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, 2017. In the opinion of the Company, the unaudited financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of its financial position at September 30, 2018, its operating results for the nine- and three-month periods ended September 30, 2018 and 2017, and its cash flows for the nine-month periods ended September 30, 2018 and 2017.
The results of operations for the nine and three months ended September 30, 2018 are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year ending December 31, 2018.
The condensed consolidated balance sheet at December 31, 2017 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, 2017.
c. Reclassification:
From time to time the Company may reclassify amounts from prior periods to conform to 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 the 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 nine months ended September 30, 2018.
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 December 31, 2017, the Company determined that the goodwill for both reporting units was not impaired.
The Company has historically performed its annual goodwill impairment test as of December 31 each year. During the quarter ended September 30, 2018, the Company voluntarily changed its annual impairment assessment date from December 31 to October 1. The Company believes this change in measurement date, which represents a change in method of applying an accounting principle, is preferable under the circumstances as it better aligns with its forecasting and annual budgeting process timeline. The Company intends to utilize the same valuation approach and does not expect the change in valuation date to produce different impairment results. As the Company assesses qualitative factors that may give rise to triggering events quarterly, the Company does not consider the change in date of its annual impairment test material to its financial statements.
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. New accounting pronouncements:
In February 2016, the FASB issued ASU No. 2016-02,
Leases (Topic 842)
. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. In addition, in July 2018, the FASB issued ASU No. 2018-10,
Codification Improvement to Topic 842
.
In July 2018, the FASB issued ASU No. 2018-11, Targeted Improvements to Topic 842. This amendment provides the Company with an additional and optional transition method to adopt the new leases standard. Under this new transition method, the Company can apply the new lease standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption and present the accounting on a prospective or go-forward basis instead of applying to the earliest comparative period presented in the financial statements. The standard will be effective for the Company beginning January 1, 2019.
The Company will elect to apply the new transition method upon adoption of the new standard. The Company will also elect the available practical expedients on adoption. In preparation for adoption of the standard, the Company is in the process of finalizing changes to systems, implementing internal controls and key processes to enable the preparation of financial information.
The new standard will have a material impact on the Company’s consolidated balance sheets, but will not have a material impact on its consolidated income statements. The most significant impact will be the recognition of ROU assets and lease liabilities for operating leases and will result in additional ROU assets and lease liabilities for operating leases of approximately
$5.6 million
and
$5.7 million
, respectively, as of January 1, 2019.
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, 2017. Significant changes to the Company’s accounting policies as a result of changes in functional currency, the impact of changes to tax legislation, and adopting Accounting Standards Codification (“ASC”) 606 are discussed below:
Functional Currency:
The United States dollar (“U.S. dollar”) is the currency of the primary economic environment in which the Company’s U.S. subsidiaries operate and the Company has adopted and is using the U.S. dollar as its functional currency. Transactions and balances originally denominated in U.S. dollars are presented at the original amounts. Accordingly, monetary accounts maintained in currencies other than dollars are re-measured into dollars, with resulting gains and losses reflected in the consolidated statements of operations and comprehensive income as financial income or expenses, as appropriate.
In the first quarter of 2018, the Company concluded that the functional currency for its Israeli subsidiary, Epsilor-EFL, changed from the New Israeli Shekel to the U.S. dollar. The primary reason for the change in functional currencies is due to a change in Epsilor-EFL operations whereby the majority of its contracts and material costs are anticipated to be sourced in U.S. dollars. The Company believes that the change in functional currency for this business was necessary as it reflects the primary economic environment in which Epsilor-EFL now operates.
The change in functional currency for Epsilor-EFL is accounted for prospectively from January 1, 2018, and prior year financial statements have not been restated for the change in functional currency. The financial statements of Epsilor-EFL are now reported in U.S. dollars. All balance sheet accounts were translated using the exchange rates in effect at the time of the change in functional currency. The statements of comprehensive income and cash flows are also reported in U.S. dollars.
Income Taxes:
The U.S. Tax Cuts and Jobs Act (“Tax Act”) was enacted on December 22, 2017. The Tax Act makes broad complex changes to the U.S. tax code including, but not limited to, reducing the U.S. federal corporate tax rate from
35%
to
21%
, requiring companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, and creating new taxes on certain foreign sourced earnings and additional limitations on the deductibility of interest.
