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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 September 30, 2004.
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Commission file number: 0-23336
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AROTECH CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware 95-4302784
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(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
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(Registrant's telephone number, including area code)
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(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 November 10,
2004 was 79,096,283.
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AROTECH CORPORATION
INDEX
PART I - FINANCIAL INFORMATION
Item 1 - Interim Consolidated Financial Statements (Unaudited):
Consolidated Balance Sheets at September 30, 2004 and December 31, 2003 (audited).............. 3
Consolidated Statements of Operations for the Nine Months Ended September 30, 2004 and 2003.... 5
Consolidated Statements of Changes in Stockholders' Equity during the Nine-Month Period Ended
September 30, 2004......................................................................... 6
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004 and 2003.... 7
Note to the Interim Consolidated Financial Statements.......................................... 11
Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations. 27
Item 3 - Quantitative and Qualitative Disclosures about Market Risk............................ 52
Item 4 - Controls and Procedures............................................................... 53
PART II - OTHER INFORMATION
Item 2 - Changes in Securities and Use of Proceeds............................................. 55
Item 5 - Other Information..................................................................... 55
Item 6 - Exhibits and Reports on Form 8-K...................................................... 55
SIGNATURES............................................................................................. 57
2
AROTECH CORPORATION
Item 1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED BALANCE SHEETS
(U.S. Dollars)
- --------------------------------------------------------------------------------
September 30, December 31,
2004 2003
----------- -----------
ASSETS (Unaudited) (Note 1.c.)
CURRENT ASSETS:
Cash and cash equivalents ...................................... $ 4,573,875 $13,685,125
Restricted securities and deposits due within one year ......... 13,236,461 706,180
Available-for-sale marketable securities ....................... 128,826 --
Trade receivables (net of allowance for doubtful accounts in the
amounts of $56,394 and $61,282 as of September 30, 2004 and
December 31, 2003, respectively) ............................. 7,800,632 4,706,423
Current portion of note receivable ............................. 329,550 --
Unbilled revenues .............................................. 2,560,108 --
Other accounts receivable and prepaid expenses ................. 1,623,183 1,187,371
Inventories .................................................... 7,631,193 1,914,748
Assets of discontinued operations .............................. -- 66,068
----------- -----------
Total current assets ................................. 37,883,828 22,265,915
----------- -----------
SEVERANCE PAY FUND ................................................. 1,837,616 1,023,342
RESTRICTED SECURITIES AND DEPOSITS ................................. 1,000,000 --
LONG TERM NOTE RECEIVABLES ......................................... 667,245 --
PROPERTY AND EQUIPMENT, NET ........................................ 4,463,675 2,292,741
GOODWILL ........................................................... 24,978,764 5,064,555
OTHER INTANGIBLE Assets, NET ....................................... 15,300,743 2,375,195
----------- -----------
$86,131,871 $33,021,748
=========== ===========
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of the
Consolidated Financial Statements.
3
AROTECH CORPORATION
CONSOLIDATED BALANCE SHEETS
(U.S. Dollars, except share data)
- --------------------------------------------------------------------------------
September 30, December 31,
2004 2003*
------------- -------------
(Unaudited) (Note 1.c.)
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade payables ........................................................ $ 4,190,155 $ 1,967,448
Other accounts payable and accrued expenses ........................... 5,947,310 4,030,411**
Current portion of promissory notes due to purchase of subsidiaries ... 1,149,509 150,000
Short-term bank loans and current portion of long-term loans .......... 106,691 40,849
Deferred revenues ..................................................... 2,884,295 140,936**
Liability related to warrants ......................................... 9,011,995 --
Liabilities of discontinued operations ................................ -- 380,108
------------- -------------
Total current liabilities .................................................. 23,289,955 6,709,752
LONG TERM LIABILITIES
Accrued severance pay ................................................. 3,241,581 2,814,492
Convertible debentures, net ........................................... 1,792,370 1,450,194
Deferred warranty revenue, less current portion ....................... 181,722 220,143
Promissory notes due to purchase of subsidiaries ...................... 977,861 150,000
------------- -------------
Total long-term liabilities ................................................ 6,193,534 4,634,829
MINORITY INTEREST .......................................................... 85,885 51,290
SHAREHOLDERS' EQUITY:
Share capital -
Common stock - $0.01 par value each;
Authorized: 250,000,000 shares as of September 30, 2004 and December
31, 2003; Issued: 79,100,166 shares as of September 30, 2004 and
47,972,407 shares as of December 31, 2003; Outstanding - 78,544,833
shares as of September 30, 2004 and 47,417,074 shares as of
December 31, 2003 ................................................. 791,002 479,726
Preferred shares - $0.01 par value each;
Authorized: 1,000,000 shares as of September 30, 2004 and December
31, 2003; No shares issued and outstanding as of September 30, 2004
and December 31, 2003 ............................................. -- --
Additional paid-in capital ............................................ 177,348,358 135,702,413
Deferred stock compensation ........................................... (1,027,653) (8,464)
Accumulated deficit ................................................... (115,698,412) (109,911,240)
Treasury stock, at cost (common stock - 555,333 shares as of September
30, 2004 and December 31, 2003) ..................................... (3,537,106) (3,537,106)
Notes receivable on account of shares ................................. (1,222,902) (1,203,881)
Accumulated other comprehensive income (loss) ......................... (90,790) 104,429
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Total shareholders' equity ................................................. 56,562,497 21,625,877
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$ 86,131,871 $ 33,021,748
============= =============
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* Restated.
** Reclassified.
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of the
Consolidated Financial Statements.
4
AROTECH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(U.S. Dollars, except share data)
- --------------------------------------------------------------------------------
Nine months ended Three months ended
September 30, September 30,
---------------------------- ----------------------------
2004 2003* 2004 2003*
------------ ------------ ------------ ------------
Revenues ........................................ $ 33,383,023 $ 13,232,486 $ 16,272,521 $ 5,705,898
Cost of revenues ................................ 22,680,921 8,365,212 11,548,948 3,252,323
------------ ------------ ------------ ------------
Gross profit .................................... 10,702,102 4,867,274 4,723,573 2,453,575
Operating expenses:
Research and development ................... 1,302,774 762,629 431,147 252,085
Selling and marketing ...................... 3,435,183 2,395,190 1,294,487 757,614
General and administrative ................. 7,571,923 3,456,286 2,111,853 982,779
Amortization of intangible assets .......... 1,731,425 727,127 739,400 103,584
------------ ------------ ------------ ------------
Total operating costs and expenses .............. 14,041,305 7,341,232 4,576,887 2,096,062
------------ ------------ ------------ ------------
Operating income (loss) ......................... (3,339,203) (2,473,958) 146,686 357,513
Financial income (expenses), net ................ (2,126,079) (1,213,582) 1,105,276 (82,333)
------------ ------------ ------------ ------------
Income (loss) before income taxes ............... (5,465,282) (3,687,540) 1,251,962 275,180
Income tax expenses, net ........................ (286,525) (308,137) (116,460) (31,089)
------------ ------------ ------------ ------------
Income (loss) before minority interest in loss
(earnings) of a subsidiary and income tax
expenses ..................................... (5,751,807) (3,995,677) 1,135,502 244,091
Minority interest in loss (earnings) of a
subsidiary ................................... (35,365) 134,813 (8,657) (25,485)
------------ ------------ ------------ ------------
Income (loss) from continuing operations ........ (5,787,172) (3,860,864) 1,126,845 218,606
Income (loss) from discontinued operations ...... -- 80,883 -- (2,285)
------------ ------------ ------------ ------------
Net income (loss) ............................... (5,787,172) (3,779,981) 1,126,845 216,321
Deemed dividend to certain stockholders of common
stock ........................................ (3,328,952) (267,026) (2,165,952) (94,676)
------------ ------------ ------------ ------------
Net income (loss) attributable to common
stockholders ................................. $ (9,116,124) $ (4,047,007) $ (1,039,107) $ 121,645
============ ============ ============ ============
Basic and diluted net earnings (loss) per share
from continuing operations .................... $ (0.14) $ (0.11) $ (0.01) $ 0.00
============ ============ ============ ============
Basic and diluted net earnings (loss) per share
from discontinued operations .................. $ 0.00 $ 0.00 $ 0.00 $ 0.00
============ ============ ============ ============
Basic and diluted net earnings (loss) per share . $ (0.14) $ (0.11) $ (0.01) $ 0.00
============ ============ ============ ============
Weighted average number of shares used in
computing basic net loss per share ............ 67,072,069 37,276,260 76,744,251 40,371,940
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* Restated.
