On December 21, 2008, Mayosar signed an agreement with Isorad Ltd., an Israeli governmental company, or Isorad, to purchase certain knowledge, know how, equipment and inventory and the activity of a factory that manufactures germanium crystals for lenses used in infra-red night vision system applications, or the Isorad Agreement.
Mayosar incorporated a wholly owned subsidiary named Isorad Optronics Ltd. that later changed its name to Isorad IR Optics Ltd., or Isorad IR, to acquire the Isorad assets. Mayosar agreed to pay Isorad royalties of 3% of total sales with no deductions, except transportation costs and VAT, for a period of 15 years commencing the effective date of the Isorad Agreement (the "Effective Date"). The minimum royalty will be NIS 500,000 (approximately $119,000) per year for the period beginning the Effective Date and ending on completion of the transfer of all activity from Isorad’s facilities (no later than 18 months from the Effective Date) and NIS 200,000 (approximately $48,800) per year or $50,000, whichever is greater, thereafter. Beginning the Effective Date, and for a 24 month period, Isorad has the right to acquire 5% of the outstanding share capital of Isorad IR. In the event that such shares are issued to Isorad, Mayosar will issue an additional 539 of its shares to Mayotex, so that Mayotex will retain a 50.1% ownership interest in the entire operation. During the four year period commencing the Effective Date, Mayosar has the option to purchase from Isorad the 5% interest in Isorad IR (if acquired by it) and the right to extinguish its royalty obligation to Isorad in consideration for $750,000 less all the royalties paid to Isorad by Mayosar. If the Israeli government does not approve the ownership of the Isorad IR shares by Isorad before December 31, 2009, Isorad will be paid $75,000 or NIS 300,000, whichever is greater, and the option to purchase the shares will terminate.
The Isorad Agreement is subject to certain closing conditions, including a resolution to approve the transaction by Isorad’s board of directors that as of the balance sheet date have not been met. We are of the opinion, based on legal advice received, that the amounts paid under Sarino and Isorad agreements will be fully refundable to us in the event that Isorad will not fulfill the closing conditions.
Our management views revenues, the sources of our revenues, gross profit margin and the level of inventory compared to revenues as the key performance indicators in assessing our company’s financial condition and results of operations. While our management believes that demand for our products will continue to grow, our business is subject to a high degree of volatility because of the impact of geopolitical events, government budgeting, and competition.
Three Months Ended March 31, 2009 Compared with Three Months Ended March 31, 2008
The following table sets forth the breakdown of sales by segment for the three months ended March 31, 2009 and 2008.
Gross Profit. Gross profit for the three months ended March 31, 2009 was $1,491,728 compared to $743,144 for the three months ended March 31, 2008. This increase in gross profit is primarily attributable to the increase in revenues from sales. Our gross profit margin for the three months ended March 31, 2009 increased to 25.7% compared to 23.8% for the three months ended March 31, 2008.
Selling Expenses. Selling expenses for the three months ended March 31, 2009 increased by 16.9% to $183,776 from $157,144 for the three months ended March 31, 2008. The increase in our selling expenses was attributable primarily to the increase in export sales and commissions paid on export sales.
General and Administrative Expenses. General and administrative expenses for the three months ended March 31, 2009 decreased by 1.6% to $529,894 from $538,325 for the three months ended March 31, 2008. This stability is primarily due to our successful effort to keep expenses consistent.
Financial (Expenses) Income, Net. We had financial income, net of $441,025 for the three months ended March 31, 2009 compared to financial expenses, net of $115,258 for the three months ended March 31, 2008. Our financial income is primarily due to the change in the U.S. dollar exchange rate versus the NIS, which resulted in a gain of $390,967 for the three months ended March 31, 2009 compared to a loss of $112,778 for the three months ended March 31, 2008.
Other Income (Expense), Net. We had other income, net for the three months ended March 31, 2009 of $164,204 as compared to other expense, net of $40,480 for the three months ended March 31, 2008. Our other income in three months ended March 31, 2009 is mainly attributable to a gain derived from sales of tradable securities of $19,875 and an unrealized gain of $105,578 on tradable securities. Our other expense in three months ended March 31, 2008 is mainly attributable to a loss of $50,207 derived from sales of tradable securities.
Income Tax Expense. Our income tax expense for the three months ended March 31, 2009 was $284,851 compared to income tax expense of $79,694 for the three months ended March 31, 2008. The increase in income tax expense was mainly due to the increase in our operating income in the three months ended March 31, 2009.
