================================================================================

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004.

COMMISSION FILE NUMBER: 0-23336
-------

AROTECH CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)

DELAWARE 95-4302784
- ------------------------------------------ ----------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

250 WEST 57TH STREET, SUITE 310, NEW YORK, NEW YORK 10107
- --------------------------------------------------- ----------------
(Address of principal executive offices) (Zip Code)

(212) 258-3222
--------------------------------------------------
(Registrant's telephone number, including area code)

632 BROADWAY, SUITE 1200, NEW YORK, NEW YORK 10012
--------------------------------------------------
(Former address, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No|_|

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|

APPLICABLE ONLY TO CORPORATE ISSUERS:

The number of shares outstanding of the issuer's common stock as of May 15, 2004
was 64,868,912.

================================================================================

AROTECH CORPORATION

INDEX

PART I - FINANCIAL INFORMATION

Item 1 - Interim Consolidated Financial Statements (Unaudited):
Consolidated Balance Sheets at March 31, 2004 and December 31, 2003............................ 3
Consolidated Statements of Operations for the Three Months Ended March 31, 2004 and 2003....... 5
Consolidated Statements of Changes in Stockholders'
Equity during the Three-Month Period Ended March 31, 2004.................................... 6
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2004 and 2003....... 7
Note to the Interim Consolidated Financial Statements.......................................... 10

Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations. 20

Item 3 - Quantitative and Qualitative Disclosures about Market Risk............................ 28

Item 4 - Controls and Procedures............................................................... 40

PART II - OTHER INFORMATION

Item 2 - Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities...... 42

Item 6 - Exhibits and Reports on Form 8-K...................................................... 43

SIGNATURES..................................................................................... 45

ITEM 1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

CONSOLIDATED BALANCE SHEETS
(U.S. DOLLARS)

MARCH 31, 2004 DECEMBER 31, 2003
-------------- -----------------
ASSETS (Unaudited) (Note 1.b.)

CURRENT ASSETS:

Cash and cash equivalents ............................................ $ 4,852,795 $13,685,125
Restricted securities and deposits due within one year ............... 5,735,529 706,180
Available-for-sale marketable securities ............................. 124,153 --
Trade receivables (netof allowance for doubtful accounts in
the amounts of $70,087 and $61,282 as of March 31, 2004
and December 31, 2003, respectively) ............................... 5,219,099 4,706,423
Current portion of note receivable ................................... 306,116 --
Unbilled revenues .................................................... 756,388 --
Other accounts receivable and prepaid expenses ....................... 1,214,914 1,187,371
Inventories .......................................................... 4,542,899 1,914,748
Assets of discontinued operations .................................... 65,894 66,068
----------- -----------

TOTAL CURRENT ASSETS ....................................... 22,817,787 22,265,915
----------- -----------

SEVERANCE PAY FUND ....................................................... 1,732,591 1,023,342

PROPERTY AND EQUIPMENT, NET .............................................. 3,190,825 2,292,741

RESTRICTED SECURITIES AND DEPOSITS ....................................... 3,769,047 --

LONG TERM RECEIVABLES .................................................... 876,016 --

GOODWILL ................................................................. 13,905,371 5,064,555

OTHER INTANGIBLE ASSETS, NET ............................................. 13,585,811 2,375,195
----------- -----------

$59,877,448 $33,021,748
=========== ===========

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

CONSOLIDATED BALANCE SHEETS
(U.S. DOLLARS, EXCEPT SHARE AND PER SHARE DATA)

MARCH 31, 2004 DECEMBER 31, 2003
-------------- -----------------
(Unaudited) (Note 1.b.)
LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:

Trade payables ...................................................... $ 2,863,266 $ 1,967,448
Other accounts payable and accrued expenses ......................... 4,251,695 4,180,411 *
Current portion of promissory note due to purchase of subsidiaries .. 1,000,926 150,000
Short-term bank loans and current portion of long-term loans ........ 967,858 40,849
Deferred revenues ................................................... 336,901 140,936 *
Liabilities of discontinued operations .............................. 323,817 380,108
----------- -----------

TOTAL CURRENT LIABILITIES ................................................ 9,744,463 6,859,752

LONG TERM LIABILITIES
Accrued severance pay ............................................... 3,226,038 2,814,492
Convertible debentures .............................................. 849,037 881,944
Deferred warranty revenue, less current portion ..................... 168,818 220,143
Long-term loan ...................................................... 17,827 --
Promissory note due to purchase of a subsidiary ..................... 1,801,171 150,000
----------- -----------

TOTAL LONG-TERM LIABILITIES .............................................. 6,062,891 4,066,579

MINORITY INTEREST ........................................................ 50,766 51,290

SHAREHOLDERS' EQUITY:
Share capital -
Common stock - $0.01 par value each;
Authorized: 100,000,000 shares as of March 31, 2004 and December 31,
2003; Issued: 62,868,129 shares as of March 31, 2004 and 47,972,407
shares as of December 31, 2003; Outstanding - 62,312,796 shares as
of March 31, 2004 and 47,417,074 shares as of December 31, 2003.. 628,683 479,726
Preferred shares - $0.01 par value each;
Authorized: 1,000,000 shares as of March 31, 2004 and December 31,
2003; No shares issued and outstanding as of March 31, 2004 and
December 31, 2003 ............................................... -- --
Additional paid-in capital .......................................... 162,331,180 135,891,316
Deferred stock compensation ......................................... (8,464) (8,464)
Accumulated deficit ................................................. (113,988,048) (109,681,893)
Treasury stock, at cost (common stock - 555,333 shares as of March 31,
2004 and December 31, 2003) ....................................... (3,537,106) (3,537,106)
Notes receivable on account of shares ............................... (1,207,819) (1,203,881)
Accumulated other comprehensive income (loss) ....................... (199,098) 104,429
----------- -----------

TOTAL SHAREHOLDERS' EQUITY ............................................... 44,019,328 22,044,127
----------- -----------

$59,877,448 $33,021,748
=========== ===========

* Reclassified.

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

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(U.S. DOLLARS, EXCEPT SHARE AND PER SHARE DATA)

THREE MONTHS ENDED MARCH 31,
-------------------------
2004 2003
----------- -----------

Revenues ................................................................. $ 7,182,254 $ 4,033,453

Cost of revenues ......................................................... 4,557,220 2,633,719
----------- -----------

Gross profit ............................................................. 2,625,034 1,399,734

Operating expenses:
Research and development ............................................ 463,506 358,039
Selling and marketing expenses ...................................... 1,021,084 703,987
General and administrative expenses ................................. 3,680,993 1,012,756
Amortization of intangible assets ................................... 496,013 311,771
----------- -----------
Total operating costs and expenses ....................................... 5,661,596 2,386,552
----------- -----------

Operating loss ........................................................... (3,036,562) (986,818)
Financial expenses, net .................................................. (1,273,954) (261,075)
----------- -----------

Loss before taxes ........................................................ (4,310,516) (1,247,893)
Tax income, net .......................................................... 4,907 --
----------- -----------
Loss before minority interest in earnings of a subsidiary and tax expenses (4,305,609) (1,247,893)
Minority interest in earnings of a subsidiary ............................ (546) (43,228)
----------- -----------
Loss from continuing operations .......................................... (4,306,155) (1,291,121)
Loss from discontinued operations ........................................ -- (95,962)
----------- -----------
Net loss ................................................................. $(4,306,155) $(1,387,083)
=========== ===========

Basic and diluted net loss per share from continuing operations .......... $ (0.07) $ (0.04)
=========== ===========
Basic and diluted net loss per share from discontinued operations ........ $ -- $ (0.00)
=========== ===========
Combined basic and diluted net loss per share ............................ $ (0.07) $ (0.04)
=========== ===========

Weighted average number of shares used in computing basic and diluted net
loss per share ......................................................... 59,406,466 34,758,960
=========== ===========

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

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(U.S. DOLLARS, EXCEPT SHARE AND PER SHARE DATA)

COMMON STOCK ADDITIONAL DEFERRED
--------------------------- PAID-IN STOCK
SHARES AMOUNT CAPITAL COMPENSATION
------------- ------------- ------------ -----------

BALANCE AT
JANUARY 1, 2004 - NOTE 1 ..... 47,972,407 $ 479,726 $ 135,891,316 $ (8,464)

CHANGES DURING THE THREE-MONTH
PERIOD ENDED MARCH 31, 2004

Issuance of shares, net ...... 10,290,426 102,904 18,455,096 --
Investment in subsidiary
against issuance of shares . 1,003,856 10,039 1,996,789 --
Issuance of shares on
conversion of convertible
debentures ................. 1,796,875 17,969 1,103,031 --
Issuance of shares on
exercise of warrants ....... 1,722,050 17,220 2,473,502 --
Issuance of shares to
consultants ................ 74,215 742 170,938 --
Compensation related to
options and warrants
issued to consultants and
investors .................. -- -- 2,226,685 --
Compensation related to
non-recourse loan granted
to shareholder ............. -- -- 4,500 --

Employee option exercises .... 8,300 83 5,385 --
Interest accrued on notes 1
receivable from
shareholders ............... -- -- 3,938 --
Other comprehensive loss -
foreign currency
translation adjustment ..... -- -- -- --

Net loss ...................... -- -- -- --
------------- ------------- ------------- -----------
Total comprehensive loss ...... -- -- -- --

BALANCE AT MARCH 31, 2004 -
UNAUDITED ................... 62,868,129 $ 628,683 $ 162,331,180 $ (8,464)
============= ============= ============= ===========

NOTES ACCUMULATED
RECEIVABLE OTHER TOTAL
ACCUMULATED TREASURY FROM COMPREHENSIVE COMPREHENSIVE
DEFICIT STOCK SHAREHOLDERS INCOME (LOSS) LOSS TOTAL
------------- --------- ------------- -------------- ------------ -------------

BALANCE AT
JANUARY 1, 2004 - NOTE 1 ..... $(109,681,893) $ (3,537,106) $ (1,203,881) $ 104,429 $ -- $ 22,044,127

CHANGES DURING THE THREE-MONTH
PERIOD ENDED MARCH 31, 2004

Issuance of shares, net ...... -- -- -- -- -- 18,558,000
Investment in subsidiary
against issuance of shares . -- -- -- -- -- 2,006,828
Issuance of shares on
conversion of convertible
debentures ................. -- -- -- -- -- 1,121,000
Issuance of shares on
exercise of warrants ....... -- -- -- -- -- 2,490,722
Issuance of shares to
consultants ................ -- -- -- -- -- 171,680
Compensation related to
options and warrants
issued to consultants and
investors .................. -- -- -- -- -- 2,226,685
Compensation related to
non-recourse loan granted
to shareholder ............. -- -- -- -- -- 4,500

Employee option exercises .... -- -- -- -- -- 5,468
Interest accrued on notes
receivable from
shareholders ............... -- -- (3,398) -- -- --
Other comprehensive loss -
foreign currency
translation adjustment ..... -- -- -- (303,527) (303,527) (303,527)

Net loss ...................... (4,306,155) -- -- -- (4,306,155) (4,306,155)
------------- ------------- ------------- ------------- ------------- -------------
Total comprehensive loss ...... -- -- -- -- (4,494,380) --

BALANCE AT MARCH 31, 2004 -
UNAUDITED ................... $(113,988,048) $ (3,537,106) $ (1,207,819) $ (199,098) 44,019,328
============= ============= ============= ============= =============

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

CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) (U.S. DOLLARS)

THREE MONTHS ENDED MARCH 31,
--------------------------------------------
2004 2003
-------------------- -------------------

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss for the period................................................... (4,306,155) (1,387,083)
Net loss for the period from discontinued operations...................... - 95,962
Adjustments required to reconcile net loss to net cash used in operating
activities:
Depreciation............................................................ 236,408 180,591
Amortization of intangible assets....................................... 496,013 311,771
Amortization of deferred financial expenses............................. - 78,750
Amortization of compensation related to warrants issued to the holders
of convertible debentures and beneficial conversion feature........... 1,117,093 189,000
Amortization of deferred expenses related to convertible debenture
issuance.............................................................. 73,667 24,322 *
Amortization of capitalized research and development projects........... 9,163 -
Stock-based compensation due to repricing of warrants granted to
investors............................................................. 1,592,857 -
Stock-based compensation due to options granted to employees............ 4,500 -
Write-off of inventory.................................................. 41,487 20,000
Profit to minority...................................................... 546 43,227
Impairment of fixed assets.............................................. - 62,332
Interest income accrued on promissory notes due to purchase of
subsidiary............................................................ - (34,461)
Interest accrued on certificates of deposit due within one year......... (33,738) (762)
Amortization of premium related to restricted securities................ 33,993 -
Accrued interest on long-term loan...................................... 449 -
Capital gain from sale of property and equipment........................ (5,744) (1,576)
Accrued severance pay, net.............................................. (383,588) 44,216
Increase in deferred tax assets......................................... (16,809) -
Changes in operating asset and liability items:
Decrease (increase) in trade receivables................................ 2,108,359 (1,597,094)
Decrease in unbilled revenues........................................... 544,000 -
Decrease in notes receivable............................................ 97,741 -
Decrease (increase) in accounts receivable.............................. 76,912 (185,246)*
Decrease (increase) in inventories...................................... (1,398,145) 51,544
Increase (decrease) in trade payables................................... (53,819) 408,449
Decrease in deferred revenues........................................... (467,562) -
Increase (decrease) in accounts payable and accruals.................... (1,184,388) (120,060)
-------------------- -------------------
NET CASH USED IN OPERATING ACTIVITIES FROM CONTINUING OPERATIONS (1,416,760) (1,816,118)
(RECONCILED FROM CONTINUING OPERATIONS).................................
NET CASH USED IN OPERATING ACTIVITIES FROM DISCONTINUED OPERATIONS
(RECONCILED FROM DISCONTINUED OPERATIONS).............................. (56,116) (171,737)
-------------------- -------------------
NET CASH USED IN OPERATING ACTIVITIES..................................... (1,472,876) (1,987,855)
-------------------- -------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Repayment of promissory note related to purchase of subsidiary.......... (75,000) (750,000)
Investment in subsidiary(1)............................................. (7,186,837) -
Investment in subsidiary(2)............................................. (12,106,358) -
Purchase of property and equipment...................................... (234,032) (138,622)
Increase in capitalized research and development projects............... (67,482) -
Proceeds from sale of property and equipment............................ 10,284 5,402
Decrease in demo inventories, net....................................... 1,185 32,040
Purchase restricted securities and deposits, net........................ (8,418,569) -
-------------------- -------------------
NET CASH USED IN INVESTING ACTIVITIES..................................... (28,076,809) (851,180)
-------------------- -------------------
FORWARD $ (29,549,685) $ (2,839,035)
-------------------- -------------------

* Reclassified.