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The accompanying notes are an integral part of the
Consolidated Financial Statements.
5
AROTECH CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(U.S. Dollars, except share data)
- --------------------------------------------------------------------------------
Common Stock Additional Deferred
-------------------------- paid-in stock Accumulated
Shares Amount capital compensation deficit
---------- ------------- ------------- ------------- -------------
BALANCE AT JANUARY 1, 2004 -
NOTE 1 ........................ 47,972,407 $ 479,726 $ 135,702,413* $ (8,464) $(109,911,240)*
CHANGES DURING THE NINE-MONTH
PERIOD ENDED SEPTEMBER 30, 2004
Issuance of shares, net ...... 14,548,491 145,485 24,944,639 -- --
Issuance of shares in respect
of FAAC acquisition ........ 1,003,856 10,039 1,993,639 -- --
Conversion of convertible
debentures ................. 3,213,292 32,132 3,035,583 -- --
Exercise of warrants by
investors .................. 11,363,342 113,633 19,119,008 -- --
Issuance of shares to
consultants ................ 74,215 742 170,489 -- --
Compensation related to
warrants issued in
settlement of litigation ... -- -- 483,828 -- --
Compensation related to
non-recourse loan granted
to shareholder ............. -- -- (13,500) -- --
Exercise of options by
employees .................. 856,948 8,569 1,053,012 -- --
Exercise of options by
consultants ................ 27,615 276 38,399 -- --
Shares issued to employee .... 40,000 400 92,800 -- --
Deferred stock compensation .. -- -- 1,556,147 (1,556,147) --
Amortization of deferred
stock compensation ......... -- -- -- 536,958 --
Reclassification to
liability in connection
with warrants granted ...... -- -- (10,841,020) -- --
Interest accrued on notes
receivable from
shareholders ............... -- -- 12,921 -- --
Other comprehensive loss -
foreign currency
translation adjustment ..... -- -- -- -- --
Other comprehensive loss -
unrealized gain on
available for sale
marketable securities ...... -- -- -- -- --
Net loss ...................... -- -- -- -- (5,787,172)
---------- ------------- ------------- ------------- -------------
Total comprehensive loss ...... -- -- -- -- --
BALANCE AT SEPTEMBER 30, 2004 -
UNAUDITED ..................... 79,100,166 $ 791,002 $ 177,348,358 $ (1,027,653) $(115,698,412)
Notes Accumulated
receivable other Total
Treasury from comprehensive comprehensive
stock shareholders income (loss) loss Total
------------- ------------- ------------- ------------- -------------
BALANCE AT JANUARY 1, 2004 -
NOTE 1 ........................ $ (3,537,106) $ (1,203,881) $ 104,429 $ -- $ 21,625,877*
CHANGES DURING THE NINE-MONTH
PERIOD ENDED SEPTEMBER 30, 2004
Issuance of shares, net ...... -- -- -- -- 25,090,124
Issuance of shares in respect
of FAAC acquisition ........ -- -- -- -- 2,003,678
Conversion of convertible
debentures ................. -- -- -- -- 3,067,715
Exercise of warrants by
investors .................. -- -- -- -- 19,232,641
Issuance of shares to
consultants ................ -- -- -- -- 171,231
Compensation related to
warrants issued in
settlement of litigation ... -- -- -- -- 483,828
Compensation related to
non-recourse loan granted
to shareholder ............. -- -- -- -- (13,500)
Exercise of options by
employees .................. -- (6,100) -- -- 1,055,481
Exercise of options by
consultants ................ -- -- -- -- 38,675
Shares issued to employee .... -- -- -- -- 93,200
Deferred stock compensation .. -- -- -- -- --
Amortization of deferred
stock compensation ......... -- -- -- -- 536,958
Reclassification to
liability in connection
with warrants granted ...... -- -- -- -- (10,841,020)
Interest accrued on notes
receivable from
shareholders ............... -- (12,921) -- -- --
Other comprehensive loss -
foreign currency
translation adjustment ..... -- -- (198,067) (198,067) (198,067)
Other comprehensive loss -
unrealized gain on
available for sale
marketable securities ...... -- -- 2,848 2,848 2,848
Net loss ...................... -- -- -- (5,787,172) (5,787,172)
------------- ------------- ------------- ------------- -------------
Total comprehensive loss ...... -- -- -- $ (5,982,391) --
BALANCE AT SEPTEMBER 30, 2004 - =============
UNAUDITED ..................... $ (3,537,106) $ (1,222,902) $ (90,790) $ 56,562,497
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* Restated.
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of the
Consolidated Financial Statements.
6
AROTECH CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited) (U.S. Dollars)
- --------------------------------------------------------------------------------
Nine months ended September 30,
-------------------------------
2004 2003*
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss for the period .............................................................. $ (5,787,172) $ (3,779,981)
Net income for the period from discontinued operations ............................... -- (80,883)
Adjustments required to reconcile net loss to net cash used in operating activities:
Depreciation ........................................................................ 834,637 529,155
Amortization of intangible assets ................................................... 1,703,936 732,364
Amortization of subsidiary purchase price allocated to inventory .................... 586,325 --
Amortization of prepaid financial expenses .......................................... -- 236,250
Amortization of compensation related to warrants issued to the holders of convertible
debentures and beneficial conversion feature ...................................... 3,454,676 1,134,001
Amortization of deferred expenses related to convertible debenture issuance ......... 176,771 156,802
Amortization of capitalized research and development projects ....................... 27,489 --
Adjustment of liability in connection to warrants granted ........................... (1,829,025) --
Stock-based compensation due to options and shares granted to employees ............. 576,648 --
Stock-based compensation due to options granted to consultants ...................... -- 29,759
Stock-based compensation due to shares granted to consultants ....................... -- 154,331
Write-off of inventory .............................................................. 67,951 23,830
Earnings (loss) to minority ......................................................... 35,363 (134,813)
Impairment of fixed assets .......................................................... -- 62,332
Mark-up of loans to shareholders .................................................... (32,397) (12,519)
Interest expenses (income) accrued on promissory notes due to purchase of subsidiary 36,385 (35,853)
Capital gain from sale of marketable securities ..................................... (4,114) --
Interest accrued on certificates of deposit due within one year ..................... (184,374) --
Amortization of premium related to restricted securities ............................ 146,105 --
Capital gain from sale of property and equipment .................................... (5,744) (3,163)
Accrued severance pay, net .......................................................... (474,575) 24,984
Increase in deferred tax assets ..................................................... (16,499) --
Changes in operating asset and liability items:
Decrease (increase) in trade receivables ............................................ 725,593 (1,495,380)
Increase in unbilled revenues ....................................................... (1,259,720) --
Decrease in notes receivable ........................................................ 283,078 --
Increase in other accounts receivable and prepaid expenses .......................... (447,270) (232,303)**
Decrease (increase) in inventories .................................................. (2,895,083) 130,404
Increase (decrease) in trade payables ............................................... 955,347 (320,782)
Increase in deferred revenues ....................................................... 2,092,736 --
Decrease in accounts payable and accruals ........................................... 202,891 444,651
------------ ------------
Net cash used in operating activities from continuing operations (reconciled from .... (1,030,042) (2,436,814)
continuing operations)
Net cash used in operating activities from discontinued operations (reconciled from
discontinued operations) ........................................................... (211,628) (360,502)
------------ ------------
Net cash used in operating activities ................................................ (1,241,670) (2,797,316)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of the
Consolidated Financial Statements.
7
AROTECH CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited) (U.S. Dollars)
- --------------------------------------------------------------------------------
Nine months ended September 30,
-------------------------------
2004 2003*
------------ ------------
Repayment of promissory note related to purchase of subsidiary ...................... (1,150,000) (750,000)
Investment in subsidiary(1) ......................................................... (7,190,777) --
Investment in subsidiary(2) ......................................................... (12,129,103) --
Investment in subsidiary(3) ......................................................... (17,302,167) --
Proceeds from sale of marketable securities, net .................................... 812 --
Repayment of loan granted to shareholder ............................................ 32,397 9,280**
Purchase of intangible assets and inventory ......................................... -- (196,331)
Purchase of property and equipment .................................................. (1,121,991) (417,530)
Loans granted to stockholders, net .................................................. -- (13,737)**
Increase in capitalized research and development projects ........................... (304,108) (169,548)**
Proceeds from sale of property and equipment ........................................ 93,786 7,585
Decrease (increase) in demo inventories, net ........................................ (26,970) 8,733
Decrease (increase) in restricted securities and deposits, net ...................... (13,111,519) 585,807
------------ ------------
Net cash used in investing activities ................................................ (52,209,640) (935,741)
------------ ------------
FORWARD ................................................................................ $(53,451,310) $ (3,733,057)
------------ ------------
- ----------
* Restated.