Extraordinary Income. We didn’t record any extraordinary income for the three months ended March 31, 2009. For the three months ended March 31, 2008, we recognized and recorded extraordinary income of $4,681,838, net of tax, from the payments to our three subsidiaries, Export Erez, Mayotex and Achidatex, by the Israeli Government with respect to their evacuation from the Gaza Industrial Zone.
Noncontrolling Interest. For the three months ended March 31, 2009, we did not recognize or record any noncontrolling interest, compared with the noncontrolling interest in our profit of $41,417 for the three months ended March 31, 2008.
Net Income. In the three months ended March 31, 2009 our consolidated net income of controlling interest was $1,098,436, compared to of $4,452,664 for the three months ended March 31, 2008.
Liquidity and Capital Resources
As of March 31, 2009, we had $2,549,140 in cash and cash equivalents, $1,796,171 in trading securities and working capital of $9,271,253 as compared to $ $1,719,921 in cash and cash equivalents, $2,384,727 in trading securities and working capital of $10,088,528 at December 31, 2008. The decrease in our working capital position at March 31, 2009 reflects our increased accounts receivable arising from the increase in revenues.
20
The current economic climate and the uncertainty in the global financial markets resulting from the recent disruption in credit markets may affect our ability to raise additional funds in the future, if required. There can be no assurance that such additional financing will be available to us, or if available, will be on terms favorable to our company.
On October 30, 2008, our Board of Directors authorized a stock repurchase program, which authorizes the use of up to $450,000 for the purchase of shares of common stock of our company over a period of six months. As of May 10, 2009 we have not purchased any shares as part of this program, but we repurchased 1,050,000 shares purchased from the former minority shareholders in December 31, 2008 in connection with our purchase of their minority interests.
Cash Flows
The following table summarizes our cash flows for the periods presented:
| Three months ended
|
|---|
| March 31, 2009
| March 31, 2008
|
|---|
| | | |
|---|
| | |
|---|
| | |
|---|
| Net cash provided by operating activities | | | $ | 622,727 | | $ | 1,392,523 | |
| Cash provided by extraordinary items | | | | - | | | 2,691,838 | |
| Net cash provided by (used in) investing activities | | | | 1,126,092 | | | (1,047,722 | ) |
| Net cash used in financing activities | | | | (840,557 | ) | | (279,064 | ) |
| Net increase in cash and cash equivalents | | | | 829,219 | | | 2,817,234 | |
| Cash and cash equivalents at beginning of period | | | | 1,719,921 | | | 1,120,054 | |
| Cash and cash equivalents at end of period | | | | 2,549,140 | | | 3,937,288 | |
Net cash provided by operating activities was $622,727 for the three months ended March 31, 2009 as compared to $1,392,523 provided by operating activities in the three months ended March 31, 2008. This was primarily provided from net income of $1,098,436, an increase in accounts payable of $286,337, a decrease in trading securities of $486,105, and a decrease in other current assets of $458,564, offset by an increase in accounts receivable of $1,052,033, and an increase in inventories of $290,005.
Net cash provided by investing activities was $1,126,092 for the three months ended March 31, 2009 as compared to $1,047,722 net cash used in the three months March 31, 2008. During the three months ended March 31, 2009, $2,000,000 was provided from the redemption of bank deposits, $41,455 was used to purchase fixed assets and $832,453 was used to purchase of a business.
Net cash used in financing activities was $840,557 for the three months ended March 31, 2009 as compared to $279,064 net cash used in financing activities for the three months ended March 31, 2008. During the three months March 31, 2009, we incurred further short-term debt of $166,459, repaid $101,295 of long-term debt and repaid $905,721 to related party creditors for the purchase of Achidatex shares.
Most of our large contracts, which are Israeli Governmental contracts, are supported by letters of credit. As a result, we believe that we have limited exposure to doubtful accounts receivables. We have strived to balance our accounts payable and accounts receivable.
Subject to an unexpected growth in inventories as a result of future growth in sales and to a significant change in raw material prices, we intend to use our cash flow from operations for the acquisition of companies or equipment to expand our capabilities.
We anticipate that our research and development expenses in 2009 will total approximately $140,000.
We believe that we have sufficient working capital and borrowing capability to sustain our current level of operations for the next twelve months.