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

CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) (U.S. DOLLARS)

THREE MONTHS ENDED MARCH 31,
--------------------------------------------
2004 2003
-------------------- -------------------

FORWARD $ (29,549,685) $ (2,839,035)
-------------------- -------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in short-term credit from banks................................ 432,859 7,062
Proceeds from issuance of share capital, net............................ 17,807,500 -
Proceeds from exercise of options....................................... 5,468 -
Proceeds from exercise of warrants...................................... 2,490,722 -
Payment on capital lease obligation..................................... (914) (1,935)
Repayment of long-term loans............................................ (14,228) -
Issuance of convertible debenture....................................... - 3,238,662 *
-------------------- -------------------

NET CASH PROVIDED BY FINANCING ACTIVITIES.................................... 20,721,407 3,243,789
-------------------- -------------------

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............................. (8,828,278) 404,754

CASH EROSION DUE TO EXCHANGE RATE DIFFERENCES................................ (4,052) -

BALANCE OF CASH AND CASH EQUIVALENTS AT THE BEGINNING OF THE PERIOD.......... 13,685,125 1,457,526
-------------------- -------------------

BALANCE OF CASH AND CASH EQUIVALENTS AT THE END OF THE PERIOD................ $ 4,852,795 $ 1,862,280
==================== ===================

SUPPLEMENTARY INFORMATION ON NON-CASH TRANSACTIONS:
Issuance of shares and warrants against accrued expenses...................... $ 1,416,894 $ -
==================== ===================
Increase in restricted deposit due within one year........................... $ 110,114 $ -
==================== ===================
Investment in subsidiary against promissory note............................. $ 2,577,097 $ -
==================== ===================
Exercise of convertible debentures against shares............................ $ 1,150,000 $ -
==================== ===================
Compensation related to issuance of warrants in connection with convertible
debenture and beneficial conversion feature of convertible debentures........ $ - $ 1,890,000
==================== ===================

SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION - CASH (PAID) RECEIVED
DURING THE PERIOD FOR:
Interest............................................................ $ (94,865) $ (7,384)
==================== ===================

* Reclassified.

(1) In January 2004, the Company acquired substantially all of the outstanding
ordinary shares of Epsilor Electronic Industries, Ltd. ("Epsilor"). The
net fair value of the assets acquired and the liabilities assumed, at the
date of acquisition, was as follows:

Working capital, excluding cash and cash equivalents $ (533,750)
(unaudited)...........................................
Fixed assets (unaudited).............................. 709,847
Intangible assets and goodwill (unaudited)............ 9,587,837
------------
9,763,934
Issuance of promissory note (unaudited)............... (2,577,097)
------------
$ 7,186,837
============

CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) (U.S. DOLLARS)

(2) In January 2004, the Company acquired all of the outstanding common stock
of FAAC Incorporated ("FAAC"). The net fair value of the assets acquired
was as follows :

Working capital, excluding cash and cash equivalents $ 2,647,822
(unaudited)...........................................
Fixed assets (unaudited).............................. 263,669
Intangible assets and goodwill (unaudited)............ 11,201,695
------------
14,113,186
Issuance of shares, net (unaudited)................... (2,006,828)
------------
$ 12,106,358
============

AROTECH CORPORATION

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1: BASIS OF PRESENTATION

a. Company:

Arotech Corporation, formerly known as Electric Fuel Corporation ("Arotech" or
the "Company"), and its subsidiaries provide defense and security products for
the military, law enforcement and homeland security markets, including advanced
zinc-air and lithium batteries and chargers, multimedia interactive
simulators/trainers and lightweight vehicle armoring. The Company is primarily
operating through IES Interactive Training Systems, Inc., a wholly-owned
subsidiary based in Littleton, Colorado; FAAC Corporation, a wholly-owned
subsidiary based in Ann Arbor, Michigan; Electric Fuel Battery Corporation, a
wholly-owned subsidiary based in Auburn, Alabama; Electric Fuel Ltd. ("EFL") a
wholly-owned subsidiary based in Beit Shemesh, Israel; Epsilor Electronic
Industries, Ltd., a wholly-owned subsidiary located in Dimona, Israel; M.D.T.
Protective Industries, Ltd., a majority-owned subsidiary based in Lod, Israel;
and MDT Armor Corporation, a majority-owned subsidiary based in Auburn, Alabama.

b. Basis of presentation:

The accompanying interim consolidated financial statements have been prepared by
Arotech Corporation in accordance with generally accepted accounting principles
in the United States and the rules and regulations of the Securities and
Exchange Commission, and include the accounts of Arotech Corporation and its
subsidiaries. Certain information and footnote disclosures, normally included in
financial statements prepared in accordance with generally accepted accounting
principles in the United States, have been condensed or omitted pursuant to such
rules and regulations. 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 the financial position at
March 31, 2004 and the operating results and cash flows for the three months
ended March 31, 2004 and 2003.

The results of operations for the three months ended March 31, 2004 are not
necessarily indicative of results that may be expected for any other interim
period or for the full fiscal year ending December 31, 2004.

The balance sheet at December 31, 2003 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.

c. Accounting for stock-based compensation:

The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB No. 25") and FASB No.
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation" ("FIN No. 44") in accounting for its employee stock option plans.
Under APB No. 25, when the exercise price of the Company's stock options is less
than the market price of the underlying shares on the date of grant,
compensation expense is recognized.

Under Statement of Financial Accounting Standard No. 123 "Accounting for
Stock-Based Compensation ("SFAS No. 123"), pro forma information regarding net
income and net earnings per share is required, and has been determined as if the
Company had accounted for its employee stock options under the fair value method
of SFAS No. 123. The fair value for these options is amortized over their
vesting period and estimated at the date of grant using a Black-Scholes Option
Valuation Model with the following weighted-average assumptions for the three
months ended March 31, 2004 and 2003:

AROTECH CORPORATION

THREE MONTHS ENDED MARCH 31,
--------------------------------
2004 2003
------------- ---------------
(Unaudited)

Risk free interest 2.8% 3.5%
Dividend yields 0.0% 0.0%
Volatility 0.764 0.640
Expected life 5 5

Pro forma information under SFAS No. 123:

THREE MONTHS ENDED MARCH 31,
---------------------------
2004 2003
------------- ----------
Unaudited
(U.S. Dollars, except per
share data)
---------------------------

Net loss as reported $ (4,306,155) $(1,387,083)
============= ===========
Add: Stock-based compensation expense
determined under fair value method for
all awards, net of related tax effects $ (210,283) (551,397)
============= ===========

Pro forma net loss $ (4,516,438) $(1,938,480)
============= ===========
Loss per share:
Basic and diluted, as reported $ (0.07) $ (0.04)
============= ===========
Diluted, pro form $ (0.08) $ (0.06)
============= ===========

NOTE 2: ACQUISITION OF EPSILOR

In January of 2004, the Company entered into a stock purchase agreement between
itself and all of the shareholders of Epsilor Electronic Industries, Ltd.
("Epsilor"), pursuant to the terms of which the Company purchased all of the
outstanding stock of Epsilor from Epsilor's existing shareholders. Epsilor
develops and sells rechargeable and primary lithium batteries and smart chargers
to the military, and to private industry in the Middle East, Europe and Asia.
The total consideration of $10.0 million for the shares purchased consisted of
(i) cash in the amount of $7,000,000, and (ii) a series of three $1,000,000
promissory notes, due on the first, second and third anniversaries of the
agreement, which were recorded at their fair value of $2,577,097.

Based upon a preliminary valuation of tangible and intangible assets acquired,
Arotech has allocated the total cost of the acquisition to Epsilor's assets as
follows (unaudited):

AROTECH CORPORATION

Tangible assets acquired $ 2,360,968
Intangible assets
Technology 159,364
Customer list 4,889,671
Goodwill 4,538,801
Liabilities assumed (2,184,870)
-----------------
Total consideration $ 9,763,934
=================

In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets,"
goodwill arising from acquisitions will not be amortized. In lieu of
amortization, Arotech is required to perform an annual and interim impairment
review. If Arotech determines, through the impairment review process, that
goodwill has been impaired, it will record the impairment charge in its
statement of operations. Arotech will also assess the impairment of goodwill
whenever events or changes in circumstances indicate that the carrying value may
not be recoverable.

NOTE 3: ACQUISITION OF FAAC

In January of 2004, the Company entered into a stock purchase agreement with the
shareholders of FAAC Incorporated ("FAAC"), pursuant to the terms of which it
acquired all of the issued and outstanding common stock of FAAC, a leading
provider of driving simulators, systems engineering and software products to the
United States military, government and private industry.

The consideration for the purchase consisted of (i) cash in the amount of $12.0
million, and (ii) the issuance of a total of 1,003,856 shares of our common
stock, $0.01 par value per share, having a value of $2.0 million. Additionally,
there is an earn-out based on 2004 net pretax profit, with an additional
earn-out on the 2005 net profit from certain specific and limited programs. The
total consideration of $14.0 million was determined based upon arm's-length
negotiations between the Company and FAAC's shareholders.

Based upon a preliminary valuation of tangible and intangible assets acquired,
Arotech has allocated the total cost of the acquisition to FAAC's assets as
follows (unaudited):

Tangible assets acquired $ 5,684,583
Intangible assets
Technology 4,610,000
Existing contracts 636,000
Website 14,000
Customer list 1,125,000
Trademarks 360,000
Goodwill 4,456,695
Liabilities assumed (2,770,843)
-----------------
Total consideration $ 14,115,436
=================

AROTECH CORPORATION

NOTE 4: PRO FORMA FINANCIAL INFORMATION

In January 2004, the Company acquired FAAC and Epsilor, as more fully described
in "Note 2 - Acquisition of Epsilor" and "Note 3 - Acquisition of FAAC," above
(the "Acquisitions"). The following summary pro forma information includes the
effects of the Acquisitions. The pro forma data for the three months ended March
31, 2004 and 2003 are presented as if the Acquisitions had been completed on
January 1, 2004 and 2003, respectively. This pro forma financial information
does not purport to be indicative of the results of operations that would have
occurred had the Acquisitions taken place at the beginning of the period, nor do
they purport to be indicative of the results that will be obtained in the
future.

THREE MONTHS ENDED MARCH 31,
---------------------------------------
2004 2003
----------------- -----------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(Unaudited)

Total revenues................................ $ 7,182 $ 7,452
================= =================
Gross profit.................................. 2,625 3,217
================= =================
Net loss...................................... (4,306) (1,132)
================= =================
Basic and diluted net loss per share.......... $ (0.07) $ (0.03)
================= =================

NOTE 5: INVENTORIES

Inventories are stated at the lower of cost or market value. Cost is determined
using the average cost method. The Company periodically evaluates the quantities
on hand relative to current and historical selling prices and historical and
projected sales volume. Based on these evaluations, provisions are made in each
period to write down inventory to its net realizable value. Inventories are
composed of the following:

MARCH 31, 2004 DECEMBER 31, 2003
------------------ -----------------
(Unaudited) (Note 1.b.)