The SEC issued Staff Accounting Bulletin No. 118 (SAB 118) in December, 2017, to provide guidance on accounting for the effects of the Tax Act. SAB 118 provides for a measurement period of up to one year from the Tax Act enactment date for companies to complete their assessment of and accounting for those effects of the Tax Act. Under SAB 118, a company must first reflect the income tax effects of the Tax Act for which the accounting is complete in the period of the date of enactment. To the extent the accounting for other income tax effects is incomplete, but a reasonable estimate can be determined, companies must record a provisional estimate to be included in their financial statements. For any income tax effect for which a reasonable estimate cannot be determined, an entity must continue to apply ASC 740 based on the provisions of the tax laws in effect immediately prior to the Tax Act being enacted until such time as a reasonable estimate can be determined. The Company requires additional time to complete its analysis of the impacts of the Tax Act and therefore its accounting for the Tax Act is provisional but is a reasonable estimate based on available information. The Company will
complete its analysis and finalize its accounting for this provisional estimate during the one year measurement period as prescribed by SAB 118.
Revenue recognition:
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, as a new Topic, ASC 606. The new revenue recognition standard relates to revenue from contracts with customers, which, along with amendments issued in 2016 and 2015, supersedes nearly all current U.S. GAAP guidance on this topic and eliminates industry-specific guidance.
The Company accounts for revenue in accordance with ASC 606, Revenue from Contracts with Customers, which the Company adopted on January 1, 2018, using the modified retrospective method. The Company evaluated the distinct performance obligations and the pattern of revenue recognition of its significant contracts upon adoption of the standard. Consequently, after its review of contracts in each revenue stream, the Company concluded that the impact of adopting the standard did not have an impact to its consolidated balance sheets, statements of operations, changes in stockholders’ equity, or cash flows.
During 2018 and 2017, 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 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.
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
92%
and
93%
of its revenue for the nine-month periods ended September 30, 2018 and 2017, 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.
On September 30, 2018, the Company had
$70.7 million
of expected future revenue relating to performance obligations currently in progress, which it also refers to as total backlog. The Company expects to recognize approximately
29%
percent of its backlog as revenue in 2018, and the remaining
71%
percent by the end of 2019 and 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 recognize 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 it is identified.
The aggregate impact of adjustments in contract estimates to net income (loss) is presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months ended September 30,
|
|
2018
|
|
2017
|
|
Training and Simulation Division
|
|
Power Systems Division
|
|
Training and Simulation Division
|
|
Power Systems Division
|
Net income (loss)
|
$
|
449,580
|
|
|
$
|
77,403
|
|
|
$
|
858,769
|
|
|
$
|
92,050
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended September 30,
|
|
2018
|
|
2017
|
|
Training and Simulation Division
|
|
Power Systems Division
|
|
Training and Simulation Division
|
|
Power Systems Division
|
Net income (loss)
|
$
|
(139,016
|
)
|
|
$
|
320,269
|
|
|
$
|
402,581
|
|
|
$
|
(208,861
|
)
|
Revenue by Category.
As of September 30, 2018 and 2017 the Company’s portfolio of products and services consisted of 525 and 500 active contracts, respectively.