** Reclassified.
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of the
Consolidated Financial Statements.
8
AROTECH CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited) (U.S. Dollars)
- --------------------------------------------------------------------------------
Nine months ended September 30,
-------------------------------
2004 2003*
------------ ------------
FORWARD ................................................................... $(53,451,310) $ (3,733,057)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in short-term credit from banks ............................. (419,085) (93,799)
Proceeds from issuance of share capital, net ......................... 24,319,890 --
Proceeds from exercise of options .................................... 1,094,156 57,285
Proceeds from exercise of warrants ................................... 19,387,651 1,730,732
Payment on capital lease obligation .................................. (2,888) (343)
Repayment of long-term loans ......................................... (42,529) --
Issuance of convertible debenture .................................... -- 3,238,662**
------------ ------------
Net cash provided by financing activities ................................. 44,337,195 4,932,537
------------ ------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .......................... (9,114,115) 1,199,480
CASH EROSION DUE TO EXCHANGE RATE DIFFERENCES ............................. 2,865 (4,063)
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 ............. $ 4,573,875 $ 2,652,943
============ ============
SUPPLEMENTARY INFORMATION ON NON-CASH TRANSACTIONS:
Issuance of shares and warrants against accrued expenses .................. $ 1,310,394 $ --
============ ============
Exercise of options and warrants against notes receivable ................. $ 6,100 $ --
============ ============
Issuance expenses against account payable ................................. $ 155,002 $ --
============ ============
Purchase of property and equipment against accounts payable ............... $ 32,841 $ --
============ ============
Purchase of intangible assets against notes receivable .................... $ -- $ 300,000
============ ============
Increase of investment in subsidiary against shares of common stock ....... $ -- $ 123,480
============ ============
Investment in subsidiary against promissory note .......................... $ 2,940,985 $ --
============ ============
Conversion of promissory note to shares of common stock ................... $ -- $ 450,000
============ ============
Exercise of convertible debentures against shares ......................... $ 3,112,500 $ 1,500,000
============ ============
Liability in connection to warrants granted ............................... $ 10,841,020 $ --
============ ============
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 DURING THE
PERIOD FOR:
Interest ......................................................... $ (404,503) $ (24,384)
============ ============
- ----------
* Restated.
** Reclassified.
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of the
Consolidated Financial Statements.
9
AROTECH CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) (U.S. Dollars)
- --------------------------------------------------------------------------------
(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
(unaudited) ............................................... $ (688,592)
Property and equipment (unaudited) .......................... 709,847
Intangible assets and goodwill (unaudited) .................. 10,110,507
------------
10,131,762
Issuance of promissory note (unaudited) ..................... (2,940,985)
------------
$ 7,190,777
============
(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
(unaudited) ............................................... $ 2,647,822
Property and equipment (unaudited) .......................... 263,669
Intangible assets and goodwill (unaudited) .................. 11,221,290
------------
14,132,781
Issuance of shares, net (unaudited) ......................... (2,003,678)
------------
$ 12,129,103
============
(3) In August 2004, the Company acquired all of the outstanding common stock
of Armour of America, Incorporated ("AoA"). The net fair value of the
assets acquired was as follows:
Working capital, excluding cash and cash equivalents
(unaudited) ............................................... $ 3,219,728
Property and equipment (unaudited) .......................... 997,148
Intangible assets and goodwill (unaudited) .................. 13,085,291
------------
$ 17,302,167
============
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of the
Consolidated Financial Statements.
10
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;
MDT Armor Corporation, a majority-owned subsidiary based in Auburn, Alabama; and
Armour of America, Incorporated, a wholly-owned subsidiary based in Los Angeles,
California.
In June 2004, the Company established a European subsidiary in Germany, Arotech
Europa, in order to market Arotech's simulation and armoring products.
b. Restatement of previously-issued financial statements:
During management's review of the Company's interim financial statements for the
period ended September 30, 2004 the Company, after discussion with and based on
a new and revised review of accounting treatment by its independent auditors,
conducted a comprehensive review on the re-pricing of warrants and grant of new
warrants to certain of its investors and others during 2003 and 2004. As a
result of that review, the Company, upon recommendation of management and with
the approval of the Audit Committee of the Board of Directors after discussion
with the Company's independent auditors, reconsidered the accounting related to
these transactions and is now reclassifying certain expenses as a deemed
dividend, a non-cash item, instead of as general and administrative expenses due
to the recognition of these transactions as capital transactions that should not
be expensed. The consolidated financial statements for the nine and three months
ended September 30, 2003 and for the year ended December 31, 2003 will be
restated to record deemed dividends and to decrease general and administrative
expenses accordingly. These restatements do not affect the balance sheet, the
shareholders' equity or the cash flow statements. In addition and as a result of
the remeasurement described above, the Company has reviewed assumptions used in
the calculation of fair value of all warrants granted during the year 2003. As a
result of this comprehensive review, the Company has decreased its general and
administrative expenses in the amount of $150,000, related to errors found in
valuation underlying assumptions of warrants granted as a result of a litigation
settlement, in the financial statements for the year ended December 31, 2003.
In addition, during management's review of the Company's interim financial
statements for the period ended September 30, 2004, the Company also reviewed
its calculation of amortization of debt discount attributable to the beneficial
conversion feature of convertible debentures. As a result of this review, the
Company found errors which increased (decreased) its financial expenses for the
nine and three months ended September 30, 2003 and for the year ended December
31, 2003. The errors were related to the debt discount attributable to the
warrants and their related convertible debentures, whereby the Company
understated the amount of amortization in the year ended December 31, 2003
attributable to the conversion of certain of the convertible debentures, and
overstated the amount of amortization in the six months ended June 30, 2004
attributable to the exercise of certain of the warrants.
11
AROTECH CORPORATION
The impacts of certain of these restatements are summarized below:
Statement of Operations Data:
For the Three Months ended September 30, 2003
-------------------------------------------------
Previously
Reported Adjustment As Restated
-------------- -------------- --------------
General and administrative expenses .......... $ 1,105,864 $ (123,085) $ 982,779
Operating income ............................. 234,428 123,085 357,513
Financial expenses, net ...................... 100,761 (18,428) 82,333
Net income from continuing operations ........ 77,093 141,513 218,606
-------------- -------------- --------------
Net income ................................... 74,808 141,513 216,321
Deemed dividend to certain stockholders of
common stock .............................. -- (94,676) (94,676)
Net income attributable to common stockholders $ 74,808 $ 46,837 $ 121,645
============== ============== ==============
Basic and diluted net earnings per share from
continuing operations ...................... $ 0.00 $ 0.00 $ 0.00
============== ============== ==============
Basic and diluted net earnings per share ..... $ 0.00 $ 0.00 $ 0.00
============== ============== ==============
For the Nine Months ended September 30, 2003
-------------------------------------------------
Previously
Reported Adjustment As Restated
-------------- -------------- --------------
General and administrative expenses ........ $ 3,579,371 $ (123,085) $ 3,456,286
Operating loss ............................. 2,597,043 (123,085) 2,473,958
Financial expenses, net .................... 1,084,582 129,000 1,213,582
Net income from continuing operations ...... 3,854,949 5,915 3,860,864
-------------- -------------- --------------
Net loss ................................... 3,774,066 5,915 3,779,981
Deemed dividend to certain stockholders of
common stock ............................ -- 267,026 267,026
Net loss attributable to common stockholders $ 3,774,066 $ 272,941 $ 4,047,007
============== ============== ==============
Basic and diluted net loss per share from
continuing operations .................... $ 0.10 $ 0.01 $ 0.11
============== ============== ==============
Basic and diluted net loss per share ....... $ 0.10 $ 0.01 $ 0.11
============== ============== ==============
12
AROTECH CORPORATION
Balance sheet data:
As of December 31, 2003
--------------------------------------------------
Previously
Reported Adjustment As Restated
-------------- -------------- --------------
Other accounts payable and
accrued expenses ........ $ 4,180,411 $ (150,000) $ 4,030,411
Convertible debenture ..... 881,944 568,250 1,450,194
Total long term liabilities 4,066,579 568,250 4,634,829
Additional paid in capital 135,891,316 (188,903) 135,702,413
Accumulated deficit ....... (109,681,893) (229,347) (109,911,240)
Total shareholders' equity 22,044,127 (418,250) 21,625,877
Cash flow data:
For the Nine Months ended September 30, 2003
-------------------------------------------------
Previously
Reported Adjustment As Restated
-------------- -------------- --------------
Net loss ....................................... $ 3,774,066 $ (5,915) $ 3,779,981
Stock based compensation related to repricing of
warrants granted to investors and the grant of
new warrants ................................. 152,844 (123,085) 29,759
Amortization of compensation related to
beneficial conversion feature and warrants
issued to holders of convertible debentures .. 1,005,001 129,000 1,134,001
c. 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 its financial position at
September 30, 2004 and its operating results and cash flows for the nine month
periods ended September 30, 2004 and 2003.