Raw materials................... $ 2,566,681 $ 657,677
Work-in-progress................ 727,002 634,221
Finished goods.................. 1,249,216 622,851
------------------ -----------------
$ 4,542,899 $ 1,914,748
================== =================

NOTE 6: IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN No. 46") which clarifies the application of
Accounting Research Bulletin (ARB) No. 51, "Consolidated Financial Statements,"
relating to consolidation of certain entities. First, FIN No. 46 will require
identification of the Company's participation in variable interest entities
(VIEs), which are defined as entities with a level of invested equity that is
not sufficient to fund future activities to permit them to operate on a
stand-alone basis, or whose equity holders lack certain characteristics of a
controlling financial interest. Then, for entities identified as VIEs, FIN No.
46 sets forth a model to evaluate potential consolidation based on an assessment
of which party to the VIE, if any, bears a majority of the exposure to its
expected losses, or stands to gain from a majority of its expected returns. FIN
No. 46 is effective for all new VIEs created or acquired after January 31, 2003.
For VIEs created or acquired prior to February 1, 2003, the provisions of FIN
No. 46 must be applied for the first interim or annual period beginning after
December 15, 2003. FIN No. 46 also sets forth certain disclosures regarding
interests in VIEs that are deemed significant, even if consolidation is not
required. The adoption of FIN No. 46 has not had a material impact on the
Company's results of operations or financial position.

AROTECH CORPORATION

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS No. 149"). SFAS No. 149
amends and clarifies the accounting for derivative instruments, including
certain derivative instruments embedded in other contracts, and for hedging
activities under SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities." SFAS No. 149 is generally effective for contracts entered
into or modified after June 30, 2003 and for hedging relationships designated
after June 30, 2003. The adoption of SFAS No. 149 has not had a material impact
on the Company's results of operations or financial position.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS No.
150"). SFAS No. 150 requires that certain financial instruments, which under
previous guidance were accounted for as equity, must now be accounted for as
liabilities. The financial instruments affected include mandatory redeemable
stock, certain financial instruments that require or may require the issuer to
buy back some of its shares in exchange for cash or other assets and certain
obligations that can be settled with shares of stock. SFAS No. 150 is effective
for all financial instruments entered into or modified after May 31, 2003 and
must be applied to the Company's existing financial instruments effective July
1, 2003, the beginning of the first fiscal period after June 15, 2003. The
adoption of SFAS No. 150 has not had a material effect on the Company's
financial position, results of operations or cash flows.

NOTE 7: SEGMENT INFORMATION

a. General:

The Company and its subsidiaries operate primarily in three business segments
and follow the requirements of SFAS No. 131.

The Company previously managed its business in two reportable segments organized
on the basis of differences in its related products and services. With the
acquisition of FAAC and Epsilor early in 2004, the Company reorganized into
three segments: Simulation, Training and Consulting; Battery and Power Systems;
and Armored Vehicles. As a result the Company reclassified information
previously reported in order to comply with new segment reporting.

The Company's reportable operating 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 operating segments are the
same as those of the Company. The Company evaluates performance based upon two
primary factors, one is the segment's operating income and the other is based on
the segment's contribution to the Company's future strategic growth.

b. The following is information about reported segment revenues, income (losses)
and assets for the three months ended March 31, 2004 and 2003 (in U.S. dollars):

AROTECH CORPORATION

SIMULATION,
TRAINING AND BATTERY AND ARMORED
CONSULTING POWER SYSTEMS VEHICLES ALL OTHERS TOTAL
--------------- --------------- --------------- --------------- --------------
THREE MONTHS ENDED MARCH 31, 2004

Revenues from outside customers $ 3,212,082 $ 2,505,621 $ 1,464,550 $ - $ 7,182,254
Depreciation expenses and amortization (385,100) (282,870) (29,450) (35,000) (732,421)
Direct expenses (1) (3,167,491) (2,463,960) (1,328,452) (2,519,963) (9,479,866)
--------------- --------------
Segment gross profit (loss) $ (340,509) $ (241,209) $ 106,648 $ (2,554,963) (3,030,033)
=============== =============== =============== ===============
Financial expense (after deduction of
minority interest) (1,276,122)
--------------
Net loss from continuing operations $(4,306,155)
==============
Segment assets 18,795,589 12,629,305 3,360,366 439,646 35,224,906
=============== =============== =============== =============== ==============

THREE MONTHS ENDED MARCH 31, 2003
Revenues from outside customers $ 1,958,446 $ 828,645 $ 1,246,362 $ - $ 4,033,453
Depreciation expenses and amortization (271,821) (119,024) (53,517) (48,000) (492,362)
Direct expenses (1) (1,725,235) (991,690) (1,150,274) (719,547) (4,586,746)
--------------- --------------- --------------- --------------- --------------
Segment gross profit (loss) $ (38,610) $ (282,069) $ 42,571 $ (767,547) (1,045,655)
=============== =============== =============== ===============
Financial income (after deduction of
minority interest) (245,466)
--------------
Net loss from continuing operations $(1,291,121)
==============
Segment assets 6,551,606 2,135,749 2,124,422 469,436 11,281,213
=============== =============== =============== =============== ==============

(1) Including sales and marketing, general and administrative and tax
expenses.
(2) Consisting of property and equipment, inventory and intangible assets.

NOTE 8: CONVERTIBLE DEBENTURES

a. 9% Secured Convertible Debentures due June 30, 2005

Pursuant to the terms of a Securities Purchase Agreement dated December 31,
2002, the Company issued and sold to a group of institutional investors an
aggregate principal amount of 9% secured convertible debentures in the amount of
$3.5 million due June 30, 2005. These debentures are convertible at any time
prior to June 30, 2005 at a conversion price of $0.75 per share (see also Note
9.a). The conversion price of these debentures was adjusted to $0.64 per share
in April 2003. In accordance with EITF 96-19, "Debtor's Accounting for a
Modification or Exchange of Debt Instruments," the terms of convertible
debentures are not treated as changed or modified when the cash flow effect on a
present value basis is less than 10%, and therefore the Company did not record
any compensation related to the change in the conversion price of the
convertible debentures.

During the three months ended March 31, 2004, the remaining $1,150,000 of 9%
secured convertible debentures outstanding was converted into an aggregate of
1,796,875 shares of common stock.

In determining whether the convertible debentures include a beneficial
conversion feature in accordance with EITF 98-5 "Accounting for Convertible
Securities with Beneficial Conversion Features or Continently Adjustable
Conversion Ratios" and EITF 00-27, the total proceeds were allocated to the
convertible debentures and the detachable warrants based on their relative fair
values. In connection with these convertible debentures, the Company recorded
financial expenses of $600,000 with respect to the beneficial conversion
feature. The $600,000 was amortized from the date of issuance to the actual
conversion date as financial expenses.

AROTECH CORPORATION

During the three months ended March 31, 2004, the Company recorded an expense of
$118,286, all which was attributable to amortization due to conversion of the
convertible debenture into shares.

b. 8% Secured Convertible Debentures due September 30, 2006

Pursuant to the terms of a Securities Purchase Agreement dated September 30,
2003, the Company issued and sold to a group of institutional investors an
aggregate principal amount of 8% secured convertible debentures in the amount of
$5.0 million due September 30, 2006. These debentures are convertible at any
time prior to September 30, 2006 at a conversion price of $1.15 per share, or a
maximum aggregate of 4,347,826 shares of common stock (see also Note 9.b).

In determining whether the convertible debentures include a beneficial
conversion option in accordance with EITF 98-5 "Accounting for Convertible
Securities with Beneficial Conversion Features or Continently Adjustable
Conversion Ratios" and EITF 00-27, the total proceeds were allocated to the
convertible debentures and the detachable warrants based on their relative fair
values. In connection with these convertible debentures, the Company will record
financial expenses of $1,938,043 with respect to the beneficial conversion
feature. The $1,938,043 is amortized from the date of issuance to the stated
redemption date - September 30, 2006 - as financial expenses.

During the three months ended March 31, 2004 the Company recorded an expense of
$39,424, all of which was attributable to amortization of the beneficial
conversion feature of the convertible debenture over its term.

c. 8% Secured Convertible Debentures due December 31, 2006

Pursuant to the terms of a Securities Purchase Agreement dated September 30,
2003, the Company issued and sold to a group of institutional investors an
aggregate principal amount of 8% secured convertible debentures in the amount of
$6.0 million due December 31, 2006. These debentures are convertible at any time
prior to December 31, 2006 at a conversion price of $1.45 per share, or a
maximum aggregate of 4,137,931 shares of common stock (see also Note 9.c).

In determining whether the convertible debentures include a beneficial
conversion option in accordance with EITF 98-5 "Accounting for Convertible
Securities with Beneficial Conversion Features or Continently Adjustable
Conversion Ratios" and EITF 00-27, the total proceeds were allocated to the
convertible debentures and the detachable warrants based on their relative fair
values. In connection with these convertible debentures, the Company will record
financial expenses of $3,157,500 with respect to the beneficial conversion
feature. The $3,157,500 is amortized from the date of issuance to the stated
redemption date - December 31, 2006 - as financial expenses.

During the three months ended March 31, 2004 the Company recorded an expense of
$257,236, all of which was attributable to amortization of the beneficial
conversion feature of the convertible debenture over its term.

AROTECH CORPORATION

NOTE 9: WARRANTS

a. Warrants issued in connection with the 9% Secured Convertible Debentures
due June 30, 2005

As part of the securities purchase agreement on December 31, 2002 (see Note
8.a), the Company issued to the purchasers of its 9% secured convertible
debentures due June 30, 2005, warrants, as follows: (i) Series A Warrants to
purchase an aggregate of 1,166,700 shares of common stock at any time prior to
December 31, 2007 at a price of $0.84 per share; (ii) Series B Warrants to
purchase an aggregate of 1,166,700 shares of common stock at any time prior to
December 31, 2007 at a price of $0.89 per share; and (iii) Series C Warrants to
purchase an aggregate of 1,166,700 shares of common stock at any time prior to
December 31, 2007 at a price of $0.93 per share. The exercise price of these
warrants was adjusted to $0.64 per share in April 2003.

In connection with these warrants, the Company recorded a deferred debt discount
of $1,290,000, which will be amortized ratably over the life of the convertible
debentures (3 years), unless these warrants are exercised, in which case any
remaining financial expense will be taken in the quarter in which the exercise
occurs. This transaction was accounted according to APB No. 14 "Accounting for
Convertible debt and Debt Issued with Stock Purchase Warrants" and Emerging
Issue Task Force No. 00-27 "Application of Issue No. 98-5 to Certain Convertible
Instruments" ("EITF 00-27"). The fair value of these warrants was determined
using Black-Scholes pricing model, assuming a risk-free interest rate of 3.5%, a
volatility factor 64%, dividend yields of 0% and a contractual life of 5 years.

During the three months ended March 31, 2003, the Company recorded an expense of
$73,714 for amortization of these debt discounts over their term, which is
included in financial expenses.

b. Warrants issued in connection with the 8% Secured Convertible Debentures due
September 30, 2006

As part of the securities purchase agreement on September 30, 2003 (see Note
8.b), the Company issued to the purchasers of its 8% secured convertible
debentures due September 30, 2006, warrants to purchase an aggregate of
1,250,000 shares of common stock at any time prior to September 30, 2006 at a
price of $1.4375 per share.

In connection with these warrants, the Company recorded a deferred debt discount
of $1,025,000, which will be amortized ratably over the life of the convertible
debentures (3 years). This transaction was accounted according to APB No. 14
"Accounting for Convertible debt and Debt Issued with Stock Purchase Warrants"
and Emerging Issue Task Force No. 00-27 "Application of Issue No. 98-5 to
Certain Convertible Instruments" ("EITF 00-27"). The fair value of these
warrants was determined using Black-Scholes pricing model, assuming a risk-free
interest rate of 1.95%, a volatility factor 98%, dividend yields of 0% and a
contractual life of 3 years.

During the three months ended March 31, 2004, an aggregate of 500,000 shares
were issued pursuant to exercises of these warrants.

During the three months ended March 31, 2004, the Company recorded an expense of
$396,860, of which $51,203 was attributable to amortization of the debt discount
over their term and $345,657 was attributable to amortization due to exercise of
warrants. Those expenses were included in the financial expenses.

AROTECH CORPORATION

c. Warrants issued in connection with 8% Secured Convertible Debentures due
December 31, 2006

As a further part of the securities purchase agreement on September 30, 2003
(see Note 8.c), the Company issued to the purchasers of its 8% secured
convertible debentures due December 31, 2006, warrants to purchase an aggregate
of 1,500,000 shares of common stock at any time prior to December 31, 2006 at a
price of $1.8125 per share. Additionally, the Company issued to the investors
supplemental warrants to purchase an aggregate of 1,038,000 shares of common
stock at any time prior to December 31, 2006 at a price of $2.20 per share.

