Annual report pursuant to Section 13 and 15(d)

NOTE 1: - GENERAL

v2.4.0.6
NOTE 1: - GENERAL
12 Months Ended
Dec. 31, 2012
Organization, Consolidation and Presentation of Financial Statements Disclosure and Significant Accounting Policies [Text Block]
NOTE 1:–                  GENERAL

a.              Corporate structure:

Arotech Corporation (“Arotech”) and its wholly-owned subsidiaries (the “Company”) provide defense and security products for the military, law enforcement and homeland security markets, including advanced zinc-air and lithium batteries and chargers, and multimedia interactive simulators/trainers. The Company operates primarily through its wholly-owned subsidiaries FAAC Incorporated (“FAAC”), based in Ann Arbor, Michigan with locations in Royal Oak, Michigan and Orlando, Florida; Electric Fuel Battery Corporation (“EFB”), based in Auburn, Alabama; and Epsilor-Electric Fuel Ltd. (“Epsilor-EFL”), based in Dimona, Israel with a location in Beit Shemesh, Israel. EFB and Epsilor-EFL form the Company’s Battery and Power Systems Division. IES Interactive Training (“IES”) and Realtime Technologies (“RTI”) were merged with FAAC in 2007 and 2010, respectively, to create Arotech’s Training and Simulation Division. Pursuant to a management decision in the fourth quarter of 2011 and sale in 2012, the Company’s Armor Division, consisting of M.D.T. Protective Industries, Ltd. (“MDT”), based in Lod, Israel, and MDT Armor Corporation (“MDT Armor”), based in Auburn, Alabama, along with the trade name of Armour of America Incorporated (“AoA”), are reflected as discontinued operations for all periods presented.

b.              Impairment of 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 their carrying value. All of the Company’s continuing reporting units have goodwill. Fair value is determined using discounted cash flows. Significant estimates used in the methodologies include estimates of future cash flows, future short-term and long-term growth rates and weighted average cost of capital.

In September 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-08, “Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment.” ASU 2011-08 amends the guidance in Accounting Standards Codification (“ASC”) 350, Intangibles – Goodwill and Other. Under the revised guidance, when testing goodwill for impairment, the Company has the option of performing a qualitative assessment in order to determine whether it needs to calculate the fair value of a reporting unit. If the Company determines, on the basis of qualitative factors, that it is more likely than not that the fair value of the reporting unit is greater than the carrying amount, the two-step impairment test would not be required. The Company early adopted the ASU in 2011.

In both 2012 and 2011, the Company determined, using qualitative factors, that the goodwill for the Training and Simulation reporting unit was not impaired. In both 2012 and 2011, the Company completed the first step of the quantitative analysis of the goodwill in the Battery and Power Systems reporting unit, in which it computed a fair value of that reporting unit. Because the fair value was greater than the carrying value of the unit at the measurement date, the second step of the quantitative impairment assessment was not required and no goodwill was impaired. Although the valuation for Battery and Power Systems Division exceeded the reporting unit’s carrying value by 14%, the Company will continue to monitor the actual results of the reporting unit versus the forecast used for the impairment review and reevaluate the goodwill as required. Additionally, the Company performed a complete long-lived asset impairment review of the discontinued Armor reporting unit in 2011 that resulted in the full impairment of that unit’s goodwill ($1,792,339) and property and equipment ($1,487,219), as reported in discontinued operating results.

Although the cumulative carrying value of the Company’s reporting units exceeded the Company’s market value as determined by its stock price as of the impairment review, management nevertheless determined that the fair value of the Training and Simulation and Battery and Power Systems reporting units exceeded their respective carrying values, and therefore, there would be no impairment charges relating to goodwill for these reporting units. Several factors contributed to this determination:

·  
The long term horizon of the valuation process versus a short term valuation using current market conditions;

·  
The valuation by individual business segments versus the market share value based on the Company as a whole, including unallocated corporate costs;

·  
The Company’s stock is thinly traded and widely dispersed with minimal institutional ownership, and thus not followed by major market analysts, leading management to conclude that the market in the Company’s securities was not acting as an informationally efficient reflection of all known information regarding the Company and thereby serves to understate their value; and

·  
Control premiums reflected in the reporting unit fair values but not in the Company’s stock price.

The Company’s long-lived assets and amortizable identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of the carrying amount of assets to be held and used is measured by a comparison of the carrying amount of the assets to the future undiscounted cash flows expected to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.

c.              Related parties

The Company has had a consulting agreement with Sampen Corporation since 2005. Sampen is a New York corporation owned by members of the immediate family of one of the Company’s executive officers, and this executive officer is an employee of both the Company and of Sampen. The term of this consulting agreement was extended automatically for an additional term of two years until December 31, 2014, unless either Sampen or the Company terminates the agreement sooner.

Pursuant to the terms of the Company’s agreement with Sampen, Sampen provides one of its employees to the Company for such employee to serve as the Company’s President. The Company pays Sampen $12,800 per month, plus an annual bonus, on a sliding scale, in an amount equal to a minimum of 20% of Sampen’s annual base compensation then in effect, up to a maximum of 75% of its annual base compensation then in effect if the results the Company actually attained for the year in question are 120% or more of the amount the Company budgeted at the beginning of the year. The Company also pays Sampen to cover the cost of the Company’s use of Sampen’s offices as an ancillary New York office and the attendant expenses and insurance costs, an amount equal to 16% of each monthly payment of base compensation.