The results of operations for the nine months ended September 30, 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. These consolidated financial statements should be read in
conjunction with the audited financial statements included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2003.
13
AROTECH CORPORATION
d. Revenue recognition according to Statement of Position 81-1, "Accounting
for Performance of Construction-Type and Certain Production-Type
Contracts"
Revenues from contracts that involve customization of FAAC's simulation system
to customer specific specifications are recognized in accordance with Statement
Of Position 81-1, "Accounting for Performance of Construction-Type and Certain
Production-Type Contracts," using contract accounting on a percentage of
completion method, in accordance with the "Input Method." The amount of revenue
recognized is based on the percentage to completion achieved. The percentage to
completion is measured by monitoring progress using records of actual time
incurred to date in the project compared to the total estimated project
requirement, which corresponds to the costs related to earned revenues.
Estimates of total project requirements are based on prior experience of
customization, delivery and acceptance of the same or similar technology and are
reviewed and updated regularly by management. Provisions for estimated losses on
uncompleted contracts are made in the period in which such losses are first
determined, in the amount of the estimated loss on the entire contract. As of
September 30, 2004 no such estimated losses were identified.
e. Right of return:
When a right of return exists, the Company defers its revenues until the
expiration of the period in which returns are permitted.
f. Available-for-sale marketable securities
The Company and its subsidiaries account for investments in debt and equity
securities in accordance with Statement of Financial Accounting Standard No.
115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS
No. 115"). Management determines the appropriate classification of its
investments in debt and equity securities at the time of purchase and
reevaluates such determinations at each balance sheet date.
Securities classified as available for sale are stated at fair value, with
unrealized gains and losses reported in accumulated other comprehensive income
(loss), a separate component of shareholders' equity, net of taxes. Realized
gains and losses on sales of investments, as determined on a specific
identification basis, are included in the consolidated statement of operations.
g. 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.
The Company adopted the disclosure provisions of Statement of Financial
Accounting Standard No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure" ("SFAS No. 148"), which amended certain provisions of
Statement of Financial Accounting Standard No. 123 "Accounting for Stock-Based
Compensation" ("SFAS No. 123"), to provide alternative methods of transition for
14
AROTECH CORPORATION
an entity that voluntarily changes to the fair value based method of accounting
for stock-based employee compensation. The Company continues to apply the
provisions of APB No. 25 in accounting for stock-based compensation.
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 nine and
three month periods ended September 30, 2004 and 2003:
Nine months ended September 30, Three months ended September 30,
------------------------------- --------------------------------
2004 2003 2004 2003
------------- -------------- -------------- -------------
(Unaudited)
Risk free interest 3.38 1.0% 3.38 1.0%
Dividend yields 0.0% 0.0% 0.0% 0.0%
Volatility 0.817 0.69 0.817 0.69
Expected life 5 years 4 years 5 years 4 years
Pro forma information under SFAS No. 123:
Nine months ended September 30, Three months ended September 30,
-------------------------------- --------------------------------
2004 2003* 2004 2003*
-------------- -------------- -------------- --------------
Unaudited
(U.S. Dollars, except per share data)
Net income (loss) as reported $ (9,116,124) $ (4,047,007) $ (1,039,107) $ 121,645
Add - stock-based compensation expense
determined under APB 25 536,958 -- 174,787 --
Deduct - stock based compensation expense
determined under fair value method for
all awards (1,605,146) (2,073,362 (745,546) (660,205)
============== ============== ============== ==============
Pro forma net loss $ (10,184,312) $ (6,120,369) $ (1,609,866) $ (538,560)
============== ============== ============== ==============
Loss per share:
Basic and diluted, as reported $ (0.14) $ (0.11) $ (0.01) $ 0.00
============== ============== ============== ==============
Pro forma basic and diluted $ (0.15) $ (0.16) $ (0.02) $ (0.01)
============== ============== ============== ==============
- -------------------------------------
* Restated. See also Note 1.b.
NOTE 2: ACQUISITION OF EPSILOR
In January 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 shares 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 Acquisition was accounted under the purchase method accounting. Accordingly,
all assets and liabilities acquired were recorded at their estimated market
values as of the date of acquisition, and results of Epsilor's operations have
been included in the consolidated financial statements commencing the date of
15
AROTECH CORPORATION
acquisition. The total consideration of $10,131,762 (including transaction
costs) 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 $2,940,985.
Based upon a valuation of tangible and intangible assets acquired, Arotech has
allocated the total cost of the acquisition to Epsilor's net assets as follows
(unaudited):
Tangible assets acquired $ 2,313,277
Intangible assets
Technology 159,364
Customer list 4,889,671
Goodwill 5,061,472
Liabilities assumed (2,292,022)
-----------
Total consideration $10,131,762
===========
Intangible assets in the amount of $5,049,035 have a weighted-average useful
life of approximately ten years.
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 impairment test. 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.
The value assigned to tangible, intangible assets and liabilities was determined
as follows:
1. To determine the estimated market value of Epsilor's net current
assets, property and equipment, and net liabilities, the "Cost
Approach" was used. According to the valuation made, the book values
for the current assets and liabilities were reasonable proxies for
their market values.
2. The amount of the excess cost attributable to technology of
developing a system with battery and charger was determined using
the Cost Approach, and was valued at $159,364.
3. The customer list is the asset that generates most of the Company's
sales. Hence, the "Income Approach" was used to estimate its value,
resulting in a value of $4,889,671.
See Note 5 for pro forma financial information.
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.
16
AROTECH CORPORATION
The Acquisition was accounted under the purchase method accounting. Accordingly,
all assets and liabilities were recorded at their estimated market values as of
the date acquired, and results of FAAC's operations have been included in the
consolidated financial statements commencing the date of acquisition. 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 approximately $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. When the contingency on the earn-out provision is resolved, the
additional consideration will be recorded as additional purchase price. The
total consideration of $14.1 million (including $135,131 of transaction costs)
was determined based upon arm's-length negotiations between the Company and
FAAC's shareholders.
Based upon a 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 $ 5,684,584
Intangible assets
Technology 4,610,000
Existing contracts 636,000
Customer list 1,125,000
Trademarks 374,000
Goodwill 4,476,290
Liabilities assumed (2,770,843)
-----------
Total consideration $14,135,031
===========
Intangible assets in the amount of $6,385,000 have a weighted-average useful
life of approximately eight years.
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 impairment test. 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.
The value assigned to tangible, intangibles assets and liabilities was
determined as follows:
1. To determine the estimated fair value of FAAC's net current assets,
property and equipment, and net liabilities, the "Cost Approach" was
used. According to the valuation made, the book values for the
current assets and liabilities were reasonable proxies for their
market values.
2. The amount of the cost attributable to technology of the software,
documentation and know-how that drives the vehicle simulators and
the high-speed missile fly-out simulators is $4,610,000 and was
determined using the "Income Approach."
3. FAAC's sales are all made on a contractual basis, most of which are
over a relatively long period of time. At the date of the purchase
FAAC had
17
AROTECH CORPORATION
several signed contracts at various stages of completion. The value
of the existing contracts was determined using the Income approach
and resulting in a value of $636,000.