In connection with these warrants, the Company will record financial expenses of
$ 1,545,000 and $1,297,500 for the additional and the supplemental warrants
referred to above, respectively, which will be amortized ratably over the life
of the convertible debentures (3 years). This transaction was accounted
according to APB No. 14 "Accounting for Convertible debt and Debt Issued with
Stock Purchase Warrants" and Emerging Issue Task Force No. 00-27 "Application of
Issue No. 98-5 to Certain Convertible Instruments" ("EITF 00-27"). The fair
value of these warrants was determined using Black-Scholes pricing model,
assuming a risk-free interest rate of 2.45%, a volatility factor 98%, dividend
yields of 0% and a contractual life of 3 years.

During the three months ended March 31, 2003, the Company recorded an expense of
$231,573 for amortization of these debt discounts over their term, which is
included in financial expenses.

d. Warrants issued to an investor

In November 2000 and May 2001, the Company issued a total of 916,667 warrants to
an investor, which warrants contained certain antidilution provisions: a Series
A warrant to purchase 666,667 shares of the Company's common stock at a price of
$3.50 per share, and a Series C warrant to purchase 250,000 shares at a price of
$3.08 per share. Operation of the antidilution provisions provided that the
Series A warrant should be adjusted to be a warrant to purchase 888,764 shares
at a price of $2.67 per share, and the Series C warrant should be adjusted to be
a warrant to purchase 333,286 shares at a price of $2.35 per share. After
negotiations, the investor agreed to exercise its warrants immediately, in
exchange for a lowering of the exercise price to $1.45 per share, and the
issuance of a new six-month Series D warrant to purchase 1,222,050 shares at an
exercise price of $2.10 per share. The new Series D warrant would not have
similar antidilution provisions. As a result of this repricing and the issuance
of these new warrants, the Company recorded a compensation expense in the amount
of approximately $1,299,690 in the first quarter of 2004.

NOTE 10: ISSUANCE OF SHARES AND WARRANTS

Pursuant to the terms of a Securities Purchase Agreement dated January 7, 2004
by and between the Company and several institutional investors, the Company
issued and sold (i) an aggregate of 9,840,426 shares of the Company's common
stock at a purchase price of $1.88 per share, and (ii) three-year warrants to
purchase up to an aggregate of 9,840,426 shares of the Company's common stock at
any time beginning six months after closing at an exercise price per share of
$1.88. Gross proceeds of this offering were approximately $18.5 million.

AROTECH CORPORATION

NOTE 11: LITIGATION SETTLEMENT

On February 4, 2004, the Company entered into an agreement settling the
litigation brought against it in the Tel-Aviv, Israel district court by I.E.S.
Electronics Industries, Ltd. ("IES Electronics") and certain of its affiliates
in connection with the Company's purchase of the assets of its IES Interactive
Training, Inc. from IES Electronics in August 2002. The litigation had sought
monetary damages in the amount of approximately $3.0 million.

Pursuant to the terms of the settlement agreement, in addition to agreeing to
dismiss their lawsuit with prejudice, IES Electronics agreed (i) to cancel the
Company's $450,000 debt to IES Electronics that had been due on December 31,
2003, and (ii) to transfer to the Company title to certain certificates of
deposit in the approximate principal amount of $112,000.

In consideration of the foregoing, the Company issued to IES Electronics (i)
450,000 shares of its common stock, and (ii) five-year warrants to purchase up
to an additional 450,000 shares of its common stock at a purchase price of $1.91
per share.

NOTE 12: SUBSEQUENT EVENTS

a. Conversion of debentures:

In April 2004, a total of $850,000 principal amount of debentures was converted
into an aggregate of 649,176 shares of our common stock.

b. Exercise of warrants:

In May 2004, warrants to purchase a total of 337,500 shares of common stock,
having an aggregate exercise price of $541,406 and issued in connection with the
issuance of the Company's debentures, were exercised.

c. Amendment to Certificate of Incorporation:

In February 2004, the Board of Directors of the Company approved a proposed
amendment to Article Four of the Company's Amended and Restated Certificate of
Incorporation to increase the number of shares of common stock that the Company
is authorized to issue from 100,000,000 to 250,000,000. The Board directed that
the proposed amendment be submitted to a vote of the Company's stockholders at
the Company's next annual meeting of stockholders, to be held on June 14, 2004.

AROTECH CORPORATION

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

This report contains forward-looking statements made pursuant to the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995. These
statements involve inherent risks and uncertainties. When used in this
discussion, the words "believes," "anticipated," "expects," "estimates" and
similar expressions are intended to identify such forward-looking statements.
Such statements are subject to certain risks and uncertainties that could cause
actual results to differ materially from those projected. Readers are cautioned
not to place undue reliance on these forward-looking statements, which speak
only as of the date hereof. We undertake no obligation to publicly release the
result of any revisions to these forward-looking statements that may be made to
reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events. Our actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors including, but not limited to, those set forth elsewhere in this
report. Please see "Risk Factors," below, and in our other filings with the
Securities and Exchange Commission.

Arotech(TM) is a trademark and Electric Fuel(R) is a registered trademark
of Arotech Corporation. All company and product names mentioned may be
trademarks or registered trademarks of their respective holders. Unless the
context requires otherwise, all references to us refer collectively to Arotech
Corporation and its subsidiaries.

The following discussion and analysis should be read in conjunction with
the interim financial statements and notes thereto appearing elsewhere in this
Quarterly Report. We have rounded amounts reported here to the nearest thousand,
unless such amounts are more than 1.0 million, in which event we have rounded
such amounts to the nearest hundred thousand.

EXECUTIVE SUMMARY

DIVISIONS AND SUBSIDIARIES

We operate primarily as a holding company, through our various
subsidiaries, which we have organized into three divisions. Our divisions and
subsidiaries (all 100% owned by us, unless otherwise noted) are as follows:

>> Our SIMULATION, TRAINING AND CONSULTING DIVISION, which develops,
manufactures and markets advanced hi-tech multimedia and interactive
digital solutions for use-of-force and driving training of military, law
enforcement and security personnel, as well as offering security
consulting and other services, consisting of:

o IES Interactive Training, Inc., located in Littleton, Colorado, which
provides specialized "use of force" training for police, security
personnel and the military ("IES");

o FAAC Incorporated, located in Ann Arbor, Michigan, which provides
simulators, systems engineering and software products to the United States
military, government and private industry ("FAAC"); and

AROTECH CORPORATION

o Arocon Security Corporation, located in New York, New York, which provides
security consulting and other services, focusing on protecting life,
assets and operations with minimum hindrance to personal freedom and daily
activities ("Arocon").

>> Our BATTERY AND POWER SYSTEMS DIVISION, which manufactures and sells
Zinc-Air and lithium batteries for defense and security products and other
military applications and pioneers advancements in Zinc-Air battery
technology for electric vehicles, consisting of:

o Electric Fuel Battery Corporation, located in Auburn, Alabama, which
manufactures and sells Zinc-Air fuel sells, batteries and chargers for the
military, focusing on applications that demand high energy and light
weight ("EFB");

o Epsilor Electronic Industries, Ltd., located in Dimona, Israel (in
Israel's Negev desert area), which develops and sells rechargeable and
primary lithium batteries and smart chargers to the military and to
private industry in the Middle East, Europe and Asia ("Epsilor"); and

o Electric Fuel (E.F.L.) Ltd., located in Beit Shemesh, Israel, which
produces water-activated lifejacket lights for commercial aviation and
marine applications, and which conducts our Electric Vehicle effort,
focusing on obtaining and implementing demonstration projects in the U.S.
and Europe, and on building broad industry partnerships that can lead to
eventual commercialization of our Zinc-Air energy system for electric
vehicles ("EFL").

>> Our ARMORED VEHICLE DIVISION, which utilizes sophisticated lightweight
materials and advanced engineering processes to armor vehicles, consisting
of:

o MDT Protective Industries, Ltd., located in Lod, Israel, which specializes
in using state-of-the-art lightweight ceramic materials, special ballistic
glass and advanced engineering processes to fully armor vans and cars, and
is a leading supplier to the Israeli military, Israeli special forces and
special services ("MDT") (75.5% owned by us); and

o MDT Armor Corporation, located in Auburn, Alabama, which conducts MDT's
United States activities ("MDT Armor") (88% owned by us).

OVERVIEW OF RESULTS OF OPERATIONS

We incurred significant operating losses for the years ended December 31,
2001, 2002 and 2003 and for the first three months of 2004. While we expect to
continue to derive revenues from the sale of products that we manufacture and
the services that we provide, there can be no assurance that we will be able to
achieve or maintain profitability on a consistent basis.

During 2003, we substantially increased our revenues and reduced our
operating loss, from $18.5 million in 2002 to $9.0 million in 2003. This was
achieved through a combination of cost-cutting measures and increased revenues,
particularly from the sale of Zinc-Air batteries to the military and from sales
of interactive training systems by IES. We believe that our acquisitions of FAAC
and Epsilor will contribute to our goal of achieving profitability.

AROTECH CORPORATION

We regard moving the company to a positive cash flow situation on a
consistent basis to be an important goal, and we are focused on achieving that
goal for the second half of 2004 and beyond. In this connection, we note that
most of our business lines historically have had weaker first halves than second
halves, and weaker first quarters than second quarters. We expect this to be the
case for 2004 as well.

A portion of our operating loss during the first three months of 2004
arose as a result of non-cash charges. These charges were primarily related to
our acquisitions and to our raising capital. Because we anticipate continuing
these activities during 2004, we expect to continue to incur such non-cash
charges in the future.

Non-cash charges related to acquisitions arise when the purchase price for
an acquired company exceeds the company's book value. In such a circumstance, a
portion of the excess of the purchase price is recorded as goodwill, and a
portion as intangible assets. In the case of goodwill, the assets recorded as
goodwill are not amortized; instead, we are required to perform an annual
impairment review. If we determine, through the impairment review process, that
goodwill has been impaired, we must record the impairment charge in our
statement of operations. Intangible assets are amortized in accordance with
their useful life. Accordingly, for a period of time following an acquisition,
we incur a non-cash charge in the amount of a fraction (based on the useful life
of the intangible assets) of the amount recorded as intangible assets. Our
acquisitions of FAAC and Epsilor resulted in our incurring similar non-cash
charges during the first three months of 2004.

As a result of the application of the above accounting rule, we incurred
non-cash charges related to our acquisitions in the amount of $496,013 during
the first three months of 2004.

The non-cash charges that relate to our financings occurred in connection
with our sale of convertible debentures with warrants. When we issue convertible
debentures, we record an expense for a beneficial conversion feature that is
amortized ratably over the life of the debenture. When a debenture is converted,
however, the entire remaining unamortized beneficial conversion feature expense
is immediately recognized in the quarter in which the debenture is converted.
Similarly, when we issue warrants in connection with convertible debentures, we
record an expense for financial expenses that is amortized ratably over the term
of the warrant; when the warrant is exercised, the entire remaining unamortized
financial expense is immediately recognized in the quarter in which the warrant
is exercised. As and to the extent that our remaining convertible debentures and
warrants are converted and exercised, we would incur similar non-cash charges
going forward.

As a result of the application of the above accounting rule, we incurred
non-cash charges related to our financings in the amount of $1,117,093 during
the first three months of 2004.

Additionally, in an effort to improve our cash situation and our
shareholders' equity, during the first three months of 2004 we induced holders
of certain of our warrants to exercise their warrants by lowering the exercise
price of the warrants in exchange for immediate exercise of such warrants, and
by issuing to such investors new warrants at a higher exercise price. Under such
circumstances, accounting rules require us to record a compensation expense in
an amount determined based upon the fair value of the new warrants (using a
Black-Scholes pricing model). As and to the extent that we engage in similar
warrant repricings and issuances in the future, we would incur similar non-cash
charges.

As a result of the application of the above accounting rule, we incurred
non-cash charges related to warrant repricings in the amount of $1,299,690
during the first three months of 2004.

AROTECH CORPORATION

In addition, we incurred non-cash charges in the amount of $293,167 during
the first three months of 2004 as a result of warrants granted to some of our
investors in the past.

FUNCTIONAL CURRENCY

We consider the United States dollar to be the currency of the primary
economic environment in which we and our Israeli subsidiary EFL operate and,
therefore, both we and EFL have adopted and are using the United States dollar
as our functional currency. Transactions and balances originally denominated in
U.S. dollars are presented at the original amounts. Gains and losses arising
from non-dollar transactions and balances are included in net income.

The majority of financial transactions of our Israeli subsidiaries MDT and
Epsilor, is in New Israel Shekels ("NIS") and a substantial portion of MDT's and
Epsilor's costs is incurred in NIS. Management believes that the NIS is the
functional currency of MDT and Epsilor. Accordingly, the financial statements of
MDT and Epsilor have been translated into U.S. dollars. All balance sheet
accounts have been translated using the exchange rates in effect at the balance
sheet date. Statement of operations amounts have been translated using the
average exchange rate for the period. The resulting translation adjustments are
reported as a component of accumulated other comprehensive loss in shareholders'
equity.

