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Edited Transcript of ARTX earnings conference call or presentation 7-Nov-18 2:00pm GMT

Q3 2018 Arotech Corp Earnings Call

Ann Arbor Nov 20, 2018 (Thomson StreetEvents) -- Edited Transcript of Arotech Corp earnings conference call or presentation Wednesday, November 7, 2018 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Dean M. Krutty

Arotech Corporation - President & CEO

* Kelli L. Kellar

Arotech Corporation - VP of Finance & CFO

* Yaakov Har-Oz

Arotech Corporation - Senior VP, General Counsel & Corporate Secretary

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Conference Call Participants

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* Michael Roy Crawford

B. Riley FBR, Inc., Research Division - Senior MD, Co-Head of The Discovery Group & Senior Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the Arotech Corporation Third Quarter 2018 Earnings Results Conference Call.

(Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Yaakov Har-Oz, General Counsel. Thank you, Mr. Har-Oz. You may begin.

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Yaakov Har-Oz, Arotech Corporation - Senior VP, General Counsel & Corporate Secretary [2]

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Thank you, Jerry. I would like to welcome everyone to Arotech's Third Quarter 2018 Earnings Call. Hosting the call today are Dean Krutty, our Chief Executive Officer; and Kelli Kellar, our Chief Financial Officer.

Before I turn the call over to Dean and Kelli, I'd like to remind everyone that this conference call may contain projections or other forward-looking statements regarding future events or the future performance of the company. These statements are only predictions, and there could be no assurance that they will, in fact, occur. Arotech does not assume any obligation to update that information. Actual events and results may differ materially from those projected, including as a result of changing market trends, reduced demand and the competitive nature of Arotech's industry as well as other risks identified in the documents filed by the company with the Securities and Exchange Commission.

In addition, certain non-GAAP financial measures will be discussed during this call. These non-GAAP measures are used by management to make strategic decisions, forecast future results and evaluate the company's current performance. Management believes the presentation of these non-GAAP financial measures is useful to investors' understanding and assessment of the company's ongoing core operations and prospects for the future. Unless it is otherwise stated, it should be assumed that any financials discussed in this conference call will be provided on a non-GAAP basis. Full reconciliations of non-GAAP to GAAP financial measures are included in the earnings release.

And with that, I would like to now introduce Arotech's CEO, Dean Krutty. Dean, the call is yours.

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Dean M. Krutty, Arotech Corporation - President & CEO [3]

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Thank you, Yaakov. Good morning. Thank you for joining us.

In the third quarter of 2018, we reported $23.8 million in revenue and $2.4 million in adjusted EBITDA, bringing our year-to-date adjusted EBITDA to $6 million, an increase of 36% over the first 9 months of 2017.

Our Training and Simulation Division reported $14.7 million in third quarter revenue, while our Power Systems Division reported $9.1 million of revenue last quarter. Our third quarter 2018 results show continued strength from our Simulation division, but our power system division's performance reflects some unexpected market challenges.

In September, the U.S. Marine Corps canceled its Amphibious Assault Vehicle Survivability Upgrade effort with SAIC. The Marine Corps reported that they will focus investment on new vehicles instead of upgrading their legacy AAV. Our U.S. power company in South Carolina, UEC, was performing an electrical upgrade as a subcontract to the SAIC in support of this effort. We are working through a settlement with SAIC and the U.S. Marine Corps for our work to date and are busy replacing the lost future revenues with new revenue streams. To that end, UEC announced at the end of August its place as 1 of 5 companies on an indefinite delivery, indefinite quantity contract from the space and naval warfare center or SPAWAR. The contract is for cyber mission systems, kitting and supplies; and carries a $950 million ceiling. SPAWAR expects to procure a system that provide wireless communications, detection, collection and exploitation of electrical and electronic equipment to support the warfighter. Related services such as sustainment, maintenance and disposal may also be procured under the scope of this contract.

UEC secured its position on the contract vehicle based on our history of successfully performing similar work for SPAWAR over the last decade. The new vehicle is expected to serve SPAWAR for 5 to 7 years.

UEC continues to support the U.S. Marines with testing of the hybrid power solution known as MEHPS, which we delivered late last year. Our smaller systems, the MEHPS-Lite, have completed testing. And the Marines are now focusing on testing the larger MEHPS medium systems. In the third quarter, we sold a hybrid energy solution similar to MEHPS to the U.S. Army. It is scheduled to be delivered in the spring, and the army will test this system for suitability to their mission with a stated need of 160 units.