Revenue by major product line was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months ended September
30,
|
|
Three months ended September
30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Product Revenue
|
|
|
|
|
|
|
|
Air Warfare Simulation
|
$
|
13,324,429
|
|
|
$
|
14,476,934
|
|
|
$
|
3,667,058
|
|
|
$
|
5,075,082
|
|
Vehicle Simulation
|
17,040,554
|
|
|
8,694,974
|
|
|
6,040,922
|
|
|
4,351,624
|
|
Use-of-Force
|
10,677,612
|
|
|
9,636,388
|
|
|
4,132,059
|
|
|
4,489,977
|
|
Service Revenue
|
|
|
|
|
|
|
|
Warranty
|
2,533,558
|
|
|
2,331,673
|
|
|
825,863
|
|
|
680,284
|
|
Total Training and Simulation Division
|
$
|
43,576,153
|
|
|
$
|
35,139,969
|
|
|
$
|
14,665,902
|
|
|
$
|
14,596,967
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract Manufacturing
|
$
|
10,130,597
|
|
|
$
|
9,565,368
|
|
|
$
|
3,100,586
|
|
|
$
|
3,114,482
|
|
Power Distribution and Generation
|
5,695,039
|
|
|
3,810,061
|
|
|
1,413,117
|
|
|
1,479,509
|
|
Batteries
|
9,767,890
|
|
|
16,134,215
|
|
|
3,118,375
|
|
|
4,944,867
|
|
Engineering Services and Other
|
3,797,917
|
|
|
5,076,966
|
|
|
1,546,497
|
|
|
1,794,616
|
|
Total Power Division
|
$
|
29,391,443
|
|
|
$
|
34,586,610
|
|
|
$
|
9,178,575
|
|
|
$
|
11,333,474
|
|
The table below details the percentage of total recognized revenue by type of arrangement for the nine and three months ended September 30, 2018 and 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months ended September
30,
|
|
Three months ended September
30,
|
Type of Revenue
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Sale of products
|
95.0
|
%
|
|
96.7
|
%
|
|
94.5
|
%
|
|
97.2
|
%
|
Maintenance and support agreements
|
3.5
|
%
|
|
3.3
|
%
|
|
3.5
|
%
|
|
2.6
|
%
|
Long term research and development contracts
|
1.5
|
%
|
|
—
|
%
|
|
2.0
|
%
|
|
0.2
|
%
|
Total
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
Revenue by contract type was as follows:
|
|
|
|
|
|
|
|
|
|
Training and
Simulation
Division
|
|
Power Systems
Division
|
Nine months ended September
30, 2018
|
|
|
|
Fixed Price
|
$
|
35,975,495
|
|
|
$
|
26,807,005
|
|
Cost Reimbursement (Cost Plus)
|
4,120,987
|
|
|
1,822,659
|
|
Time and Materials
|
3,479,671
|
|
|
761,779
|
|
Total
|
$
|
43,576,153
|
|
|
$
|
29,391,443
|
|
Nine months ended September
30, 2017
|
|
|
|
Fixed Price
|
$
|
28,849,966
|
|
|
$
|
28,830,143
|
|
Cost Reimbursement (Cost Plus)
|
4,610,512
|
|
|
4,203,220
|
|
Time and Materials
|
1,679,491
|
|
|
1,553,247
|
|
Total
|
$
|
35,139,969
|
|
|
$
|
34,586,610
|
|
Three months ended September
30, 2018
|
|
|
|
Fixed Price
|
$
|
11,948,500
|
|
|
$
|
8,372,521
|
|
Cost Reimbursement (Cost Plus)
|
1,511,711
|
|
|
567,767
|
|
Time and Materials
|
1,205,691
|
|
|
238,287
|
|
Total
|
$
|
14,665,902
|
|
|
$
|
9,178,575
|
|
Three months ended September
30, 2017
|
|
|
|
Fixed Price
|
$
|
12,657,859
|
|
|
$
|
9,250,841
|
|
Cost Reimbursement (Cost Plus)
|
1,524,987
|
|
|
1,714,584
|
|
Time and Materials
|
414,121
|
|
|
368,049
|
|
Total
|
$
|
14,596,967
|
|
|
$
|
11,333,474
|
|
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.