During the years ended December 31, 2012 and 2011, the Company incurred a total of $185,856 each year related to Sampen.

On February 9, 2000, Mr. Ehrlich, the Company’s Chief Executive Officer, exercised 9,404 stock options. Mr. Ehrlich paid the exercise price of the stock options and certain taxes that the Company paid on his behalf by giving the Company a non-recourse promissory note due in 2025 in the amount of $329,163, bearing annual interest at 1% over the then-current federal funds rate announced from time to time by the Wall Street Journal, secured by the shares of the Company’s common stock acquired through the exercise of the options and certain compensation due to Mr. Ehrlich upon termination. As of December 31, 2012 and 2011, the aggregate amount outstanding pursuant to this promissory note was $452,995.  Additionally, there is a former employee with the same arrangement.

On June 10, 2002, Mr. Ehrlich exercised 3,571 stock options. Mr. Ehrlich paid the exercise price of the stock options by giving the Company a non-recourse promissory note due in 2012 in the amount of $36,500, bearing simple annual interest at a rate equal to the lesser of (i) 5.75%, and (ii) 1% over the then-current federal funds rate announced from time to time, secured by the shares of the Company’s common stock acquired through the exercise of the options. As of December 31, 2012, the aggregate amount outstanding pursuant to this promissory note was $46,593, which was not repaid and was charged to paid in capital in the fourth quarter of 2012. Pursuant to the terms of the note, the shares of stock securing the note were returned to the Company and retired in 2013 when the loan was not repaid.

d.              Discontinued operations

In December 2011, the Company’s Board of Directors approved management’s plan to sell the Armor Division. On March 8, 2012, the Company signed a non-binding letter of intent to sell the division to an Israeli public company.  The sale of the assets was completed in June 2012 at a cash purchase price of $50,000. Unless otherwise indicated, discontinued operations are not included in the Company’s reported results.

Unless otherwise noted, amounts and disclosures throughout the Notes to Consolidated Financial Statements relate to the Company’s continuing operations. The assets and liabilities of the discontinued operation after impairment, the revenues and expenses of the discontinued operation and a list of unusual expenses relating to the discontinued operation are shown below.

ASSETS AND LIABILITIES – DISCONTINUED
 
December 31,
 
   
2012
   
2011
 
ASSETS
           
CURRENT ASSETS:
           
Cash and cash equivalents
  $ 106,548     $ 74,945  
Restricted collateral deposits
    44,827       193,488  
Trade receivables
    164,824       2,131,599  
Other accounts receivable and prepaid expenses
    73,073       133,149  
Inventories
          3,499,444  
Total current assets 
    389,272       6,032,625  
LONG TERM ASSETS:
               
Severance pay fund
          683,883  
Total long term assets
          683,883  
Total assets
  $ 389,272     $ 6,716,508  
LIABILITIES
               
CURRENT LIABILITIES:
               
Trade payables
  $ 75,862     $ 4,165,367  
Other accounts payable and accrued expenses
    453,443       2,250,584  
Current portion of long term debt (building mortgage)
    59,287       401,600  
Deferred revenues
          489,416  
Total current liabilities
    588,592       7,306,967  
LONG TERM LIABILITIES
               
Long term debt (building mortgage)
    912,813       963,814  
Total long-term liabilities
    912,813       963,814  
Total liabilities
  $ 1,501,405     $ 8,270,781  

REVENUE AND EXPENSES – DISCONTINUED
 
December 31,
 
   
2012
   
2011
 
Revenues
 
$
6,890,664
   
$
17,411,879
 
                 
Cost of revenues
   
6,476,082
     
15,924,925
 
Research and development expenses
   
     
643,201
 
Selling and marketing expenses 
   
301,990
     
835,957
 
General and administrative expenses 
   
493,868
     
2,504,746
 
Impairment of long lived assets 
   
     
3,279,558
 
Amortization of intangible assets
   
     
13,350
 
Total operating costs and expenses
   
7,271,940
     
23,201,737
 
                 
Operating loss
   
(381,276
)
   
(5,789,858
)
                 
Other (income) expense
   
(288,594
)
   
20,909
 
Financial expense, net
   
66,111
     
483,624
 
Loss from affiliated company
   
     
269,453
 
Total other expense
   
(222,483
)
   
773,986
 
Loss before income tax benefit
   
(158,793
)
   
(6,563,844
)
Income tax benefit
   
     
 
Net loss
 
$
(158,793
)
 
$
(6,563,844
)
Loss on sale, net of $0 income taxes
 
$
(829,490
)
 
$
 

Non-recurring charges related to discontinued operations
 
Year Ended December 31, 2011
 
Impairment of goodwill and intangibles
  $ 1,792,339  
Impairment of property and equipment, net
    1,487,219  
Write off of affiliated company loan and investment
    269,453  
Adjustments to severance - Israel
    301,876  
Total
  $ 3,850,887  

The Company retained the facility used by the Armor operations and currently leases it to the buyer of those operations under a three year operating lease for $9,300 per month.  The Company is marketing the facility for sale (it is included within Discontinued Operations), and it has no recorded book value as of December 31, 2012. The Company remains responsible for the outstanding mortgage on this facility, which was $950,000 as of December 31, 2012 (as further described in Note 11), and which it expects to either transfer with the sale of the facility or pay off with the related sales proceeds plus other available cash resources as necessary