21
Foreign Currency Exchange Risk
We develop products in Israel and sell them in Israel, North and South America, Asia, Africa and several European countries. Our sales in Israel are denominated in NIS while most of our export sales are denominated in U.S. dollars. In addition, our labor expenses are primarily paid in NIS while our expenses for raw materials are paid in U.S. dollars and Euros. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets.
Our foreign currency exposure with respect to our sales is mitigated, and we expect it will continue to be mitigated, through salaries, materials and support operations, in which part of these costs are denominated in NIS.
In the year ended December 31, 2008, the inflation rate in Israel was 3.8% and the NIS appreciated in relation to the U.S. dollar at a rate of 1.14%, from NIS 3.846per $1 on December 31, 2007 to NIS 3.802 per $1 on December 31, 2008. In the period ending in March 31, 2009 deflation in Israel was0.1% while the NIS devaluated in relation to the U.S. dollar at a rate of 10.1%. If future inflation in Israel exceeds the devaluation of the NIS against the U.S. dollar or if the timing of such devaluation lags behind increases in inflation in Israel, our results of operations may be materially adversely affected.
We did not enter into any foreign exchange contracts or hedging transactions in the three months ended March 31, 2009.
Inflation and Seasonality
We do not believe that our operating results have been materially affected by inflation during the preceding two years. There can be no assurance, however, that our operating results will not be affected by inflation in the future. Our business is subject to minimal seasonal variations with slightly increased sales historically in the second and third quarters of fiscal year.
Off-balance Sheet Arrangements
None.
Contractual Obligations
The following table summarizes our contractual obligations and commercial commitments as of March 31, 2009.
Contractual Obligations
| | Payments due by Period
|
|---|
| Total
| Less than 1 year
| 2 -3 years
| 4 -5 years
| more than 5 years
|
|---|
| | | | | | |
|---|
| | | | | |
|---|
| | | | | |
|---|
| Long-term debt obligations | | | $ | 728,537 | | $ | 299,232 | | $ | 360,953 | | $ | 68,352 | | $ | - | |
| Estimated interest | | |
| payments on long-term debt | | |
| obligations | | | | 65,467 | | | 34,343 | | | 27,763 | | | 3,361 | | | - | |
| Operating lease obligations | | | | 289,388 | | | 235,663 | | | 51,576 | | | 2,149 | | | - | |
|
| |
| |
| |
| |
| |
| Total | | | $ | 1,083,392 | | $ | 569,238 | | $ | 440,292 | | $ | 73,862 | | $ | - | |
|
| |
| |
| |
| |
| |
22
Critical Accounting Policies
A discussion of our critical accounting policies was provided in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2008. There were no significant changes to these policies in the three months ended March 31, 2009.
Recent Accounting Pronouncements adopted in the reported period
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (SFAS 141(R)). SFAS 141(R) expands the definition of transactions and events that qualify as business combinations; requires that the acquired assets and liabilities, including contingencies, be recorded at the fair value determined on the acquisition date and changes thereafter reflected in revenue, not goodwill; changes the recognition timing for restructuring costs; and requires acquisition costs to be expensed as incurred. Adoption of SFAS 141(R) is required for annual periods beginning after December 15, 2008. Early adoption and retroactive application of SFAS 141(R) to fiscal years preceding the effective date are not permitted. The adoption of SFAS 141(R) will be effective for business combinations consummated in 2009.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interest in Consolidated Financial Statements” (SFAS 160). SFAS 160 re-characterizes minority interests in consolidated subsidiaries as non-controlling interests and requires the classification of minority interests as a component of equity. Under SFAS 160, a change in control will be measured at fair value, with any gain or loss recognized in earnings. The effective date for SFAS 160 is for annual periods beginning on or after December 15, 2008. SFAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing noncontrolling interests. All other requirements of SFAS 160 shall be applied prospectively. As a result of the adoption of SFAS 160, we reclassified the noncontrolling interest as a component of equity in prior years.
In March 2008, the FASB issued SFAS No. 161 (SFAS 161), “Disclosures about Derivative Instruments and Hedging Activities”, as an amendment to SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS 161 requires that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation. The fair value of derivative instruments and their gains and losses will need to be presented in tabular format in order to present a more complete picture of the effects of using derivative instruments. SFAS 161 is effective for financial statements issued for fiscal years beginning after November 15, 2008. The adoption of SFAS 161 did not have a material impact on our interim financial statements.