Revenue by customer was as follows:
|
|
|
|
|
|
|
|
|
|
Training and
Simulation
Division
|
|
Power Systems
Division
|
Nine months ended September
30, 2018
|
|
|
|
U.S. Government
|
|
|
|
Department of Defense (DoD)
|
$
|
12,399,861
|
|
|
$
|
2,115,108
|
|
Non-DoD
|
7,655,130
|
|
|
—
|
|
Foreign Military Sales (FMS)
|
2,055,333
|
|
|
—
|
|
Total U.S. Government
|
$
|
22,110,324
|
|
|
$
|
2,115,108
|
|
|
|
|
|
U.S. Commercial
|
$
|
16,546,210
|
|
|
$
|
16,159,067
|
|
Non-U.S. Government
|
1,786,538
|
|
|
2,003,417
|
|
Non-U.S. Commercial
|
3,133,081
|
|
|
9,113,851
|
|
Total Revenue
|
$
|
43,576,153
|
|
|
$
|
29,391,443
|
|
Nine months ended September
30, 2017
|
|
|
|
U.S. Government
|
|
|
|
Department of Defense (DoD)
|
$
|
7,698,425
|
|
|
$
|
7,166,810
|
|
Non-DoD
|
8,604,167
|
|
|
—
|
|
Foreign Military Sales (FMS)
|
1,128,897
|
|
|
—
|
|
Total U.S. Government
|
17,431,489
|
|
|
7,166,810
|
|
|
|
|
|
U.S. Commercial
|
$
|
13,697,477
|
|
|
$
|
10,603,502
|
|
Non-U.S. Government
|
2,815,271
|
|
|
9,014,963
|
|
Non-U.S. Commercial
|
1,195,732
|
|
|
7,801,335
|
|
Total Revenue
|
$
|
35,139,969
|
|
|
$
|
34,586,610
|
|
Three months ended September
30, 2018
|
|
|
|
U.S. Government
|
|
|
|
Department of Defense (DoD)
|
$
|
4,753,006
|
|
|
$
|
772,751
|
|
Non-DoD
|
3,272,251
|
|
|
—
|
|
Foreign Military Sales (FMS)
|
341,933
|
|
|
—
|
|
Total U.S. Government
|
8,367,190
|
|
|
772,751
|
|
|
|
|
|
U.S. Commercial
|
$
|
4,744,148
|
|
|
$
|
4,669,493
|
|
Non-U.S. Government
|
394,091
|
|
|
180,253
|
|
Non-U.S. Commercial
|
1,160,473
|
|
|
3,556,078
|
|
Total Revenue
|
$
|
14,665,902
|
|
|
$
|
9,178,575
|
|
Three months ended September
30, 2017
|
|
|
|
U.S. Government
|
|
|
|
Department of Defense (DoD)
|
$
|
3,226,920
|
|
|
$
|
2,715,675
|
|
Non-DoD
|
3,162,425
|
|
|
—
|
|
Foreign Military Sales (FMS)
|
721,353
|
|
|
—
|
|
Total U.S. Government
|
7,110,698
|
|
|
2,715,675
|
|
|
|
|
|
U.S. Commercial
|
$
|
5,765,592
|
|
|
$
|
3,204,902
|
|
Non-U.S. Government
|
1,496,856
|
|
|
3,392,865
|
|
Non-U.S. Commercial
|
223,821
|
|
|
2,020,032
|
|
Total Revenue
|
$
|
14,596,967
|
|
|
$
|
11,333,474
|
|
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 are billed as work progresses in accordance with agreed-upon contractual terms, either at 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 assets and liabilities are reported on the Consolidated Balance Sheet on a contract-by-contract basis at the end of each reporting period.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
|
Training and Simulation Division
|
|
Power Systems
Division
|
|
Training and Simulation Division
|
|
Power Systems
Division
|
Unbilled Receivables – Current
|
$
|
9,681,738
|
|
|
$
|
9,867,754
|
|
|
$
|
7,263,461
|
|
|
$
|
8,831,055
|
|
Deferred Revenues – Current
|
(6,061,829
|
)
|
|
(452,272
|
)
|
|
(5,860,345
|
)
|
|
(917,968
|
)
|
Net Contract Assets and Liabilities:
|
$
|
3,619,909
|
|
|
$
|
9,415,482
|
|
|
$
|
1,403,116
|
|
|
$
|
7,913,087
|
|
The
$3.7
million increase in the Company’s net contract assets (liabilities) from December 31, 2017 to September 30, 2018 was due to the timing of milestone payments on certain US Government and commercial contracts.
During the nine months ended September 30, 2018 and 2017, the Company recognized
$5.2
million and
$4.8
million in revenue related to the Company’s contract liabilities at December 31, 2017 and 2016, respectively.
The Company did not record any provisions for impairment of its unbilled receivables during the nine months ended September 30, 2018 or 2017, respectively.