Our Training and Simulation Division announced in the third quarter that FAAC is Phase 2 planning for its virtual clearance training suites contract with the U.S. Army in the amount of $10.2 million. This is the second of 3 phases intended by the Army and will be delivered over the next 2 years. The U.S. Marine Corps also exercised nearly $1 million in options in our Combat Convoy Simulator contract announced earlier this year. The increased funding on VCTS and CCS is expected to grow this segment of our Training and Simulation Division in 2019.

Also within this division, we announced this quarter 2 U.S. Air Force purchases of our MILO U.S. Air Force training solutions. Significant awards from the Air Force Global Strike Command and the Pacific Air Forces, combined with other orders from individual air bases, totaled over $4 million. The Air Force will receive a variety of training solutions, taking advantage of the breadth of offerings from our MILO range brand, to include the fully immersive MILO Range Theater 300. The training systems will be used to train U.S. Air Force security forces around the globe and are scheduled for delivery through the first quarter 2019, with extended product support through 2024.

In our commercial driver training group, we received an important order from Georgia Tech, adding that university to the list of research customers who've chosen our simulators as a key element of their automobile research. The third quarter also brought sales of our fire truck simulators and their related pump op trainer. We recently developed a new version of our pump ops trainer to service fire teams whose pump equipment is mounted on top of their fire truck, and we are seeing sales of that system on on-base military firefighting units as we had anticipated when we invested in the new design.

Finally, our air warfare systems group was awarded a contract to include a version of our Zone Acquisition Process in a demonstration program to alert aircrew to the capability of surface-to-air missiles. This is a different application of our technology which has historically provided aircrew information about their own weapons capability and represents a new area for future expansion. In addition, we are part of a 3-company joint venture that secured a place on a TSC IV contract vehicle out of the Naval Air Warfare Center Training Systems Division. NAWCTSD serves as the principal source of a broad range of training solutions for the U.S. Navy, and our position on this vehicle will allow us to compete for new naval training systems and for performing upgrades to existing training systems for the next 5 to 9 years.

Based on our visibility after 3 quarters, we have increased our 2018 full year EBITDA guidance to the range of $7.3 million to $7.6 million while decreasing our revenue guidance to the range of $95 million to $100 million.

With that, I'd like to now turn the call over to Kelli.

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Kelli L. Kellar, Arotech Corporation - VP of Finance & CFO [4]

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Thank you, Dean. Good morning, and thank you for joining our call today.

I will now discuss our third quarter results.

Revenues for the third quarter were $23.8 million compared to $25.9 million for the comparable period in 2017. The year-over-year decrease in revenue was primarily due to a decline in the Power Systems Division related to the decline in battery orders from the Israeli Ministry of Defense contract that was completed in early 2018 and, to a lesser extent, the stop-work order issued by the marines related to the AAV program. The stop-work order eventually led to the termination of the AAV contract, as Dean had previously described.

Our gross profit for the third quarter was $7.3 million or 30.7% of revenues compared to $7.3 million or 28% of revenues for the prior year period. The year-over-year increase in gross profit percentage was primarily due to program losses that incurred in 2017 in the Power Systems Division and, to a lesser extent, product mix in the Training and Simulation Division for the current period.

Operating expenses were $6.2 million in the third quarter of 2018 compared to $6 million for the prior year. We had operating income of $1.1 million for the third quarter of 2018 compared to $1.3 million in the corresponding period 2017. The decrease in operating income for the quarter was primarily associated with higher general and administrative costs in our Training and Simulation Division and corporate, primarily related to personnel costs.

Our net income for the third quarter was $741,000 or $0.03 earnings per share for basic and diluted compared to net income of $788,000 or $0.03 earnings per share for the same period last year. Our adjusted earnings per share, adjusted EPS, for the third quarter of 2018 and 2017 was $0.06 per share.

Adjusted earnings before interest, tax, depreciation and amortization, adjusted EBITDA, for the third quarter was approximately $2.4 million compared to $2.3 million for the corresponding period of 2017. We believe that information concerning adjusted EBITDA and adjusted earnings per share enhances overall understanding of our current financial performance.