OVERVIEW OF OPERATING PERFORMANCE AND BACKLOG

We shut down our money-losing consumer battery operations and began
acquiring new businesses in the defense and security field in 2002. Since then,
we have concentrated on eliminating our operating deficit and moving Arotech to
cash-flow positive operations. In order to do this, we have focused on acquiring
businesses with strong revenues and profitable operations.

In the first three months of 2004, IES experienced a substantial slowdown
of new sales. As of March 31, 2004, our backlog for our Simulation, Training and
Consulting Division totaled $5.5 million, most of which was attributable to
FAAC.

In our Battery and Power Systems Division, EFB and Epsilor had revenues
roughly in line with expectations. As of March 31, 2004, our backlog for our
Battery and Power Systems Division totaled $7.2 million.

In our Armored Vehicle Division, MDT Armor experienced an increase in
revenues during the first three months of 2004 as a result of new orders in
connection with the War in Iraq. As of March 31, 2004, our backlog for our
Armored Vehicle Division totaled $8.8 million.

AROTECH CORPORATION

RESULTS OF OPERATIONS

PRELIMINARY NOTE

Results for the three months ended March 31, 2004 include the results of
FAAC and Epsilor for such period as a result of our acquisitions of these
companies early in the first quarter of 2004. The results of FAAC and Epsilor
were not included in our operating results for the three months ended March 31,
2003. Accordingly, the following period-to-period comparisons should not
necessarily be relied upon as indications of future performance.

THREE MONTHS ENDED MARCH 31, 2004 COMPARED TO THE THREE MONTHS ENDED MARCH 31,
2003.

REVENUES. During the first three months of 2004, we (through our
subsidiaries) recognized revenues as follows:

>> IES and FAAC recognized revenues from the sale of interactive use-of-force
training systems and from the provision of warranty services in connection
with such systems;

>> MDT and MDT Armor recognized revenues from payments under vehicle armoring
contracts and for service and repair of armored vehicles;

>> EFB and Epsilor recognized revenues from the sale of batteries, chargers
and adapters to the military, and under certain development contracts with
the U.S. Army;

>> Arocon recognized revenues under consulting agreements; and

>> EFL recognized revenues from the sale of lifejacket lights and from
subcontracting fees received in connection with Phase IV of the
United States Department of Transportation (DOT) electric bus
program.

Revenues for the three months ended March 31, 2004 totaled $7.2 million,
compared to $4.0 million in the comparable period in 2003, an increase of $3.1
million, or 78%. This increase was primarily attributable to the following
factors:

>> Increased revenues from our Armored Vehicle Division, particularly MDT
Armor;

>> Increased revenues from our Battery and Power Systems Division,
particularly CECOM revenues from EFB;

>> Revenues from FAAC and Epsilor present in the first quarter of 2004 that
were not present in the corresponding period of 2003.

These revenues were offset to some extent by

>> Decreased revenues from our IES subsidiary.

In the first quarter of 2004, revenues were $3.2 million for the
Simulation, Training and Consulting Division (compared to $2.0 million in the
first quarter of 2003, an increase of $1.3 million, or 64%, due primarily to the
added revenues of FAAC, offset to some extent by decreased revenues from IES);
$2.5 million for the Battery and Power Systems Division (compared to $829,000 in
the first quarter of 2003, an increase of $1.7 million, or 202%, due primarily
to increased sales of our Zinc-Air military batteries and the added revenues of
Epsilor); and $1.5 million for the Armored Vehicle Division (compared to $1.2
million in the first quarter of 2003, an increase of $218,000, or 18%, due
primarily to increased revenues from MDT Armor).

AROTECH CORPORATION

COST OF REVENUES AND GROSS PROFIT. Cost of revenues totaled $4.6 million
during the first quarter of 2004, compared to $2.6 million in the first quarter
of 2003, an increase of $1.9 million, or 73%, due primarily to increased sales
in all divisions.

Direct expenses for our three divisions during the first quarter of 2004
were $3.2 million for the Simulation, Training and Consulting Division (compared
to $1.7 million in the first quarter of 2003, an increase of $1.4 million, or
84%, due primarily the added expenses of FAAC, offset to some extent by
decreased sales by IES); $2.5 million for the Battery and Power Systems Division
(compared to $1.0 million in the first quarter of 2003, an increase of $1.5
million, or 148%, due primarily to increased in sales of our Zinc-Air military
batteries and the added revenues of Epsilor ($738,000); and $1.3 million for the
Armored Vehicle Division (compared to $1.2 million in the first quarter of 2003,
an increase of $178,000, or 15%, due primarily to increased revenues from MDT
Armor).

Gross profit was $2.6 million during the first quarter of 2004, compared
to $1.4 million during the first quarter of 2003, an increase of $1.2 million,
or 88%. This increase was the direct result of all factors presented above, most
notably the presence of FAAC and Epsilor in our results and the increase in
vehicle armoring revenues.

RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses for
the first quarter of 2004 were $464,000, compared to $358,000 during the first
quarter of 2003, an increase of $105,000, or 29%. This increase was the result
of the inclusion of the research and development expenses of FAAC and Epsilor in
our results this quarter.

SALES AND MARKETING EXPENSES. Sales and marketing expenses for the first
quarter of 2004 were $1.0 million, compared to $704,000 the first quarter of
2003, an increase of $317,000, or 45%. This increase was primarily attributable
to the following factors:

>> The inclusion of the sales and marketing expenses of FAAC and
Epsilor in our results for 2004; and

>> We incurred expenses in connection with new activities by our Arocon
and MDT Armor subsidiaries.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
for the first quarter of 2004 were $3.7 million compared to $1.0 million in the
first quarter of 2003, an increase of $2.7 million, or 263%. This increase was
primarily attributable to the following factors:

AROTECH CORPORATION

>> The inclusion of the general and administrative expenses of FAAC and
Epsilor in our results for 2004;

>> Expenses in 2004 in connection with warrant repricings and grants of
new warrants, in the amount of $1.6 million, that were not present
in 2003; and

>> Increases in other general and administrative expenses in comparison
to 2003, such as employee accruals and amortization of certain
expenses related to convertible debentures.

FINANCIAL EXPENSES, NET. Financial expenses, net of interest income and
exchange differentials, totaled approximately $1.3 million in the first quarter
of 2004 compared to $261,000 in the first quarter of 2003, a difference of $1.0
million. This difference was due primarily to amortization of compensation
related to the issuance of convertible debentures, as well as interest expenses
related to those debentures.

INCOME TAXES. We and certain of our subsidiaries incurred net operating
losses during 2004 and, accordingly, we were not required to make any provision
for income taxes. With respect to those of our subsidiaries that operated at a
net profit during 2004, we were able to offset federal taxes against our loss
carryforwards. We recorded a total of $5,000 in tax income in the first quarter
of 2004, on account of deferred tax assets with respect to certain of our
subsidiaries. In the first quarter of 2003, we did not accrue any tax expenses.

AMORTIZATION OF INTANGIBLE ASSETS. Amortization of intangible assets
totaled $496,000 in the first quarter of 2004, compared to $312,000 the first
quarter of 2003, an increase of $184,000, or 59%. $226,000 of this amortization
was attributable to FAAC and $142,000 was attributable to Epsilor.

NET LOSS. Due to the factors cited above, we reported a net loss of $4.3
million in the first quarter of 2004, compared to a net loss of $1.4 million the
first quarter of 2003, an increase of $2.9 million.

LIQUIDITY AND CAPITAL RESOURCES

As of March 31, 2004, we had $4.9 million in cash, $5.7 million in
restricted collateral securities and cash deposits due within one year, $3.8
million in long-term restricted securities and deposits, and $124,000 in
marketable securities, as compared to at December 31, 2003, when we had $13.7
million in cash and $706,000 in restricted cash deposits due within one year.
The decrease in cash was primarily the result of the costs of the acquisitions
of FAAC and Epsilor, and working capital needed in our other segments.

We used available funds in the first quarter of 2004 primarily for
acquisitions, sales and marketing, continued research and development
expenditures, and other working capital needs. We increased our investment in
fixed assets during the quarter ended March 31, 2004 by $234,000 over the
investment as at December 31, 2003, primarily in the Battery and Power Systems
Division and in the Simulation, Training and Consulting Division. Our fixed
assets amounted to $3.2 million at quarter end.

Net cash used in operating activities from continuing operations for the
three months ended March 31, 2004 and 2003 was $1.4 million and $1.8 million,
respectively, a decrease of $399,000, or 22%. This decrease was primarily the
result of changes in operating assets and liabilities, particularly a decrease
in trade receivables.

AROTECH CORPORATION

Net cash used in investing activities for the three months ended March 31,
2004 and 2003 was $28.1 million and $851,000, respectively, an increase of $27.0
million. This increase was primarily the result of our investment in the
acquisition of FAAC and Epsilor in 2004.

Net cash provided by financing activities for the three months ended March
31, 2004 and 2003 was $20.7 million and $3.2 million, respectively, an increase
of $17.5 million, or 539%. This increase was primarily the result of higher
amounts of funds raised through sales of our securities in 2004 compared to
2003.

During the three months ended March 31, 2004, certain of our employees
exercised options under our registered employee stock option plan. The proceeds
to us from the exercised options were approximately $5,000.

On January 7, 2004, we issued (i) an aggregate of 9,840,426 shares of our
common stock at a purchase price of $1.88 per share, and (ii) three-year
warrants to purchase up to an aggregate of 9,840,426 shares of our common stock
at any time beginning six months after closing at an exercise price per share of
$1.88, as more fully described in the Current Report on Form 8-K that we filed
with the Securities and Exchange Commission on January 8, 2004. Gross proceeds
of this offering were approximately $18.5 million.

As of March 31, 2004, we had (based on the contractual amount of the debt
and not on the accounting valuation of the debt) approximately $9.4 million in
long term bank and certificated debt outstanding, of which $7.2 million was
convertible debt, and approximately $2.0 million in short-term debt.

Our current debt agreements grant to our investors a right of first
refusal on any future financings, except for underwritten public offerings in
excess of $30 million. We do not believe that this covenant will materially
limit our ability to undertake future financings.

Based on our internal forecasts, we believe that our present cash position
and anticipated cash flows from operations should be sufficient to satisfy our
current estimated cash requirements through the next year. This belief is based
on certain assumptions that our management believes to be reasonable, some of
which are subject to the risk factors detailed below. Over the long term, we
will need to become profitable, at least on a cash-flow basis, and maintain that
profitability in order to avoid future capital requirements. Additionally, we
would need to raise additional capital in order to fund any future acquisitions.

RISK FACTORS

The following factors, among others, could cause actual results to differ
materially from those contained in forward-looking statements made in this
Report and presented elsewhere by management from time to time.

AROTECH CORPORATION

BUSINESS-RELATED RISKS

WE HAVE HAD A HISTORY OF LOSSES AND MAY INCUR FUTURE LOSSES.

We were incorporated in 1990 and began our operations in 1991. We have
funded our operations principally from funds raised in each of the initial
public offering of our common stock in February 1994; through subsequent public
and private offerings of our common stock and equity and debt securities
convertible into shares of our common stock; research contracts and supply
contracts; funds received under research and development grants from the
Government of Israel; and sales of products that we and our subsidiaries
manufacture. We have incurred significant operating losses since our inception.
Additionally, as of March 31, 2004, we had an accumulated deficit of
approximately $114.0 million. There can be no assurance that we will ever be
able to maintain profitability consistently or that our business will continue
to exist.

OUR EXISTING INDEBTEDNESS MAY ADVERSELY AFFECT OUR ABILITY TO OBTAIN
ADDITIONAL FUNDS AND MAY INCREASE OUR VULNERABILITY TO ECONOMIC OR BUSINESS
DOWNTURNS.

Our bank and certificated indebtedness aggregated approximately $11.4
million as of March 31, 2004. Accordingly, we are subject to the risks
associated with indebtedness, including:

o we must dedicate a portion of our cash flows from operations to pay debt
service costs and, as a result, we have less funds available for
operations, future acquisitions of consumer receivable portfolios, and
other purposes;

o it may be more difficult and expensive to obtain additional funds through
financings, if available at all;

o we are more vulnerable to economic downturns and fluctuations in interest
rates, less able to withstand competitive pressures and less flexible in
reacting to changes in our industry and general economic conditions; and

o if we default under any of our existing debt instruments or if our
creditors demand payment of a portion or all of our indebtedness, we may
not have sufficient funds to make such payments.

The occurrence of any of these events could materially adversely affect our
results of operations and financial condition and adversely affect our stock
price.

The agreements governing the terms of our debentures contain numerous
affirmative and negative covenants that limit the discretion of our management
with respect to certain business matters and place restrictions on us, including
obligations on our part to preserve and maintain our assets and restrictions on
our ability to incur or guarantee debt, to merge with or sell our assets to
another company, and to make significant capital expenditures without the
consent of the debenture holders. Our ability to comply with these and other
provisions of such agreements may be affected by changes in economic or business
conditions or other events beyond our control.