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 September 30, 2018 and December 31, 2017, the Company’s trade receivables recorded in the consolidated balance sheets were
$14.2
million and
$19.3 million
, respectively. The Company has not recorded any provisions for doubtful accounts and no reserves have been established at September 30, 2018 or December 31, 2017, respectively. 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.
Contract Costs
Certain eligible costs, typically incurred during the initial phases of the Company’s service contracts, are capitalized when the costs related directly to the contract, are expected to be recovered, and generate or enhance resources to be used in satisfying the performance obligation. These costs primarily consist of production design. If the carrying amount is not recoverable, an impairment loss is recognized.
Practical Expedients and Exemptions
The Company has elected the following practical expedients and exemptions as allowed under the new revenue guidance:
Sales Commissions
The Company has elected to expense its sales commissions when incurred because the amortization period is less than one year. These costs are recorded within selling and marketing expenses.
Financing
The Company has elected to not adjust the consideration for the effects of a significant financing component as the term of the majority of contracts is twelve months or less.
Sales Tax
The Company acts as an agent in the collection and remittance of sales taxes. Historically, the Company has excluded these amounts from the calculation of revenue. These taxes will continue to be excluded from the transaction price.
Shipping and Handling Costs
The Company has elected to account for shipping and handling activities that are incurred after the customer obtained control of the product as fulfillment costs rather than a separate service provided to the customer for which consideration would need to be allocated.
The Company will continue to account for shipping and handling as fulfillment costs when these costs are incurred prior to the customer obtaining control.
NOTE 3: INVENTORIES
Inventories are stated at the lower of cost or net realizable value. Cost is determined by the first in, first out (“FIFO”) method. 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 nine months ended September 30, 2018 and 2017, the Company wrote off approximately
$558,000
and
$26,000
, respectively, of obsolete inventory, which has been included in the cost of revenues.
Inventories by component are as follows:
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
Raw and packaging materials
|
$
|
7,212,539
|
|
|
$
|
6,843,479
|
|
Work in progress
|
2,157,068
|
|
|
718,085
|
|
Finished products
|
380,152
|
|
|
1,093,314
|
|
Total:
|
$
|
9,749,759
|
|
|
$
|
8,654,878
|
|
NOTE 4: SEGMENT INFORMATION
a. The Company and its subsidiaries operate in
two
business segments. The two segments are also treated by the Company as reporting units for goodwill impairment evaluation purposes. The goodwill amounts associated with the Training and Simulation Division and the Power Systems Division were determined and valued when the specific businesses were purchased. The Company and its subsidiaries operate in two continuing business segments and follow the requirements of FASB ASC 280-10.
The Company’s reportable segments have been determined in accordance with the Company’s internal management structure, which is organized based on operating activities. The accounting policies of the reportable segments are the same as those used by the Company in the preparation of its annual financial statements. The Company evaluates performance based on two primary factors, one is the segment’s operating income and the other is the segment’s contribution to the Company’s future strategic growth.