4. FAAC's customer list includes various branches of the U.S. military,
major defense contractors, various city and country governments and
others. Since customer relationship represent one of the most
important revenue generating assets for FAAC, its value was
estimated using the Income Approach, resulting in a value of
$1,125,000.
5. FAAC's trade name value represents the name recognition value of the
FAAC brand name as a result of advertising spending by the company.
The Cost Approach was used to determine the value of FAAC's trade
name in the amount of $360,000.
See Note 5 for pro forma financial information.
NOTE 4: ACQUISITION OF AOA
In August 2004, the Company purchased all of the outstanding stock of Armour of
America, Incorporated, a California corporation ("AoA"), from AoA's existing
shareholder. The assets acquired through the purchase of all of AoA's
outstanding stock consisted of all of AoA's assets, including AoA's current
assets, property and equipment, and other assets (including intangible assets
such as intellectual property and contractual rights).
The total purchase price consisted of $19,000,000 in cash, with additional
possible earn-outs if AoA is awarded certain material contracts. An additional
$3,000,000 was to be paid into an escrow account pursuant to the terms of an
escrow agreement, to secure a portion of the Earnout Consideration. Pursuant to
the purchase agreement, the total consideration, sale price plus Earnout
Consideration, will not be in excess of $40,000,000. When the contingency on the
earn-out provision is resolved, the additional consideration will be recorded as
additional purchase price. The purchase price also included $83,837 of
transaction costs. The transaction has been accounted for using the purchase
method of accounting, and accordingly, the purchase price has been allocated to
the assets acquired and liabilities assumed based upon their fair values at the
date the acquisition was completed.
Based upon a preliminary valuation of tangible and intangible assets acquired,
Arotech has allocated the total cost of the acquisition to AoA's assets as
follows (unaudited):
Tangible assets acquired $ 6,346,316
Intangible assets
Patent 1,969
Certifications 245,000
Backlog 1,583,000
Customer relationships 490,000
Tradename /Trademark 70,000
Covenants not to compete 260,000
Goodwill and workforce in place 10,435,322
Liabilities assumed (347,770)
-----------
Total consideration $19,083,837
===========
18
AROTECH CORPORATION
Intangible assets in the amount of $2,648,000 have a weighted-average useful
life of approximately two years.
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 impairment test. 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.
See Note 5 for pro forma financial information.
NOTE 5: 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,
and in August 2004, the Company acquired AoA, as more fully described in "Note 4
- - Acquisition of AoA," above (the "Acquisitions"). The following summary pro
forma information includes the effects of the Acquisitions on the operating
results of the Company. The pro forma data for the nine months ended September
30, 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 of operations that will be obtained
in the future.
Nine Months Ended September 30,
-----------------------------------
2004 2003*
---------------- ----------------
(in thousands, except per share data)
(Unaudited)
Total revenues ................................... $ 44,515,874 $ 27,869,907
================ ================
Gross profit ..................................... 15,783,252 12,798,206
================ ================
Net loss ......................................... (2,932,378) (3,381,393)
================ ================
Deemed dividend of common stock
attributable to certain shareholders .......... (3,328,952) (267,026)
================ ================
Net loss attributable to stockholders of
common stock .................................. $ (6,261,330) $ (3,648,419)
================ ================
Basic and diluted net loss per share ............. $ (0.09) $ (0.07)
================ ================
Weighted average number of shares used in
computing basic net loss per share ............ 67,072,069 51,352,416
================ ================
- ------------------------
* Restated.
19
AROTECH CORPORATION
NOTE 6: 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
write-offs are provided to cover risks arising from slow-moving items,
technological obsolescence, excess inventories, and for market prices lower than
cost. In the nine months ended September 30, 2004 the Company wrote off
inventory in the amount of $67,951, which has been included in cost of revenues.
Inventories are composed of the following:
September 30, 2004 December 31, 2003
------------------ ------------------
(Unaudited) (Note 1.b.)
Raw materials .......... $ 2,553,612 $ 657,677
Work-in-progress ....... 4,221,470 634,221
Finished goods ......... 856,111 622,850
------------------ ------------------
$ 7,631,193 $ 1,914,748
================== ==================
NOTE 7: 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 requires
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.
NOTE 8: SEGMENT INFORMATION
a. General:
The Company and its subsidiaries operate primarily in three business segments
and follow the requirements of SFAS No. 131.
Prior to its purchase of FAAC, Epsilor and AoA, the Company had 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 restated information previously reported in order to comply with new
segment reporting.
20
AROTECH CORPORATION
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 nine and three months ended September 30, 2004 and 2003:
Simulation,
Training and Battery and Armored
Consulting Power Systems Vehicles All Others Total
------------ ------------ ------------ ------------ ------------
Nine months ended September 30, 2004
Revenues from outside customers $ 13,258,943 $ 8,046,095 $ 12,077,985 $ -- $ 33,383,023
Depreciation expenses and amortization (1) (1,225,248) (855,797) (941,342) (130,000) (3,152,387)
Direct expenses (2) (11,947,426) (7,476,476) (10,650,363) (3,818,306) (33,892,571)
------------ ------------ ------------ ------------ ------------
Segment gross profit (loss) $ 86,269 $ (286,178) $ 486,280 $ (3,948,306) (3,661,935)
============ ============ ============ ============
Financial expenses (after deduction of
minority interest) (2,125,237)
------------
Net loss from continuing operations $ (5,787,172)
============
Segment assets (3) $ 18,393,997 $ 12,914,008 $ 20,367,854 $ 698,516 $ 52,374,375
============ ============ ============ ============ ============
Nine months ended September 30, 2003
Revenues from outside customers $ 5,760,231 $ 4,697,143 $ 2,775,112 $ -- $ 13,232,486
Depreciation expenses and amortization (634,188) (339,572) (139,522) (143,000) (1,256,282)
Direct expenses (2) (5,139,480) (4,339,425) (2,834,817) (2,317,071)* (14,630,793)
------------ ------------ ------------ ------------ ------------
Segment gross profit (loss) $ (13,436) $ 18,146 $ (199,227) $ (2,460,071) (2,654,589)
============ ============ ============ ============
Financial expenses (after deduction of
minority interest) (1,206,275)*
------------
Net loss from continuing operations $ (3,860,864)
============
Segment assets (3) $ 7,098,090 $ 1,404,092 $ 1,930,079 $ 394,755 $ 10,827,016
============ ============ ============ ============ ============
Three months ended September 30, 2004
Revenues from outside customers $ 6,034,299 $ 2,913,705 $ 7,324,517 $ -- $ 16,272,521
Depreciation expenses and amortization (1) (417,005) (291,806) (882,219) (51,000) (1,642,030)
Direct expenses (1) (5,010,108) (2,398,561) (6,245,370) (957,319) (14,611,358)
------------ ------------ ------------ ------------ ------------
Segment gross profit (loss) $ 607,186 $ 223,338 $ 196,928 $ (1,008,319) 19,133
============ ============ ============ ============
Financial income (after deduction of
minority interest) 1,107,712
------------
Net income from continuing operations $ 1,126,845
============
Three months ended September 30, 2003
Revenues from outside customers $ 2,918,866 $ 1,844,061 $ 942,971 $ -- $ 5,705,898
Depreciation expenses and amortization (90,545) (113,524) (32,269) (48,000) (284,338)
Direct expenses (2) (2,083,404) (1,580,982) (780,071) (676,194)* (5,120,651)*
------------ ------------ ------------ ------------ ------------
Segment gross profit (loss) $ 744,917 $ 149,555 $ 130,631 $ (724,194) 300,909
============ ============ ============ ============
Financial expenses (after deduction of
minority interest) (82,303)*
------------
Net income from continuing operations $ 218,606*
============
- -------------------------------------
* Restated
(1) Includes depreciation of property and equipment, amortization expenses of
intangible assets and other amortization expenses.
(2) Including sales and marketing, general and administrative and tax
expenses.
(3) Consisting of property and equipment, inventory and intangible assets.
21
AROTECH CORPORATION
NOTE 9: CONVERTIBLE DEBENTURES AND DETACHABLE WARRANTS
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. 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.
As part of the Securities Purchase Agreement dated December 31, 2002, 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.
During the nine months ended September 30, 2004, the remaining principal amount
of $1,150,000 of 9% secured convertible debentures outstanding was converted
into an aggregate of 1,796,875 shares of common stock.
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 five
years.
In connection with these convertible debentures, the Company recognized
$1,890,000 with respect to the beneficial conversion feature, which was
amortized from the date of issuance to the actual conversion dates as financial
expenses.