In April 2008, the FASB issued FSP No. FAS 142-3, Determination of the Useful Life of Intangible Assets, which amends the list of factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under SFAS No. 142, Goodwill and Other Intangible Assets. The new guidance applies to (1) intangible assets that are acquired individually or with a group of other assets and (2) intangible assets acquired in both business combinations and asset acquisitions. Under FSP No. FAS 142-3, entities estimating the useful life of a recognized intangible asset must consider their historical experience in renewing or extending similar arrangements or, in the absence of historical experience, must consider assumptions that market participants would use about renewal or extension. This FSP will require certain additional disclosures for the Company’s 2009 fiscal year and the application to useful life estimates prospectively for intangible assets acquired after December 15, 2008. The Company adopted FSP No. FAS 142-3 as of the beginning of fiscal year 2009. Our adoption of FSP No. FAS 142-3 did not have a material impact on its financial statements.
23
| Item 3. | | Quantitative and Qualitative Disclosures About Market Risk |
Interest Rate Risk
We do not believe that we have any material exposure to interest rate risk other than sensitivity to prevailing interest rates that may affect income from our cash deposits and marketable securities.
Foreign Exchange Risk
Most of our sales are currently denominated in dollars, while the majority of our operating expenses are incurred in foreign currencies, principally the NIS. As a result, the decrease in the value of the U.S. dollar against these currencies has resulted in increased expenses for our company. In 2006, 2007 and 2008, the U.S dollar depreciated against the NIS by approximately 8%, 9%, 1%, respectively. In the first fiscal quarter of 2009, the U.S dollar appreciated in relation to the NIS by approximately 10%.
| Item 4. | | Controls and Procedures |
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities Exchange Act of 1934, or the Exchange Act, reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our chief executive officer and chief financial officer to allow timely decisions regarding required disclosure. Our management, including our chief executive officer and chief financial officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures, as defined under Exchange Act Rule 13a-15(e), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation, our chief executive officer and chief financial officer have concluded that, as of such date, our disclosure controls and procedures were effective.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting that occurred during the quarter ended March 31, 2009 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
PART II – OTHER INFORMATION:
On February 11, 2009, a lawsuit was filed in the Jerusalem District Court against our subsidiaries, Export Erez USA Inc. and Achidatex, and its chief executive officer, Mr. Avraham Hazor. The suit alleges that Achidatex materially breached its agreement with the plaintiff, dated February 22, 2000, relating to the development of inflatable mine-field crossing enabling sandals, because Achidatex allegedly failed to register patents for the technology worldwide and only registered patents in the United States. The plaintiff further claims that the defendants, jointly and severally, committed a breach of trust. The plaintiff is seeking damages in the amount of NIS 10 million (approximately $2.4 million), and claiming for all rights in the patent. Contemporaneously with the filing of the claim, the plaintiff also filed a motion seeking an exemption from payment of the requisite court filing fee, and stated that he would withdraw the lawsuit if the motion is not granted. On March 12, 2009, Achidatex filed a request to respond to the motion and requested a 30 day extension to file its statement of defense. On May 24, 2009, We filed our statement of defense. We believe that it is likely that the plaintiff’s motion for an exemption from payment of the court filing fee will be granted and that the lawsuit will therefore proceed. We believe that the plaintiff’s claim is unfounded and intend to vigorously defend against the claim. Due to the preliminary stage of the claim, we and our legal advisors cannot currently assess the outcome or possible adverse effect on our financial position or results of operations, however, we believe we have substantial legal arguments to oppose the allegations.
24
Our business may be negatively affected by the current global economic and credit crisis.
The current economic climate and the uncertainty in the global economic conditions resulting from the recent disruption in credit markets pose a risk to the overall economy that could impact customer demand for our products, as well as our ability to manage normal commercial relationships with our customers, suppliers and creditors. If the current situation deteriorates significantly, our business could be negatively impacted, including such areas as reduced demand for our products from a slow-down in the general economy, or supplier or customer disruptions resulting from tighter credit markets.
There have been no other material changes to our “Risk Factors” set forth in our Annual Report on Form 10-K for the year ended December 31, 2008.
| Item 6. | | Exhibits and Reports on Form 8-K |
| 31.1 | | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act, as amended. |
| 31.2 | | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act, as amended. |
| 32.1 | | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act, as amended. |
| 32.2 | | Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
25
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: June 11, 2009 | | DEFENSE INDUSTRIES INTERNATIONAL, INC.
By: /s/ Joseph Postbinder
——————————————
Joseph Postbinder
Chairman and Chief Executive Officer |
26