AROTECH CORPORATION

FAILURE TO COMPLY WITH THE TERMS OF OUR DEBENTURES COULD RESULT IN A DEFAULT
THAT COULD HAVE MATERIAL ADVERSE CONSEQUENCES FOR US.

A failure to comply with the obligations contained in our debenture
agreements could result in an event of default under such agreements which could
result in an acceleration of the debentures and the acceleration of debt under
other instruments evidencing indebtedness that may contain cross-acceleration or
cross-default provisions. If the indebtedness under the debentures or other
indebtedness were to be accelerated, there can be no assurance that our assets
would be sufficient to repay in full such indebtedness.

WE HAVE PLEDGED A SUBSTANTIAL PORTION OF OUR ASSETS TO SECURE OUR BORROWINGS.

Our debentures are secured by a substantial portion of our assets. If we
default under the indebtedness secured by our assets, those assets would be
available to the secured creditors to satisfy our obligations to the secured
creditors, which could materially adversely affect our results of operations and
financial condition and adversely affect our stock price.

WE NEED SIGNIFICANT AMOUNTS OF CAPITAL TO OPERATE AND GROW OUR BUSINESS.

We require substantial funds to market our products and develop and market
new products. To the extent that we are unable to fully fund our operations
through profitable sales of our products and services, we may continue to seek
additional funding, including through the issuance of equity or debt securities.
However, there can be no assurance that we will obtain any such additional
financing in a timely manner or on acceptable terms. If additional funds are
raised by issuing equity securities, stockholders may incur further dilution. If
additional funding is not secured, we will have to modify, reduce, defer or
eliminate parts of our anticipated future commitments and/or programs.

WE MAY NOT BE SUCCESSFUL IN OPERATING A NEW BUSINESS.

Prior to the acquisitions of IES and MDT in 2002 and the acquisitions of
FAAC and Epsilor in January 2004, our primary business was the marketing and
sale of products based on primary and refuelable Zinc-Air fuel cell technology
and advancements in battery technology for defense and security products and
other military applications, electric vehicles and consumer electronics. As a
result of our acquisitions, a substantial component of our business is the
marketing and sale of hi-tech multimedia and interactive training solutions and
sophisticated lightweight materials and advanced engineering processes used to
armor vehicles. These are new businesses for us and our management group has
limited experience operating these types of businesses. Although we have
retained our acquired companies' management personnel, we cannot assure that
such personnel will continue to work for us or that we will be successful in
managing this new business. If we are unable to successfully operate these new
businesses, our business, financial condition and results of operations could be
materially impaired.

OUR ACQUISITION STRATEGY INVOLVES VARIOUS RISKS.

Part of our strategy is to grow through the acquisition of companies that
will complement our existing operations or provide us with an entry into markets
we do not currently serve. Growth through acquisitions involves substantial
risks, including the risk of improper valuation of the acquired business and the
risk of inadequate integration. There can be no assurance that suitable
acquisition candidates will be available, that we will be able to acquire or
manage profitably such additional companies or that future acquisitions will
produce returns that justify our investments therein. In addition, we may
compete for acquisition and expansion opportunities with companies that have
significantly greater resources than we do. Furthermore, acquisitions could
disrupt our ongoing business, distract the attention of our senior managers,
make it difficult to maintain our operational standards, controls and procedures
and subject us to contingent and latent risks that are different, in nature and
magnitude, than the risks we currently face.

AROTECH CORPORATION

We may finance future acquisitions with cash from operations or additional
debt or equity financings. There can be no assurance that we will be able to
generate internal cash or obtain financing from external sources or that, if
available, such financing will be on terms acceptable to us. The issuance of
additional common stock to finance acquisitions may result in substantial
dilution to our stockholders. Any debt financing may significantly increase our
leverage and may involve restrictive covenants which limit our operations.

WE MAY NOT SUCCESSFULLY INTEGRATE OUR NEW ACQUISITIONS.

In light of our recent acquisitions of IES, MDT, FAAC and Epsilor, our
success will depend in part on our ability to manage the combined operations of
these companies and to integrate the operations and personnel of these companies
along with our other subsidiaries and divisions into a single organizational
structure. There can be no assurance that we will be able to effectively
integrate the operations of our subsidiaries and divisions and our
newly-acquired businesses into a single organizational structure. Integration of
these operations could also place additional pressures on our management as well
as on our key technical resources. The failure to successfully manage this
integration could have an adverse material effect on us.

If we are successful in acquiring additional businesses, we may experience
a period of rapid growth that could place significant additional demands on, and
require us to expand, our management, resources and management information
systems. Our failure to manage any such rapid growth effectively could have a
material adverse effect on our financial condition, results of operations and
cash flows.

IF WE ARE UNABLE TO MANAGE OUR GROWTH, OUR OPERATING RESULTS WILL BE IMPAIRED.

We are currently experiencing a period of growth and development activity
which could place a significant strain on our personnel and resources. Our
activity has resulted in increased levels of responsibility for both existing
and new management personnel. Many of our management personnel have had limited
or no experience in managing growing companies. We have sought to manage our
current and anticipated growth through the recruitment of additional management
and technical personnel and the implementation of internal systems and controls.
However, our failure to manage growth effectively could adversely affect our
results of operations.

A SIGNIFICANT PORTION OF OUR BUSINESS IS DEPENDENT ON GOVERNMENT CONTRACTS.

Many of the customers of IES and FAAC to date have been in the public
sector of the U.S., including the federal, state and local governments, and in
the public sectors of a number of other countries, and most of MDT's customers
have been in the public sector in Israel, in particular the Ministry of Defense.
Additionally, all of EFB's sales to date of battery products for the military
and defense sectors have been in the public sector in the United States. A
significant decrease in the overall level or allocation of defense spending or
law enforcement in the U.S. or other countries could have a material adverse
effect on our future results of operations and financial condition. MDT has
already experienced a slowdown in orders from the Ministry of Defense due to
budget constraints and a requirement of U.S. aid to Israel that a substantial
proportion of such aid be spent in the U.S., where MDT has only recently opened
a factory in operation.

AROTECH CORPORATION

Sales to public sector customers are subject to a multiplicity of detailed
regulatory requirements and public policies as well as to changes in training
and purchasing priorities. Contracts with public sector customers may be
conditioned upon the continuing availability of public funds, which in turn
depends upon lengthy and complex budgetary procedures, and may be subject to
certain pricing constraints. Moreover, U.S. government contracts and those of
many international government customers may generally be terminated for a
variety of factors when it is in the best interests of the government and
contractors may be suspended or debarred for misconduct at the discretion of the
government. There can be no assurance that these factors or others unique to
government contracts or the loss or suspension of necessary regulatory licenses
will not have a material adverse effect on our future results of operations and
financial condition.

OUR U.S. GOVERNMENT CONTRACTS MAY BE TERMINATED AT ANY TIME AND MAY CONTAIN
OTHER UNFAVORABLE PROVISIONS.

The U.S. government typically can terminate or modify any of its contracts
with us either for its convenience or if we default by failing to perform under
the terms of the applicable contract. A termination arising out of our default
could expose us to liability and have a material adverse effect on our ability
to re-compete for future contracts and orders. Our U.S. government contracts
contain provisions that allow the U.S. government to unilaterally suspend us
from receiving new contracts pending resolution of alleged violations of
procurement laws or regulations, reduce the value of existing contracts, issue
modifications to a contract and control and potentially prohibit the export of
our products, services and associated materials.

A negative audit by the U.S. government could adversely affect our
business, and we might not be reimbursed by the government for costs that we
have expended on our contracts.

Government agencies routinely audit government contracts. These agencies
review a contractor's performance on its contract, pricing practices, cost
structure and compliance with applicable laws, regulations and standards. If we
are audited, we will not be reimbursed for any costs found to be improperly
allocated to a specific contract, while we would be required to refund any
improper costs for which we had already been reimbursed. Therefore, an audit
could result in a substantial adjustment to our revenues. If a government audit
uncovers improper or illegal activities, we may be subject to civil and criminal
penalties and administrative sanctions, including termination of contracts,
forfeitures of profits, suspension of payments, fines and suspension or
debarment from doing business with United States government agencies. We could
suffer serious reputational harm if allegations of impropriety were made against
us. A governmental determination of impropriety or illegality, or an allegation
of impropriety, could have a material adverse effect on our business, financial
condition or results of operations.

AROTECH CORPORATION

WE MAY BE LIABLE FOR PENALTIES UNDER A VARIETY OF PROCUREMENT RULES AND
REGULATIONS, AND CHANGES IN GOVERNMENT REGULATIONS COULD ADVERSELY IMPACT OUR
REVENUES, OPERATING EXPENSES AND PROFITABILITY.

Our defense and commercial businesses must comply with and are affected by
various government regulations that impact our operating costs, profit margins
and our internal organization and operation of our businesses. Among the most
significant regulations are the following:

o the U.S. Federal Acquisition Regulations, which regulate the
formation, administration and performance of government contracts;

o the U.S. Truth in Negotiations Act, which requires certification and
disclosure of all cost and pricing data in connection with contract
negotiations; and

o the U.S. Cost Accounting Standards, which impose accounting
requirements that govern our right to reimbursement under certain
cost-based government contracts.

These regulations affect how we and our customers do business and, in some
instances, impose added costs on our businesses. Any changes in applicable laws
could adversely affect the financial performance of the business affected by the
changed regulations. With respect to U.S. government contracts, any failure to
comply with applicable laws could result in contract termination, price or fee
reductions or suspension or debarment from contracting with the U.S. government.

OUR OPERATING MARGINS MAY DECLINE UNDER OUR FIXED-PRICE CONTRACTS IF WE FAIL TO
ESTIMATE ACCURATELY THE TIME AND RESOURCES NECESSARY TO SATISFY OUR OBLIGATIONS.

Some of our contracts are fixed-price contracts under which we bear the
risk of any cost overruns. Our profits are adversely affected if our costs under
these contracts exceed the assumptions that we used in bidding for the contract.
In the first three months of 2004, approximately 27% of our revenues were
derived from fixed-price contracts for both defense and non-defense related
government contracts. Often, we are required to fix the price for a contract
before we finalize the project specifications, which increases the risk that we
will mis-price these contracts. The complexity of many of our engagements makes
accurately estimating our time and resources more difficult.

IF WE ARE UNABLE TO RETAIN OUR CONTRACTS WITH THE U.S. GOVERNMENT AND
SUBCONTRACTS UNDER U.S. GOVERNMENT PRIME CONTRACTS IN THE COMPETITIVE REBIDDING
PROCESS, OUR REVENUES MAY SUFFER.

Upon expiration of a U.S. government contract or subcontract under a U.S.
government prime contract, if the government customer requires further services
of the type provided in the contract, there is frequently a competitive
rebidding process. We cannot guarantee that we, or if we are a subcontractor
that the prime contractor, will win any particular bid, or that we will be able
to replace business lost upon expiration or completion of a contract. Further,
all U.S. government contracts are subject to protest by competitors. The
termination of several of our significant contracts or nonrenewal of several of
our significant contracts, could result in significant revenue shortfalls.

AROTECH CORPORATION

WE CANNOT ASSURE YOU OF MARKET ACCEPTANCE OF OUR ELECTRIC VEHICLE TECHNOLOGY.

Our batteries for the defense industry and a signal light powered by
water-activated batteries for use in life jackets and other rescue apparatus are
the only commercial Zinc-Air battery products we currently have available for
sale. Significant resources will be required to develop and produce additional
products utilizing this technology on a commercial scale. Additional development
will be necessary in order to commercialize our technology and each of the
components of the Electric Fuel System for electric vehicles. We cannot assure
you that we will be able to successfully develop, engineer or commercialize our
Zinc-Air energy system. The likelihood of our future success must be considered
in light of the risks, expenses, difficulties and delays frequently encountered
in connection with the operation and development of a relatively early stage
business and with development activities generally.

We believe that public pressure and government initiatives are important
factors in creating an electric vehicle market. However, there can be no
assurance that there will be sufficient public pressure or that further
legislation or other governmental initiatives will be enacted, or that current
legislation will not be repealed, amended, or have its implementation delayed.
In addition, we are subject to the risk that even if an electric fuel vehicle
market develops, a different form of zero emission or low emission vehicle will
dominate the market. In addition, we cannot assure you that other solutions to
the problem of containing emissions created by internal combustion engines will
not be invented, developed and produced. Any other solution could achieve
greater market acceptance than electric vehicles. The failure of a significant
market for electric vehicles to develop would have a material adverse effect on
our ability to commercialize this aspect of our technology. Even if a
significant market for electric vehicles develops, there can be no assurance
that our technology will be commercially competitive within that market.

SOME OF THE COMPONENTS OF OUR ELECTRIC VEHICLE TECHNOLOGY AND OUR PRODUCTS POSE
POTENTIAL SAFETY RISKS WHICH COULD CREATE POTENTIAL LIABILITY EXPOSURE FOR US.