During the nine months ended September 30, 2004, the Company recorded an expense
of $372,600, all which was attributable to the accelerated amortization of debt
discount and beneficial conversion feature due to conversion of the convertible
debenture into shares. This expense was included in financial expenses.
b. 8% Secured Convertible Debentures due September 30, 2006 and issued in
September 2003
Pursuant to the terms of a Securities Purchase Agreement dated September 30,
2003, the Company, in September 2003, issued and sold to a group of
institutional investors an aggregate principal amount of 8% secured convertible
22
AROTECH CORPORATION
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 (see also Note 10.b).
As part of the Securities Purchase Agreement dated September 30, 2003, 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. During the nine months ended September 30, 2004, an aggregate of 687,500
shares were issued pursuant to exercises of these warrants.
During the nine months ended September 30, 2004, a total of $350,000 principal
amount of debentures was converted, at a conversion price of $1.15 per share. As
of September 30, 2004, $875,000 remained outstanding under these debentures.
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 three
years.
In connection with these convertible debentures, the Company recognized
financial expenses of $2,963,043 with respect to the beneficial conversion
feature, which is being amortized from the date of issuance to the stated
redemption date - September 30, 2006 - as financial expenses.
During the nine months ended September 30, 2004 the Company recorded an expense
of $319,636, of which $148,369 was attributable to amortization of debt discount
and beneficial conversion features related to the convertible debenture over its
term, and $171,267 of which was attributable to amortization due to conversion
of the convertible debentures into shares during the nine months ended September
30, 2004. These expenses were included in the financial expenses.
c. 8% Secured Convertible Debentures due September 30, 2006 and issued in
December 2003
Pursuant to the terms of a Securities Purchase Agreement dated September 30,
2003, the Company, in December 2003, 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 September 30, 2006. These debentures are
convertible at any time prior to September 30, 2006 at a conversion price of
$1.45 per share (see also Note 10.c.).
During the nine months ended September 30, 2004, a total of $1,612,500 principal
amount of debentures was converted, at a conversion price of $1.45 per share. As
of September 30, 2004, $4,387,500 remained outstanding under these debentures.
As a further part of the Securities Purchase Agreement dated September 30, 2003,
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 June 18, 2009 at a price of $2.20 per share.
23
AROTECH CORPORATION
During the nine months ended September 30, 2004 an aggregate of 1,500,000 shares
were issued pursuant to exercise of these warrants. Out of these warrants, the
holders of 1,125,000 warrants exercised their warrants on July 14, 2004 were
granted an additional warrants to purchase 1,125,000 shares of common stock of
the Company at an exercise price per share of $1.38. The fair value of the new
warrants was determined using Black-Scholes pricing model, assuming a risk-free
interest rate of 3.5%, a volatility factor 79%, dividend yields of 0% and a
contractual life of five years (see also Note 11.b.).
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 the warrants granted
in respect of convertible debentures 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 three years.
In connection with these convertible debentures, the Company recognized
financial expenses of $6,000,000 with respect to the beneficial conversion
feature, which is being amortized from the date of issuance to the stated
redemption date - September 30, 2006 - as financial expenses.
During the nine months ended September 30, 2004 the Company recorded an expense
of $2,762,440, of which $1,398,879 was attributable to amortization of the
beneficial conversion feature of the convertible debenture over its term, and
$1,363,561 of which was attributable to amortization due to conversion of the
convertible debentures into shares. These expenses were included in the
financial expenses.
NOTE 10: WARRANTS
a. 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 an exercise price reduction 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. As a result of this repricing and the issuance of new
warrants, the Company recorded a deemed dividend in the amount of approximately
$1,163,000 in the nine months ended September 30, 2004.
b. Warrants issued in January 2004
In connection with the Securities Purchase Agreement referred to in Note 11.a
below, the Company granted 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.
24
AROTECH CORPORATION
During the nine months ended September 30, 2004 an aggregate of 7,446,811 shares
were issued pursuant to exercise of these warrants. In connection with the
exercise of the warrants, the Company granted to the same investors five-year
warrants to purchase up to an aggregate of 7,446,811 shares of the Company's
common stock at an exercise price per share of $1.38. 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 79%, dividend yields of 0% and a
contractual life of five years. See also Note 11.b.
c. Warrants issued in May 2001
As part of the investment agreement in May 2001, the Company issued to one of
its investors warrants to purchase shares of common stock at a price of $3.22
per share; these warrants are exercisable by the holder at any time after
November 8, 2001 and will expire on May 8, 2006. On July 14, 2004, the Company
repriced the warrants exercise price to $1.88 in order to induce their holders
to exercise immediately. In connection with the exercise of the warrants, the
Company additionally granted five-year warrants to purchase up to an aggregate
of 145,454 shares of the Company's common stock at an exercise price per share
of $1.38. 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
79%, dividend yields of 0% and a contractual life of five years. See also Note
11.b.
NOTE 11: ISSUANCE OF SHARES
a. Shares issued in January 2004:
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 an aggregate of 9,840,426 shares of the Company's common stock
at a purchase price of $1.88 per share. Gross proceeds of this offering were
approximately $18.5 million.
b. Shares and warrants issued in July 2004:
In July 2004, pursuant to a Securities Purchase Agreement dated July 15, 2004,
the Company issued to a group of investors an aggregate of 4,258,065 shares of
common stock at a price of $1.55 per share, or a total purchase price of
$6,600,000.
On July 14, 2004, warrants to purchase 8,814,235 shares of common stock, having
an aggregate exercise price of $16,494,194, net of issuance expenses, were
exercised (see also Note 9.c and Note 10.b). Out of the shares issued in
conjunction with the exercise of these warrants, 1,125,000 shares were issued
upon exercise of warrants issued in the transaction referred to in Note 9.c
above and 7,446,811 shares were issued upon exercise of warrants issued in the
transaction referred to in the Note 10.b above; the remaining 242,424 shares
were issued upon exercise of a warrant that the Company issued to an investor in
May 2001 referred to in Note 10.c. In connection with this transaction, the
Company issued to the holders of those exercising warrants an aggregate of
8,717,265 new five-year warrants to purchase shares of common stock at an
exercise price of $1.38 per share. (See also Notes 9 c., 10.b. and 10.c.)
As a result of the aforesaid transactions, including the repricing of the
warrants to the investors and the issuance of additional warrants to the
investors, the Company recorded a deemed dividend in the amount of $2,165,952,
to reflect the additional benefit created for these investors. The deemed
25
AROTECH CORPORATION
dividend increased the loss applicable to common stockholders in the calculation
of basic and diluted net loss per share for the nine months ended September 30,
2004, without any effect on total shareholder's equity.
In addition, the Company recorded a liability related to the grant of these
warrants, which are subject to the shareholders approval, which the Company
intend to seek in its special shareholders meeting on December 14, 2004. This
transaction was accounted according to Emerging Issue Task Force No.00-19,
"Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Company's Own Stock." Accordingly 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 79%, dividend yields of 0% and a contractual
life of five years. The change in the fair value of the warrants between the
date of grant and September 30, 2004 has been recorded as finance income during
the nine months ended September 30, 2004 in the amount of $1,829,025.
NOTE 12: 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.
The fair value of the warrants was determined using Black-Scholes pricing model,
assuming a risk-free interest rate of 3.5%, a volatility factor 79%, dividend
yields of 0% and a contractual life of five years.
NOTE 13: RESTRICTED SECURITIES AND DEPOSITS
The restricted collateral deposit is invested in a $14,236,461 certificate of
deposit that is used primarily to secure earn-out provisions in respect of the
acquisition of FAAC and AoA and to secure that part of the Epsilor acquisition
price that is paid in three installments.
FAAC ............... $ 5,942,970
Epsilor ............ 2,000,000
AoA ................ 5,996,850
Other .............. 296,641
-----------
Total .............. 14,236,461
Less current portion 13,236,461
-----------
Long-term portion .. $ 1,000,000
===========
26
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.
We make available through our internet website free of charge our annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, amendments to such reports and other filings made by us with the SEC, as
soon as practicable after we electronically files such reports and filings with
the SEC. Our website address is www.arotech.com. The information contained in
this website is not incorporated by reference in this report.
