3.6 million. Net cash provided by operating activities for the six months ended June 30, 2018 was $3.6 million, representing a net change year over year of $7.2 million. The decrease in cash provided by operations is primarily attributable to the $7.2 million higher contract asset balance related to long term contracts that do not allow for milestone payments and a change from net income of $679,000 to a net loss of $(1.0) million primarily related to lower revenues associated with the termination of the AAV program on October 2, 2018.
Net cash used in investing activities for the six months ended June 30, 2019 was $2.5 million. Net cash used in investing activities for the six months ended June 30, 2018 was $896,000, representing a year over year change of $1.6 million.
Net cash provided by financing activities for the six months ended June 30, 2019 was $5.5 million. Net cash used in financing activities for the six months ended June 30, 2018 was $705,000, representing an increase of $6.2 million. In 2019, we made payments on our term loans of $1.1 million and increased our short-term borrowing on our line of credit by $6.6 million.
As of June 30, 2019, we had approximately $12.1 million in short-term bank debt under our Revolver and Revolver B as well as $7.7 million in long-term loans outstanding. This is in comparison to December 31, 2018, when we had $5.5 million in short-term bank debt under our credit facility and $8.6 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.

21


ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
There have been no material changes to our exposures to market risk since December 31, 2018.
ITEM 4.    CONTROLS AND PROCEDURES.
As of the end of the period covered by this report, an evaluation was carried out by the Company’s management, with the participation of our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that these disclosure controls and procedures were effective as of the end of the period covered by this report. In addition, no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

22


PART II
ITEM 6.    EXHIBITS.
The following documents are filed as exhibits to or furnished with this report:
Exhibit Number
 
Description
10.1
 
Incorporated by Reference
10.1.1
 
Filed Herewith
10.1.2
 
Filed Herewith
10.1.3
 
Filed Herewith
10.1.4
 
Filed Herewith
10.2
 
Incorporated by Reference
31.1
 
Filed Herewith
31.2
 
Filed Herewith
32.1
 
Furnished with this Report
32.2
 
Furnished with this Report
 
 
 
 
101.INS
 
XBRL Instance Document
Filed Herewith
101.SCH
 
XBRL Taxonomy Extension Schema Document
Filed Herewith
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document
Filed Herewith
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document
Filed Herewith
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document
Filed Herewith
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document
Filed Herewith

23


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: August 8, 2019
 
AROTECH CORPORATION
 
 
 
 
 
By:
/s/ Dean M. Krutty
 
 
 
Name:
Dean M. Krutty
 
 
 
Title:
President and Chief Executive Officer
 
 
 
 
(Principal Executive Officer)
 
 
 
 
 
 
 
By:
/s/ Kelli L. Kellar
 
 
 
Name:
Kelli L. Kellar
 
 
 
Title:
Vice President – Finance and CFO
 
 
 
 
(Principal Financial Officer)
 

24