Some of the components of our electric vehicle technology and our products
contain elements that are known to pose potential safety risks. Also, because
electric vehicle batteries contain large amounts of electrical energy, they may
cause injuries if not handled properly. In addition to these risks, and there
can be no assurance that accidents in our facilities will not occur. Any
accident, whether occasioned by the use of all or any part of our products or
technology or by our manufacturing operations, could adversely affect commercial
acceptance of our products and could result in significant production delays or
claims for damages resulting from injuries. Any of these occurrences would
materially adversely affect our operations and financial condition.

WE MAY FACE PRODUCT LIABILITY CLAIMS.

In the event that our products, including the products manufactured by
MDT, fail to perform as specified, users of these products may assert claims for
substantial amounts. These claims could have a materially adverse effect on our
financial condition and results of operations. There is no assurance that the
amount of the general product liability insurance that we maintain will be
sufficient to cover potential claims or that the present amount of insurance can
be maintained at the present level of cost, or at all.

AROTECH CORPORATION

OUR FIELDS OF BUSINESS ARE HIGHLY COMPETITIVE.

The competition to develop defense and security products and electric
vehicle battery systems, and to obtain funding for the development of these
products, is, and is expected to remain, intense.

Our defense and security products compete with other manufacturers of
specialized training systems, including Firearms Training Systems, Inc., a
producer of interactive simulation systems designed to provide training in the
handling and use of small and supporting arms. In addition, we compete with
manufacturers and developers of armor for cars and vans, including O'Gara-Hess &
Eisenhardt, a division of Armor Holdings, Inc.

Our battery technology competes with other battery technologies, as well
as other Zinc-Air technologies. The competition in this area of our business
consists of development stage companies, major international companies and
consortia of such companies, including battery manufacturers, automobile
manufacturers, energy production and transportation companies, consumer goods
companies and defense contractors. Many of our competitors have financial,
technical, marketing, sales, manufacturing, distribution and other resources
significantly greater than ours.

Various battery technologies are being considered for use in electric
vehicles and defense and safety products by other manufacturers and developers,
including the following: lead-acid, nickel-cadmium, nickel-iron, nickel-zinc,
nickel-metal hydride, sodium-sulfur, sodium-nickel chloride, zinc-bromine,
lithium-ion, lithium-polymer, lithium-iron sulfide, primary lithium,
rechargeable alkaline and Zinc-Air.

If we are unable to compete successfully in each of our operating areas,
especially in the defense and security products area of our business, our
business and results of operations could be materially adversely affected.

OUR BUSINESS IS DEPENDENT ON PROPRIETARY RIGHTS THAT MAY BE DIFFICULT TO PROTECT
AND COULD AFFECT OUR ABILITY TO COMPETE EFFECTIVELY.

Our ability to compete effectively will depend on our ability to
maintain the proprietary nature of our technology and manufacturing processes
through a combination of patent and trade secret protection, non-disclosure
agreements and licensing arrangements.

Litigation, or participation in administrative proceedings, may be
necessary to protect our proprietary rights. This type of litigation can be
costly and time consuming and could divert company resources and management
attention to defend our rights, and this could harm us even if we were to be
successful in the litigation. In the absence of patent protection, and despite
our reliance upon our proprietary confidential information, our competitors may
be able to use innovations similar to those used by us to design and manufacture
products directly competitive with our products. In addition, no assurance can
be given that others will not obtain patents that we will need to license or
design around. To the extent any of our products are covered by third-party
patents, we could need to acquire a license under such patents to develop and
market our products.

AROTECH CORPORATION

Despite our efforts to safeguard and maintain our proprietary rights, we
may not be successful in doing so. In addition, competition is intense, and
there can be no assurance that our competitors will not independently develop or
patent technologies that are substantially equivalent or superior to our
technology. Moreover, in the event of patent litigation, we cannot assure you
that a court would determine that we were the first creator of inventions
covered by our issued patents or pending patent applications or that we were the
first to file patent applications for those inventions. If existing or future
third-party patents containing broad claims were upheld by the courts or if we
were found to infringe third party patents, we may not be able to obtain the
required licenses from the holders of such patents on acceptable terms, if at
all. Failure to obtain these licenses could cause delays in the introduction of
our products or necessitate costly attempts to design around such patents, or
could foreclose the development, manufacture or sale of our products. We could
also incur substantial costs in defending ourselves in patent infringement suits
brought by others and in prosecuting patent infringement suits against
infringers.

We also rely on trade secrets and proprietary know-how that we seek to
protect, in part, through non-disclosure and confidentiality agreements with our
customers, employees, consultants, and entities with which we maintain strategic
relationships. We cannot assure you that these agreements will not be breached,
that we would have adequate remedies for any breach or that our trade secrets
will not otherwise become known or be independently developed by competitors.

WE ARE DEPENDENT ON KEY PERSONNEL AND OUR BUSINESS WOULD SUFFER IF WE FAIL TO
RETAIN THEM.

We are highly dependent on the presidents of our IES and FAAC subsidiaries
and the general managers of our MDT and Epsilor subsidiaries, and the loss of
the services of one or more of these persons could adversely affect us. We are
especially dependent on the services of our Chairman, President and Chief
Executive Officer, Robert S. Ehrlich. The loss of Mr. Ehrlich could have a
material adverse effect on us. We are party to an employment agreement with Mr.
Ehrlich, which agreement expires at the end of 2005. We do not have key-man life
insurance on Mr. Ehrlich.

THERE ARE RISKS INVOLVED WITH THE INTERNATIONAL NATURE OF OUR BUSINESS.

A significant portion of our sales are made to customers located outside
the U.S., primarily in Europe and Asia. In 2003, 2002 and 2001, without taking
account of revenues derived from discontinued operations, 42%, 56% and 49%,
respectively, of our revenues, were derived from sales to customers located
outside the U.S. We expect that our international customers will continue to
account for a substantial portion of our revenues in the near future. Sales to
international customers may be subject to political and economic risks,
including political instability, currency controls, exchange rate fluctuations,
foreign taxes, longer payment cycles and changes in import/export regulations
and tariff rates. In addition, various forms of protectionist trade legislation
have been and in the future may be proposed in the U.S. and certain other
countries. Any resulting changes in current tariff structures or other trade and
monetary policies could adversely affect our sales to international customers.

AROTECH CORPORATION

INVESTORS SHOULD NOT PURCHASE OUR COMMON STOCK WITH THE EXPECTATION OF
RECEIVING CASH DIVIDENDS.

We currently intend to retain any future earnings for funding growth and,
as a result, do not expect to pay any cash dividends in the foreseeable future.

MARKET-RELATED RISKS

THE PRICE OF OUR COMMON STOCK IS VOLATILE.

The market price of our common stock has been volatile in the past and may
change rapidly in the future. The following factors, among others, may cause
significant volatility in our stock price:

o Announcements by us, our competitors or our customers;

o The introduction of new or enhanced products and services by us or
our competitors;

o Changes in the perceived ability to commercialize our technology
compared to that of our competitors;

o Rumors relating to our competitors or us;

o Actual or anticipated fluctuations in our operating results; and

o General market or economic conditions.

IF OUR SHARES WERE TO BE DELISTED, OUR STOCK PRICE MIGHT DECLINE FURTHER AND WE
MIGHT BE UNABLE TO RAISE ADDITIONAL CAPITAL.

One of the continued listing standards for our stock on the Nasdaq
National Market is the maintenance of a $1.00 bid price. Our stock price has
periodically traded below $1.00 in the recent past. If our bid price were to go
and remain below $1.00 for 30 consecutive business days, Nasdaq could notify us
of our failure to meet the continued listing standards, after which we would
have 180 calendar days to correct such failure or be delisted from the Nasdaq
National Market.

Although we would have the opportunity to appeal any potential delisting,
there can be no assurances that this appeal would be resolved favorably. As a
result, there can be no assurance that our common stock will remain listed on
the Nasdaq National Market. If our common stock were to be delisted from the
Nasdaq National Market, we might apply to be listed on the Nasdaq SmallCap
market; however, there can be no assurance that we would be approved for listing
on the Nasdaq SmallCap market, which has the same $1.00 minimum bid and other
similar requirements as the Nasdaq National Market. If we were to move to the
Nasdaq SmallCap market, current Nasdaq regulations would give us the opportunity
to obtain an additional 180-day grace period and an additional 90-day grace
period after that if we meet certain net income, stockholders' equity or market
capitalization criteria. While our stock would continue to trade on the
over-the-counter bulletin board following any delisting from the Nasdaq, any
such delisting of our common stock could have an adverse effect on the market
price of, and the efficiency of the trading market for, our common stock. Also,
if in the future we were to determine that we need to seek additional equity
capital, it could have an adverse effect on our ability to raise capital in the
public equity markets.

AROTECH CORPORATION

In addition, if we fail to maintain Nasdaq listing for our securities, and
no other exclusion from the definition of a "penny stock" under the Securities
Exchange Act of 1934, as amended, is available, then any broker engaging in a
transaction in our securities would be required to provide any customer with a
risk disclosure document, disclosure of market quotations, if any, disclosure of
the compensation of the broker-dealer and its salesperson in the transaction and
monthly account statements showing the market values of our securities held in
the customer's account. The bid and offer quotation and compensation information
must be provided prior to effecting the transaction and must be contained on the
customer's confirmation. If brokers become subject to the "penny stock" rules
when engaging in transactions in our securities, they would become less willing
to engage in transactions, thereby making it more difficult for our stockholders
to dispose of their shares.

A SUBSTANTIAL NUMBER OF OUR SHARES ARE AVAILABLE FOR SALE IN THE PUBLIC MARKET
AND SALES OF THOSE SHARES COULD ADVERSELY AFFECT OUR STOCK PRICE.

Sales of a substantial number of shares of common stock into the public
market, or the perception that those sales could occur, could adversely affect
our stock price or could impair our ability to obtain capital through an
offering of equity securities. As of May 15, 2004, we had 64,868,912 shares of
common stock issued and outstanding. Of these shares, most are freely
transferable without restriction under the Securities Act of 1933, and a
substantial portion of the remaining shares may be sold subject to the volume
restrictions, manner-of-sale provisions and other conditions of Rule 144 under
the Securities Act of 1933.

In connection with a stock purchase agreement dated September 30, 1996
between Leon S. Gross and us, we also entered into a registration rights
agreement with Mr. Gross dated September 30, 1996, providing registration rights
with respect to the shares of common stock issued to Mr. Gross in connection
with the offering. These rights include the right to make two demands for the
registration of the shares of our common stock owned by Mr. Gross. In addition,
Mr. Gross was granted unlimited rights to "piggyback" on registration statements
that we file for the sale of our common stock. Mr. Gross presently owns
3,482,534 shares, of which 1,538,462 have never been registered.

EXERCISE OF OUR WARRANTS, OPTIONS AND CONVERTIBLE DEBT COULD ADVERSELY AFFECT
OUR STOCK PRICE AND WILL BE DILUTIVE.

As of May 7, 2004, there were outstanding warrants to purchase a total of
18,570,040 shares of our common stock at a weighted average exercise price of
$1.84 per share, options to purchase a total of 8,486,790 shares of our common
stock at a weighted average exercise price of $1.30 per share (not including
940,502 options granted contingent on shareholder approval of a new stock option
plan), of which 5,216,017 were vested, at a weighted average exercise price of
$1.52 per share, and outstanding debentures convertible into a total of
4,036,732 shares of our common stock at a weighted average conversion price of
$1.39 per share. Holders of our options, warrants and convertible debt will
probably exercise or convert them only at a time when the price of our common
stock is higher than their respective exercise or conversion prices.
Accordingly, we may be required to issue shares of our common stock at a price
substantially lower than the market price of our stock. This could adversely
affect our stock price. In addition, if and when these shares are issued, the
percentage of our common stock that existing stockholders own will be diluted.

AROTECH CORPORATION

OUR CERTIFICATE OF INCORPORATION AND BYLAWS AND DELAWARE LAW CONTAIN PROVISIONS
THAT COULD DISCOURAGE A TAKEOVER.

Provisions of our amended and restated certificate of incorporation may
have the effect of making it more difficult for a third party to acquire, or of
discouraging a third party from attempting to acquire, control of us. These
provisions could limit the price that certain investors might be willing to pay
in the future for shares of our common stock. These provisions:

o divide our board of directors into three classes serving staggered
three-year terms;

o only permit removal of directors by stockholders "for cause," and
require the affirmative vote of at least 85% of the outstanding
common stock to so remove; and

o allow us to issue preferred stock without any vote or further action
by the stockholders.

The classification system of electing directors and the removal provision
may tend to discourage a third-party from making a tender offer or otherwise
attempting to obtain control of us and may maintain the incumbency of our board
of directors, as the classification of the board of directors increases the
difficulty of replacing a majority of the directors. These provisions may have
the effect of deferring hostile takeovers, delaying changes in our control or
management, or may make it more difficult for stockholders to take certain
corporate actions. The amendment of any of these provisions would require
approval by holders of at least 85% of the outstanding common stock.