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:
27
AROTECH CORPORATION
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
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);
o MDT Armor Corporation, located in Auburn, Alabama, which conducts
MDT's United States activities ("MDT Armor") (88% owned by us); and
o Armour of America, located in Los Angeles, California, which
manufacturers aviation armor both for helicopters and for fixed wing
aircraft, marine armor, personnel armor, armoring kits for military
vehicles, fragmentation
28
AROTECH CORPORATION
blankest and a unique ballistic/flotation vest (ArmourFloat) that is U.S.
Coast Guard-certified ("AoA").
Restatement of Previously-Issued Financial Statements
During our management's review of our interim financial statements for the
period ended September 30, 2004 we, after discussion with and based on a new and
revised review of accounting treatment by our independent auditors, conducted a
comprehensive review on the re-pricing of warrants and grant of new warrants to
certain of our investors and others during the years 2004 and 2003. As a result
of that review, we, upon recommendation of our management and with the approval
of the Audit Committee of our Board of Directors after discussion with our
independent auditors, reconsidered the accounting related to these transactions
and are now reclassifying certain expenses as a deemed dividend, a non-cash
item, instead of as general and administrative expenses due to the recognition
of this transaction as a capital transaction that should not be expensed. The
consolidated financial statements for the nine months ended September 30, 2003,
for the six months ended June 2003 and 2004, for the three months ended March
31, 2004 and the year ended December 31, 2003 will be restated to record deemed
dividends and to decrease general and administrative expenses accordingly. These
restatements do not affect our balance sheet, shareholders' equity or cash flow
statements. In addition and as a result of the remeasurement described above, we
have reviewed assumptions used in the calculation of fair value of all warrants
granted during the year 2003. As a result of this comprehensive review, we have
decreased general and administrative expenses in the amount of $150,000, related
to errors found in valuation underlying assumptions of warrants granted as a
result of a litigation settlement, in the financial statements for the year
ended December 31, 2003.
In addition, during our management's review of our interim financial
statements for the period ended September 30, 2004, we also reviewed our
calculation of amortization of debt discount attributable to the beneficial
conversion feature of convertible debentures. As a result of this review, we
found errors which increased (decreased) our financial expenses for the nine
months ended September 30, 2003, for the six months ended June 2003 and 2004,
for the three months ended March 31, 2004 and the year ended December 31, 2003.
The errors were related to the debt discount attributable to the warrants and
their related convertible debentures, whereby we understated the amount of
amortization in the year ended December 31, 2003 attributable to the conversion
of certain of the convertible debentures, and we overstated the amount of
amortization in the six months ended June 30, 2004 attributable to the exercise
of certain of the warrants.
The impacts of certain of these restatements are summarized below:
29
AROTECH CORPORATION
Statement of Operations Data:
For the Three Months ended September 30, 2003
-------------------------------------------------
Previously
Reported Adjustment As Restated
-------------- -------------- --------------
General and administrative expenses .......... $ 1,105,864 $ (123,085) $ 982,779
Operating income ............................. 234,428 123,085 357,513
Financial expenses, net ...................... 100,761 (18,428) 82,333
Net income from continuing operations ........ 77,093 141,513 218,606
-------------- -------------- --------------
Net income ................................... 74,808 141,513 216,321
Deemed dividend to certain stockholders of
common stock .............................. -- (94,676) (94,676)
Net income attributable to common stockholders $ 74,808 $ 46,837 $ 121,645
============== ============== ==============
Basic and diluted net earnings per share from
continuing operations ...................... $ 0.00 $ 0.00 $ 0.00
============== ============== ==============
Basic and diluted net earnings per share ..... $ 0.00 $ 0.00 $ 0.00
============== ============== ==============
For the Nine Months ended September 30, 2003
-------------------------------------------------
Previously
Reported Adjustment As Restated
-------------- -------------- --------------
General and administrative expenses .......... $ 3,579,371 $ (123,085) $ 3,456,286
Operating loss ............................... 2,597,043 (123,085) 2,473,958
Financial expenses, net ...................... 1,084,582 129,000 1,213,582
Net income from continuing operations ........ 3,854,949 5,915 3,860,864
-------------- -------------- --------------
Net loss ..................................... 3,774,066 5,915 3,779,981
Deemed dividend to certain stockholders of
common stock .............................. -- 267,026 267,026
Net loss attributable to common stockholders . $ 3,774,066 $ 272,941 $ 4,047,007
============== ============== ==============
Basic and diluted net loss per share from
continuing operations ...................... $ 0.10 $ 0.01 $ 0.11
============== ============== ==============
Basic and diluted net loss per share ......... $ 0.10 $ 0.01 $ 0.11
============== ============== ==============
Balance sheet data:
As of December 31, 2003
-----------------------------------------------------------------
Previously Reported Adjustment As Restated
------------------- ------------------- -------------------
Other accounts payable and
accrued expenses ........................... $ 4,180,411 $ (150,000) $ 4,030,411
Convertible debenture ........................ 881,944 568,250 1,450,194
Total long term liabilities .................. 4,066,579 568,250 4,634,829
Additional paid in capital ................... 135,891,316 (188,903) 135,702,413
Accumulated deficit .......................... (109,681,893) (229,347) (109,911,240)
Total shareholders' equity ................... 22,044,127 (418,250) 21,625,877
30
AROTECH CORPORATION
Cash flow data:
For the Nine Months ended September 30, 2003
-----------------------------------------------------------
Previously
Reported Adjustment As Restated
------------------- ------------------- -------------------
Net loss ..................................... $ 3,774,066 $ (5,915) $ 3,779,981
Stock based compensation related to
repricing of warrants granted to investors
and the grant of new warrants .............. 152,844 (123,085) 29,759
Amortization of compensation related to
beneficial conversion feature and
warrants issued to holders of
convertible debentures ..................... 1,005,001 129,000 1,134,001
Overview of Results of Operations
We incurred significant operating losses for the years ended December 31,
2001, 2002 and 2003 and for the first nine months of 2004. While we expect to
continue to derive revenues from the sale of products that our subsidiaries
manufacture and the services that they 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 $9.7 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, Epsilor and AoA will contribute to our goal of achieving profitability.
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. This has proved to be
the case thus far for 2004 as well.
A portion of our operating loss during the first nine 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, 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, Epsilor and AoA resulted in our incurring similar non-cash
charges during the first nine months of 2004.
31
AROTECH CORPORATION
As a result of the application of the above accounting rule, we incurred
non-cash charges related to our acquisitions in the amount of $2,332,900 during
the first nine months of 2004.
The non-cash charges that relate to our financings arise when we sell
convertible debentures and 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 convertible debentures; when the convertible debentures are converted,
the entire remaining unamortized financial expense is immediately recognized in
the quarter in which the conversion occurs. As and to the extent that our
remaining convertible debentures are converted, 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 $3,454,676 during
the first nine months of 2004.
Additionally, in an effort to improve our cash situation and our
shareholders' equity, we have periodically 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. Under such circumstances, we record a deemed
dividend 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 recorded a
deemed dividend related to warrants repricing in amount of $3,328,952 during the
first nine months of 2004.
In addition, we incurred non-cash charges in the amount of $576,648 during
the first nine months of 2004 in connection with options and shares granted to
employees.
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 nine months of 2004, IES experienced a substantial slowdown
of new sales. As of September 30, 2004, our backlog for our Simulation, Training
and Consulting Division totaled $12.2 million, most of which was attributable to
FAAC.
32
AROTECH CORPORATION
In our Battery and Power Systems Division, EFB and Epsilor had revenues
roughly in line with expectations. As of September 30, 2004, our backlog for our
Battery and Power Systems Division totaled $3.6 million.
In our Armored Vehicle Division, MDT Armor experienced an increase in
revenues during the first nine months of 2004 as a result of new orders in
connection with the War in Iraq. As of September 30, 2004, our backlog for our
Armored Vehicle Division totaled $7.1 million.
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.
Critical Accounting Policies
The changes to our critical accounting policies as a result of our
purchases of Epsilor, FAAC and AoA include the following:
> Revenue Recognition
> Accounting for Income Taxes
Revenue Recognition
Significant management judgments and estimates must be made and used in
connection with the recognition of revenue in any accounting period. Material
differences in the amount of revenue in any given period may result if these
judgments or estimates prove to be incorrect or if management's estimates change
on the basis of development of the business or market conditions. Management
judgments and estimates have been applied consistently and have been reliable
historically.