b. The following is information about reported segment revenues, income (losses) from operations, and total assets as of
September 30, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Training and
Simulation
Division
|
|
Power Systems
Division
|
|
Corporate
Expenses
|
|
Total
Company
|
Nine months ended September 30, 2018
|
|
|
|
|
|
|
|
Revenues from outside customers
|
$
|
43,576,153
|
|
|
$
|
29,391,443
|
|
|
$
|
—
|
|
|
$
|
72,967,596
|
|
Depreciation and amortization(1)
|
(605,195
|
)
|
|
(2,159,094
|
)
|
|
—
|
|
|
(2,764,289
|
)
|
Direct expenses(2)
|
(34,347,504
|
)
|
|
(30,102,162
|
)
|
|
(2,987,017
|
)
|
|
(67,436,683
|
)
|
Segment operating income (loss)
|
$
|
8,623,454
|
|
|
$
|
(2,869,813
|
)
|
|
$
|
(2,987,017
|
)
|
|
$
|
2,766,624
|
|
Financial expense
|
(182,524
|
)
|
|
10,148
|
|
|
(523,856
|
)
|
|
(696,232
|
)
|
Income tax expense
|
(144,221
|
)
|
|
—
|
|
|
(506,544
|
)
|
|
(650,765
|
)
|
Net income (loss)
|
$
|
8,296,709
|
|
|
$
|
(2,859,665
|
)
|
|
$
|
(4,017,417
|
)
|
|
$
|
1,419,627
|
|
Segment assets(3)
|
$
|
54,996,173
|
|
|
$
|
57,639,253
|
|
|
$
|
3,116,700
|
|
|
$
|
115,752,126
|
|
Additions to long-lived assets
|
$
|
965,651
|
|
|
$
|
782,556
|
|
|
$
|
—
|
|
|
$
|
1,748,207
|
|
Nine months ended September 30, 2017
|
|
|
|
|
|
|
|
Revenues from outside customers
|
$
|
35,139,969
|
|
|
$
|
34,586,610
|
|
|
$
|
—
|
|
|
$
|
69,726,579
|
|
Depreciation and amortization(1)
|
(772,736
|
)
|
|
(2,230,750
|
)
|
|
(3,455
|
)
|
|
(3,006,941
|
)
|
Direct expenses(2)
|
(29,723,546
|
)
|
|
(33,425,392
|
)
|
|
(2,649,455
|
)
|
|
(65,798,393
|
)
|
Segment operating income (loss)
|
$
|
4,643,687
|
|
|
$
|
(1,069,532
|
)
|
|
$
|
(2,652,910
|
)
|
|
$
|
921,245
|
|
Financial expense
|
(77,975
|
)
|
|
(170,381
|
)
|
|
(501,611
|
)
|
|
(749,967
|
)
|
Income tax benefit (expense)
|
(105,000
|
)
|
|
44,913
|
|
|
(685,908
|
)
|
|
(745,995
|
)
|
Net income (loss)
|
$
|
4,460,712
|
|
|
$
|
(1,195,000
|
)
|
|
$
|
(3,840,429
|
)
|
|
$
|
(574,717
|
)
|
Segment assets(3)
|
$
|
48,550,296
|
|
|
$
|
57,675,628
|
|
|
$
|
3,314,767
|
|
|
$
|
109,540,691
|
|
Additions to long-lived assets
|
$
|
2,454,099
|
|
|
$
|
1,410,393
|
|
|
$
|
—
|
|
|
$
|
3,864,492
|
|
Three months ended September 30, 2018
|
|
|
|
|
|
|
|
Revenues from outside customers
|
$
|
14,665,902
|
|
|
$
|
9,178,575
|
|
|
$
|
—
|
|
|
$
|
23,844,477
|
|
Depreciation and amortization(1)
|
(208,055
|
)
|
|
(688,935
|
)
|
|
—
|
|
|
(896,990
|
)
|
Direct expenses(2)
|
(11,509,826
|
)
|
|
(9,173,877
|
)
|
|
(1,122,503
|
)
|
|
(21,806,206
|
)
|
Segment operating income (loss)
|
$
|
2,948,021
|
|
|
$
|
(684,237
|
)
|
|
$
|
(1,122,503
|
)
|
|
$
|
1,141,281
|
|
Financial expense
|
(43,545
|
)
|
|
13,540
|
|
|
(143,340
|
)
|
|
(173,345
|
)
|
Income tax expense
|
(82,670
|
)
|
|
—
|
|
|
(144,710
|
)
|
|
(227,380
|
)
|
Net income (loss)
|
$
|
2,821,806
|
|
|
$
|
(670,697
|
)
|
|
$
|
(1,410,553
|
)
|
|
$
|
740,556
|
|
Three months ended September 30, 2017
|
|
|
|
|
|
|
|
Revenues from outside customers
|
$
|
14,596,967
|
|
|
$
|
11,333,474
|
|
|
$
|
—
|
|
|
$
|
25,930,441
|
|
Depreciation, amortization and impairment expenses(1)
|
(224,611
|
)
|
|
(698,939
|
)
|
|
(1,183
|
)
|
|
(924,733
|
)
|
Direct expenses(2)
|
(11,672,943
|
)
|
|
(11,269,961
|
)
|
|
(810,428
|
)
|
|
(23,753,332
|
)
|
Segment operating income (loss)
|
$
|
2,699,413
|
|
|
$
|
(635,429
|
)
|
|
$
|
(811,611
|
)
|
|
$
|
1,252,376
|
|
Financial expense
|
(40,706
|
)
|
|
7,367
|
|
|
(167,584
|
)
|
|
(200,923
|
)
|
Income tax expense
|
(35,000
|
)
|
|
401
|
|
|
(228,636
|
)
|
|
(263,235
|
)
|
Net income (loss)
|
$
|
2,623,707
|
|
|
$
|
(627,658
|
)
|
|
$
|
(1,207,831
|
)
|
|
$
|
788,218
|
|
|
|
(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 September 30, 2018 and
$24,435,641
and
$21,586,500
, respectively, as of September 30, 2017.