ISRAEL-RELATED RISKS

A SIGNIFICANT PORTION OF OUR OPERATIONS TAKES PLACE IN ISRAEL, AND WE COULD BE
ADVERSELY AFFECTED BY THE ECONOMIC, POLITICAL AND MILITARY CONDITIONS IN THAT
REGION.

The offices and facilities of three of our subsidiaries, EFL, MDT and
Epsilor, are located in Israel (in Beit Shemesh, Lod and Dimona, respectively,
all of which are within Israel's pre-1967 borders). Most of our senior
management is located at EFL's facilities. Although we expect that most of our
sales will be made to customers outside Israel, we are nonetheless directly
affected by economic, political and military conditions in that country.
Accordingly, any major hostilities involving Israel or the interruption or
curtailment of trade between Israel and its present trading partners could have
a material adverse effect on our operations. Since the establishment of the
State of Israel in 1948, a number of armed conflicts have taken place between
Israel and its Arab neighbors and a state of hostility, varying in degree and
intensity, has led to security and economic problems for Israel.

AROTECH CORPORATION

Historically, Arab states have boycotted any direct trade with Israel and
to varying degrees have imposed a secondary boycott on any company carrying on
trade with or doing business in Israel. Although in October 1994, the states
comprising the Gulf Cooperation Council (Saudi Arabia, the United Arab Emirates,
Kuwait, Dubai, Bahrain and Oman) announced that they would no longer adhere to
the secondary boycott against Israel, and Israel has entered into certain
agreements with Egypt, Jordan, the Palestine Liberation Organization and the
Palestinian Authority, Israel has not entered into any peace arrangement with
Syria or Lebanon. Moreover, since September 2000, there has been a significant
deterioration in Israel's relationship with the Palestinian Authority, and a
significant increase in terror and violence. Efforts to resolve the problem have
failed to result in an agreeable solution. Continued hostilities between the
Palestinian community and Israel and any failure to settle the conflict may have
a material adverse effect on our business and us. Moreover, the current
political and security situation in the region has already had an adverse effect
on the economy of Israel, which in turn may have an adverse effect on us.

Some of our employees are currently obligated to perform annual reserve
duty in the Israel Defense Forces and are subject to being called for active
military duty at any time. No assessment can be made of the full impact of such
requirements on us in the future, particularly if emergency circumstances occur,
and no prediction can be made as to the effect on us of any expansion of these
obligations. However, further deterioration of hostilities with the Palestinian
community into a full-scale conflict might require more widespread military
reserve service by some of our employees, which could have a material adverse
effect on our business.

SERVICE OF PROCESS AND ENFORCEMENT OF CIVIL LIABILITIES ON US AND OUR OFFICERS
MAY BE DIFFICULT TO OBTAIN.

We are organized under the laws of the State of Delaware and will be
subject to service of process in the United States. However, approximately 35%
of our assets are located outside the United States. In addition, two of our
directors and all of our executive officers are residents of Israel and a
portion of the assets of such directors and executive officers are located
outside the United States.

There is doubt as to the enforceability of civil liabilities under the
Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as
amended, in original actions instituted in Israel. As a result, it may not be
possible for investors to enforce or effect service of process upon these
directors and executive officers or to judgments of U.S. courts predicated upon
the civil liability provisions of U.S. laws against our assets, as well as the
assets of these directors and executive officers. In addition, awards of
punitive damages in actions brought in the U.S. or elsewhere may be
unenforceable in Israel.

EXCHANGE RATE FLUCTUATIONS BETWEEN THE U.S. DOLLAR AND THE ISRAELI NIS MAY
NEGATIVELY AFFECT OUR EARNINGS.

Although a substantial majority of our revenues and a substantial portion of our
expenses are denominated in U.S. dollars, a portion of our costs, including
personnel and facilities-related expenses, is incurred in New Israeli Shekels
(NIS). Inflation in Israel will have the effect of increasing the dollar cost of
our operations in Israel, unless it is offset on a timely basis by a devaluation
of the NIS relative to the dollar. In 2003, the inflation adjusted NIS
appreciated against the dollar, which raised the dollar cost of our Israeli
operations.

AROTECH CORPORATION

SOME OF OUR AGREEMENTS ARE GOVERNED BY ISRAELI LAW.

Israeli law governs some of our agreements, such as our lease agreements
on our subsidiaries' premises in Israel, and the agreements pursuant to which we
purchased IES, MDT and Epsilor. While Israeli law differs in certain respects
from American law, we do not believe that these differences materially adversely
affect our rights or remedies under these agreements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

INTEREST RATE RISK

It is our policy not to enter into interest rate derivative financial
instruments, except for hedging of foreign currency exposures discussed below.
We do not currently have any significant interest rate exposure.

FOREIGN CURRENCY EXCHANGE RATE RISK

Since a significant part of our sales and expenses are denominated in U.S.
dollars, we have experienced only insignificant foreign exchange gains and
losses to date, and do not expect to incur significant gains and losses in 2004.
Our research, development and production activities are primarily carried out by
our Israeli subsidiary, EFL, at its facility in Beit Shemesh, and accordingly we
have sales and expenses in NIS. Additionally, our MDT and Epsilor subsidiaries
operate primarily in NIS. However, the majority of our sales are made outside
Israel in U.S. dollars, and a substantial portion of our costs are incurred in
U.S. dollars. Therefore, our functional currency is the U.S. dollar.

While we conduct our business primarily in U.S. dollars, some of our
agreements are denominated in foreign currencies. Specifically, at the end of
the first quarter of 2004 our IES contract with the German National Police,
which accounted for 16% of our revenues on a consolidated basis in 2003, was
denominated in Euros. Thus, we are exposed to market risk, primarily related to
fluctuations in the value of the Euro. Therefore, due to the volatility in the
exchange rate of the Euro versus the U.S. dollar, we decided to hedge part of
the risk of a devaluation of the U.S dollar, which could have an adverse effect
on the revenues that we incur in IES. During the first three months of 2004, we
hedged revenues derived from the German National Police in order to protect
against a decrease in value of forecasted foreign currency cash flows resulting
from revenues payments denominated in Euro. We do not hold or issue derivative
financial instruments for trading or speculative purposes

ITEM 4. CONTROLS AND PROCEDURES.

As of the end of the first quarter of 2004, our management, including the
principal executive officer and principal financial officer, evaluated the
effectiveness of our disclosure controls and procedures related to the
recording, processing, summarization, and reporting of information in our
periodic reports that we file with the SEC. These disclosure controls and
procedures have been designed to ensure that material information relating to
us, including our subsidiaries, is made known to our management, including these
officers, by other of our employees, and that this information is recorded,
processed, summarized, evaluated and reported, as applicable, within the time
periods specified in the SEC's rules and forms. Due to the inherent limitations
of control systems, not all misstatements may be detected. These inherent

AROTECH CORPORATION

limitations include the realities that judgments in decision-making can be
faulty and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some
persons, by collusion of two or more people, or by management override of the
control. Our controls and procedures can only provide reasonable, not absolute,
assurance that the above objectives have been met.

As of March 31, 2004, based upon their evaluations, these officers
concluded that the design of the disclosure controls and procedures are
effective in ensuring that information required to be disclosed by us in the
reports that we file or submit under the Exchange Act is recorded, processed,
summarized, evaluated and reported, as applicable, within the time periods
specified in the SEC's rules and forms. We intend to continually strive to
improve our disclosure controls and procedures to enhance the quality of our
financial reporting.

There have been no changes in our internal control over financial
reporting that occurred during the fiscal quarter to which this Quarterly Report
on Form 10-Q relates that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.

AROTECH CORPORATION

PART II

ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES.

Issuance of Warrants in Connection with an Offering of Registered Shares

Pursuant to the terms of a Securities Purchase Agreement dated January 7,
2004 (the "SPA") by and between us and several institutional investors (the
"Investors"), we issued and sold to the Investors registered stock off of our
effective shelf registration statement, and three-year warrants to purchase up
to an aggregate of 9,840,426 shares of our common stock at any time beginning
six months after closing (the "Warrants") at an exercise price per share equal
to $1.88. The common stock underlying the Warrants was not registered.

The foregoing description of our agreement with the Investors is qualified
in its entirety by reference to the agreements with the Investors filed as
exhibits to our Current Report on Form 8-K that we filed with the SEC on January
9, 2004.

We issued the Warrants in reliance on the exemption from registration
provided by Section 4(2) of the Securities Act as transactions by an issuer not
involving a public offering. The issuance of these securities was without the
use of an underwriter, and the Warrants were issued with restrictive legends
permitting transfer thereof and of the shares underlying the Warrants only upon
registration or an exemption under the Act.

Issuance of Shares to a Consultant

Under the terms of an independent contractor agreement between us and
InteSec Group LLC, we pay InteSec a commission in stock of 5% of the military
battery sales that InteSec brings to us from U.S. and NATO defense, security and
military entities and U.S. defense contractors. Pursuant to the terms of this
agreement, in February 2004, we issued 74,215 shares to InteSec.

We issued the above securities in reliance on the exemption from
registration provided by Section 4(2) of the Securities Act as transactions by
an issuer not involving a public offering. The issuance of these securities was
without the use of an underwriter, and the shares of common stock were issued
with restrictive legends permitting transfer thereof only upon registration or
an exemption under the Act.

Issuance of Warrants to an Investor

In November 2000 and May 2001, we issued a total of 916,667 warrants to an
investor, which warrants contained certain antidilution provisions: a Series A
warrant to purchase 666,667 shares of our common stock at a price of $3.22 per
share, and a Series C warrant to purchase 250,000 shares at a price of $3.08 per
share. Operation of the antidilution provisions provided that the Series A
warrant should be adjusted to be a warrant to purchase 888,764 shares at a price
of $2.48 per share, and the Series C warrant should be adjusted to be a warrant
to purchase 333,286 shares at a price of $2.31 per share. After negotiations,
the investor agreed to exercise its warrants immediately, in exchange for a
lowering of the exercise price to $1.45 per share, and the issuance of a new
six-month Series D warrant to purchase 1,222,050 shares at an exercise price of
$2.10 per share. The new Series D warrant does not have similar antidilution
provisions.

AROTECH CORPORATION

We issued the Series D Warrant in reliance on the exemption from
registration provided by Section 4(2) of the Securities Act as transactions by
an issuer not involving a public offering. The issuance of these securities was
without the use of an underwriter, and the shares of common stock currently bear
restrictive legends permitting transfer thereof only upon registration or an
exemption under the Act.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) The following documents are filed as exhibits to this report:

EXHIBIT NUMBER DESCRIPTION

31.1............Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002

31.2............Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002

32.1............Certification of Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002

32.2............Certification of Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002

(b) The following reports on Form 8-K or Form 8-K/A were filed or
furnished during the first quarter of 2004:

DATE FILED ITEM REPORTED

January 9, 2004........Item 2 - Acquisition or Disposition of Assets; Item 5 -
Other Events and Regulation FD Disclosure; and Item 7 -
Financial Statements, Pro Forma Financial Information
and Exhibits

January 15, 2004.......Item 7 - Financial Statements, Pro Forma Financial
Information and Exhibits; and Item 12 - Results of
Operations and Financial Condition (furnished but not
filed)

January 21, 2004.......Item 5 - Other Events and Regulation FD Disclosure; and
Item 7 - Financial Statements, Pro Forma Financial
Information and Exhibits

February 4, 2004.......Item 2 - Acquisition or Disposition of Assets; and Item
7 - Financial Statements, Pro Forma Financial
Information and Exhibits

February 5, 2004.......Item 5 - Other Events and Regulation FD Disclosure; and
Item 7 - Financial Statements, Pro Forma Financial
Information and Exhibits

March 9, 2004..........Item 7 -Financial Statements, Pro Forma Financial
Information and Exhibits (amendment)

AROTECH CORPORATION

March 9, 2004..........Item 7 - Financial Statements, Pro Forma Financial
Information and Exhibits; and Item 12 - Results of
Operations and Financial Condition (furnished but not
filed)

March 26, 2004.........Item 5 - Other Events and Regulation FD Disclosure; and
Item 7 - Financial Statements, Pro Forma Financial
Information and Exhibits (amendment)

AROTECH CORPORATION

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

Dated: May 17, 2004

AROTECH CORPORATION

By: /s/ Robert S. Ehrlich
--------------------------------------
Name: Robert S. Ehrlich
Title: Chairman, President and CEO
(Principal Executive Officer)

By: /s/ Avihai Shen
--------------------------------------
Name: Avihai Shen
Title: Vice President - Finance
(Principal Financial Officer)

AROTECH CORPORATION

EXHIBIT INDEX

EXHIBIT NUMBER DESCRIPTION

31.1............Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002

31.2............Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002

32.1............Certification of Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002

32.2............Certification of Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002