We compute adjusted EBITDA and adjusted earnings per share, which are non-GAAP financial measures, as reflected in the tables of yesterday's press release.

Now I will discuss our cash flows from operations. We had net cash provided by operations of $3.4 million for the 9 months ended 2018 compared to $843,000 for the same period in 2017. The increase in cash from operations was primarily attributable to net income in 2018 versus a net loss for the same period in 2017 as well as a significant decrease in severance payments in the current year as compared to 2017.

Now turning to our balance sheet discussion. As of September 30, 2018, we had $5.2 million in cash and cash equivalents compared to $5.5 million of cash and cash equivalents at the end of the year. As of September 30, 2018, we had total debt outstanding of $13.9 million, consisting of $4.8 million in short-term bank debt under our credit facility and $9.1 million in long-term debt. This is compared to total debt outstanding of $15.9 million, which consisted of $5.1 million in short-term bank debt under our credit facility and $10.8 million in long-term debt at the end of the year.

We had $7.8 million in available unused bank lines of credit with our primary bank as of September 30, 2018, under our $15 million revolving credit facility and a $10 million term loan and a $3 million mortgage that is secured by assets of our company. Our current ratio, which is current assets divided by current liabilities, is 2.1 million (sic) [2.1] compared with a current ratio of 2.0 as of December 31, 2017.

As of December 31, 2017, we had net operating loss carryforwards for U.S. federal income tax purposes of $40.7 million, which is available to offset future taxable income, if any, expiring in 2021 through 2032. Utilization of U.S. net operating losses is subject to annual limitations due to provisions of the Internal Revenue Code of 1986 and similar state provisions. We accrued noncash tax expense of $145,000 in the third quarter of 2018, reflecting the uncertainty of the deductibility of intangible expenses for federal income tax purposes.

At the end of the third quarter 2018, 2017; and Q4 2017, we had a backlog of $70.7 million, $69.5 million and $61.1 million, respectively. The company's backlog increased by 1.7% over the same quarter last year and 15.7% over the prior year-end.

Our Simulation division had a backlog of $51.3 million at the end of third quarter 2018, $41.5 million for the same time last year and $38.8 million at the end of the prior year. Our Simulation division backlog increased by 23.6% over the same quarter last year and 32.2% over the prior year-end. This is primarily attributable to our VCTS and CCS military vehicle programs.

Our power system division had a backlog of $19.4 million at the end of the third quarter 2018, $28 million for the same time last year and $22.3 million at the prior year-end. Our power system division backlog decreased by 30.7% over the same quarter last year and 13% over the prior year. This is primarily attributable to the completion of the IMOD contract in early 2018 and the termination of the AAV program.

That concludes our prepared remarks. Before we open the call up for Q&A, I'd like to remind all participants that Dean and I are regularly available to the investment community. And throughout the year, we look to participate in relevant conferences and investor [events].

Operator, you may now open the call up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have a question from Mr. Mike Crawford, B. Riley.

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Michael Roy Crawford, B. Riley FBR, Inc., Research Division - Senior MD, Co-Head of The Discovery Group & Senior Analyst [2]

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Could you help frame the opportunity you're seeing for mobile electric power systems with MEHPS, MEHPS-Lite and related systems for the Marines and the Army; and when these could materialize in meaningful revenue?

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Dean M. Krutty, Arotech Corporation - President & CEO [3]

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Thanks, Mike. As you know, we've been working on MEHPS for a couple of years with the Marine Corps. This program dates back actually 5 or 6 years with a smaller system we did call GREENS that actually became a program of record in 2014. The Marine Corps is still advertising a schedule for a late 2019 RFP for a production contract that, according to their estimation of need, would be over $80 million of MEHPS systems to begin getting filled in 2020. The Army, with the system that they just purchased, is trying to fill a short-term need which expects to go on contract next summer for about 160 units.

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Michael Roy Crawford, B. Riley FBR, Inc., Research Division - Senior MD, Co-Head of The Discovery Group & Senior Analyst [4]

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Okay. And what is the ask you have with the SAIC and the Marines for the DPCMS system? And then I guess related, what other kind of electrical system upgrade or at least maintenance do you think you might get on that AAV platform before ACVs are fielded in any great number?

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Dean M. Krutty, Arotech Corporation - President & CEO [5]

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As far as an ask, are you asking about the amount of settlement...