|
NOTE 5: FAIR VALUE MEASUREMENT
The carrying value of short term assets and liabilities in the accompanying condensed consolidated balance sheets for cash and cash equivalents, restricted collateral deposits, trade receivables, unbilled receivables, inventories, prepaid and other assets, trade payables, accrued expenses, deferred revenues and other liabilities as of September 30, 2018 and December 31, 2017, approximate fair value because of the short maturity of these instruments. The carrying amounts of long term debt approximates the estimated fair values at September 30, 2018, based upon the Company’s ability to acquire similar debt at similar maturities.
NOTE 6: BANK FINANCING
The Company maintains credit facilities with JPMorgan Chase Bank, N.A. (“Chase”), whereby Chase provides (i) a
$15,000,000
revolving credit facility (“Revolver”), (ii) a
$10,000,000
Term Loan (“Term Loan A”), (iii) a
$1,730,895
Mortgage Loan (“Term Loan B”) and (iv) a
$1,358,000
Mortgage Loan (“Term Loan C”); collectively referred to as the “Credit Facilities.”
The maturity of the Revolver is
March 11, 2021
. The Revolver maintains an interest rate on a scale ranging from LIBOR plus
1.75%
up to LIBOR plus
3.00%
. The effective interest rate for the revolver at September 30, 2018 was
5.25%
. The balance at September 30, 2018 and December 31, 2017 was
$4.8 million
and
$5.1 million
, respectively.
The maturity of the Term Loan A is
March 11, 2021
. Term Loan A maintains an interest rate on a scale ranging from LIBOR plus
2.0%
up to LIBOR plus
3.25%
.
The repayment of Term Loan A consists of 60 consecutive monthly payments of principal plus accrued interest based on annual principal reductions of 10% during the first year, 20% during the second through fourth years, and 30% during the fifth year.
The effective interest rate for the Term Loan at September 30, 2018 was
5.50%
. The balance at September 30, 2018 and December 31, 2017 was
$6.2 million
and
$7.7 million
, respectively.
During the quarter ended June 30, 2017, the Company purchased land and a building, previously leased by its Training and Simulation Division, in Ann Arbor, Michigan. As a result, the Company now maintains
two
Mortgage Loans (“Term Loans B and C”). The maturities of Term Loans B and C are
June 1, 2024
and maintain an interest rate on a scale identical to Term Loan A.
The monthly payments on Term Loan B and Term Loan C are $7,212 and $5,660, respectively, in principal plus accrued interest, with balloon payments due on the maturity date.
The effective interest rate for the Mortgage Loans at September 30, 2018 was
5.50%
. The balance of both loans at September 30, 2018 and December 31, 2017 was
$2.9 million
and
$3.1 million
, respectively.
The Credit Facilities maintain certain reporting requirements, conditions precedent, affirmative covenants and financial covenants. The Company is required to maintain certain financial covenants that include a Maximum Debt to EBITDA ratio of 3.00 to 1.00 and a Minimum Fixed Charge Coverage Ratio of 1.20 to 1.00.
The Company was in compliance with its covenants at September 30, 2018.
The Credit Facilities are secured by the Company’s assets and the assets of the Company’s domestic subsidiaries.
NOTE 7: SUBSEQUENT EVENT
On October 3, 2018, the Company’s U.S. Power Systems Division subsidiary was informed by its customer, Science Applications International Corporation (“SAIC”), that the United States Marines 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 SAIC. As a result of this termination for the USMC’s convenience, the Company will be presenting its unreimbursed costs related to this program for reimbursement by SAIC and the USMC. The amounts of and time frame for resolution have not yet been determined.