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Michael Roy Crawford, B. Riley FBR, Inc., Research Division - Senior MD, Co-Head of The Discovery Group & Senior Analyst [6]

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Settlement, yes.

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Dean M. Krutty, Arotech Corporation - President & CEO [7]

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So we're still looking to get the costs covered for the work that we've done on that program over the last year. If you look at our balance sheet, you'll notice that our unbilled is up. Because we didn't get to deliver those systems, we haven't been able to move that to receivable as of yet, but we certainly expect to get -- made whole by SAIC for the work that we've done to date. As far as future efforts, we have done some significant work on that platform with DPCMS but still may have legs. We have actually an opportunity in December to meet with the Marine Corps and show off all of the different work we did from an electrical standpoint on the AAV. And it's uncertain at this time whether the Marine Corps will be able to fund upgrades to the AAVs that are now not getting the survivability upgrade from SAIC. So that's something we're watching closely. At the same time, we are selling DPCMS into other vehicle systems, specifically with the U.S. Army, in an effort to continue that technology as [a naval] part of our company work.

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Michael Roy Crawford, B. Riley FBR, Inc., Research Division - Senior MD, Co-Head of The Discovery Group & Senior Analyst [8]

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Okay. And then switching gears to the simulation business. Is there any update you can share on when we would see a common driver training RFP or potential award?

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Dean M. Krutty, Arotech Corporation - President & CEO [9]

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Mike, that's very hot right now as the RFP has hit the street. Proposals are due in just a couple of days. We've been working very hard this quarter on our response to that requests for proposals. And we expect that the award will be late spring probably, according to the Army's current time line.

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Michael Roy Crawford, B. Riley FBR, Inc., Research Division - Senior MD, Co-Head of The Discovery Group & Senior Analyst [10]

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But late June.

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Dean M. Krutty, Arotech Corporation - President & CEO [11]

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Spring of '19.

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Michael Roy Crawford, B. Riley FBR, Inc., Research Division - Senior MD, Co-Head of The Discovery Group & Senior Analyst [12]

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Late spring, okay.

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Dean M. Krutty, Arotech Corporation - President & CEO [13]

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Yes. May or June probably. Probably May will be my kind of bet right now. Obviously, we're not in control of that, but that's what they're advertising.

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Michael Roy Crawford, B. Riley FBR, Inc., Research Division - Senior MD, Co-Head of The Discovery Group & Senior Analyst [14]

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Okay. And then final question, on your judgment on use-of-force business, are you seeing any changes in margin on those systems delivered given competition?

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Dean M. Krutty, Arotech Corporation - President & CEO [15]

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Not this year, no. We've had some pressure. There are 5 good competitors in that space, but we've been able to maintain our price increase steady all year.

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Operator [16]

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You have a question from a private investor, [Mr. Jordan Timmet. Mr. Timmet]?

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Unidentified Participant, [17]

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Yes. I was just curious on what contract you have available this year coming up.

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Dean M. Krutty, Arotech Corporation - President & CEO [18]

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I'm not sure I understand your question, [Jordan]. Are you saying...

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Unidentified Participant, [19]

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Like do you have any future contracts this year that are counting into play?

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Dean M. Krutty, Arotech Corporation - President & CEO [20]

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Well, I think our press releases have shown recently we've had a very significant win on a program called Combat Convoy Simulators. That is going to ramp into its biggest piece in 2019, which certainly help us in 2019. We also had a announcement recently on our funding for our VCTS program, which we're working now on our first phase. Well, the second phase, which is bigger, will also cause us to grow in '19 and '20 on that contract.

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Unidentified Participant, [21]

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Right. So do you -- on the second phase, do you have a time line on that, when that's supposed to be completed?

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Dean M. Krutty, Arotech Corporation - President & CEO [22]

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Yes. It will be executed in both '19 and '20, and in 2020, we also expect the third phase of that contract to kick in, which will cause us to grow further on that contract in 2021.

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Operator [23]

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Gentlemen, there are no further questions at this time. I'd like to turn the conference back over to management. Mr. Yaakov? Mr. Har-Oz?

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Dean M. Krutty, Arotech Corporation - President & CEO [24]

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Thank you, Jerry. This is Dean. But thanks, everyone, for calling in, and we'll talk to you next time.

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Operator [25]

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This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a good day.