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AROTECH CORPORATION
A portion of our revenue is generated by our subsidiary FAAC from
arrangements involving significant customization of simulation system. Revenues
from such arrangements are recognized based on the percentage of completion
method. The percentage of completion is measured by monitoring progress using
records of actual time incurred to date in the project compared with the total
estimated project requirement, which corresponds to the costs related to earned
revenues. Estimates of total project requirements are based on prior experience
of customization, delivery and acceptance of the same or similar technology and
are reviewed and updated regularly by management. We believe that the use of the
percentage of completion method is appropriate as we have the ability to make
reasonably dependable estimates of the extent of progress towards completion,
contract revenues and contract costs. In addition, contracts executed include
provisions that clearly specify the enforceable rights regarding services to be
provided and received by the parties to the contracts, the consideration to be
exchanged and the manner and terms of settlement. In all cases we expect to
perform our contractual obligations and our licensees are expected to satisfy
their obligations under the contract. The complexity of the estimation process
and the issues related to the assumptions, risks and uncertainties inherent with
the application of the percentage of completion method of accounting affect the
amounts of revenue and related expenses reported in our consolidated financial
statements. A number of internal and external factors can affect our estimates,
including labor rates, utilization and specification and testing requirement
changes.
Accounting for Income Taxes
Significant judgment is required in determining our worldwide income tax
expense provision. In the ordinary course of a global business, there are many
transactions and calculations where the ultimate tax outcome is uncertain. Some
of these uncertainties arise as a consequence of cost reimbursement arrangements
among related entities, the process of identifying items of revenue and expense
that qualify for preferential tax treatment and segregation of foreign and
domestic income and expense to avoid double taxation. Although we believe that
our estimates are reasonable, the final tax outcome of these matters may be
different from that which is reflected in our historical income tax provisions
and accruals. Such differences could have a material effect on our income tax
provision and net income (loss) in the period in which such determination is
made.
Results of Operations
Preliminary Note
Results for the three and nine months ended September 30, 2004 include the
results of FAAC, Epsilor and AoA for such period as a result of our acquisitions
of these companies during 2004. The results of FAAC, Epsilor and AoA were not
included in our operating results for the three and nine months ended September
30, 2003. Accordingly, the following period-to-period comparisons should not
necessarily be relied upon as indications of future performance.
Three months ended September 30, 2004 compared to the three months ended
September 30, 2003.
Revenues. During the three months ended September 30, 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 maintenance
services in connection with such systems;
> MDT, MDT Armor and AoA recognized revenues from payments under
vehicle armoring contracts, for service and repair of armored vehicles,
and on sale of armoring products;
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AROTECH CORPORATION
> 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; 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 September 30, 2004 totaled $16.3
million, compared to $5.7 million in the comparable period in 2003, an increase
of $10.6 million, or 185%. This increase was primarily attributable to the
following factors:
> Increased revenues from our Armored Vehicle Division, particularly
MDT Armor; and
> Revenues generated by FAAC ($4.6 million), Epsilor ($1.9 million)
and AoA ($1.3 million) in the third quarter of 2004 that were not present
in the corresponding period of 2003.
These revenues were offset to some extent by
> Decreased U.S. Army Communications Electronics Command (CECOM)
revenues from our EFB subsidiary.
In the third quarter of 2004, revenues were $6.0 million for the
Simulation, Training and Consulting Division (compared to $2.9 million in the
third quarter of 2003, an increase of $3.1 million, or 107%, due primarily to
the added revenues of FAAC); $2.9 million for the Battery and Power Systems
Division (compared to $1.8 million in the third quarter of 2003, an increase of
$1.1 million, or 58%, due primarily to the added revenues of Epsilor, offset to
some extent by decreased revenues from EFB); and $7.3 million for the Armored
Vehicle Division (compared to $943,000 in the third quarter of 2003, an increase
of $6.4 million, or 677%, due primarily to increased revenues from MDT Armor and
to the added revenues of AoA).
Cost of revenues and gross profit. Cost of revenues totaled $11.5 million
during the third quarter of 2004, compared to $3.3 million in the third quarter
of 2003, an increase of $8.3 million, or 255%, due primarily to increased sales
in all divisions.
Direct expenses for our three divisions during the third quarter of 2004
were $5.0 million for the Simulation, Training and Consulting Division (compared
to $2.1 million in the third quarter of 2003, an increase of $2.9 million, or
140%, due primarily the added expenses of FAAC ); $2.4 million for the Battery
and Power Systems Division (compared to $1.6 million in the third quarter of
2003, an increase of $818,000, or 52%, due primarily to the added revenues of
Epsilor ($1.9 million), offset by decreased revenues of our Zinc-Air military
batteries); and $6.2 million for the Armored Vehicle Division (compared to
$780,000 in the third quarter of 2003, an increase of $5.5 million, or 701%, due
primarily to increased revenues from MDT Armor and to the added revenues of
AoA).
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AROTECH CORPORATION
Gross profit was $4.7 million during the third quarter of 2004, compared
to $2.5 million during the third quarter of 2003, an increase of $2.3 million,
or 93%. This increase was the direct result of all factors presented above, most
notably the presence of FAAC, Epsilor and AoA in our results and the increase in
vehicle armoring revenues.
Research and development expenses. Research and development expenses for
the third quarter of 2004 were $431,000, compared to $252,000 during the third
quarter of 2003, an increase of $179,000, or 71%. This increase was primarily
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 third
quarter of 2004 were $1.3 million, compared to $758,000 the third quarter of
2003, an increase of $537,000, or 71%. This increase was primarily attributable
to the inclusion of the sales and marketing expenses of FAAC, Epsilor and AoA in
our results for 2004.
General and administrative expenses. General and administrative expenses
for the third quarter of 2004 were $2.1 million compared to $1.0 million in the
third quarter of 2003, an increase of $1.1 million, or 115%. This increase was
primarily attributable to the following factors:
> The inclusion of the general and administrative expenses of FAAC,
Epsilor and AoA in our results for 2004;
> Expenses in 2004 in connection with grants of options and shares to
employees that did not exist in 2003;
> Increases in other general and administrative expenses in comparison
to 2003, such as employees salaries, travel expenses and audit fees.
Financial income (expenses), net. Financial income , net of financial
expenses and exchange differentials, totaled approximately $1.1 million in the
third quarter of 2004 compared to $(82,000) in the third quarter of 2003. The
difference was due primarily to amortization of debt discount related to the
issuance of convertible debentures, as well as interest expenses related to
those debentures. Those expenses were offset by $1.8 million financial income
due to the change in the fair market value of the warrants that were issued in
July 2004 (see Note 11.b. to the financial statements) .
Income taxes. We and certain of our subsidiaries incurred accumulated net
operating losses during previous years and, accordingly, we were not required to
make any provision for income taxes. With respect to some of our subsidiaries
that operated at a net profit during 2004, we were able to offset federal taxes
against our accumulated loss carry forward. We recorded a total of $116,000 in
tax expenses in the third quarter of 2004, with respect to certain of our
subsidiaries that operated at a net profit during 2004 and we are not able to
offset their taxes against our loss carry forward. In the third quarter of 2003,
tax expenses written were with respect to MDT's taxable income.
Amortization of intangible assets. Amortization of intangible assets
totaled $739,000 in the third quarter of 2004, compared to $104,000 the third
quarter of 2003, an increase of
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AROTECH CORPORATION
$636,000, or 614%. Of this increase, $226,000 of this amortization was
attributable to FAAC, $142,000 was attributable to Epsilor, and $213,000 was
attributable to AoA.
Net income before deemed dividend of common stock to certain stockholders.
Due to the factors cited above, we reported a net income of $1.1 million in the
third quarter of 2004, compared to a net income of $216,000 in the third quarter
of 2003, an increase in income of $911,000.
Net income (loss) after deemed dividend of common stock to certain
stockholders was a net loss of $(1.0) million in the third quarter of 2004 due
to a deemed dividend of $2.2 million in the third quarter of 2004 (see Note
11.b. to the financial statements) compared to a net income of $122,000 in the
third quarter of 2003 due to a deemed dividend of $95,000 in the third quarter
of 2003.
Nine months ended September 30, 2004 compared to the nine months ended September
30, 2003.
Revenues. During the nine months ended September 30, 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, MDT Armor and AoA recognized revenues from payments under
vehicle armoring contracts, for service and repair of armored vehicles,
and on sale of armoring products;
> 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 nine months ended September 30, 2004 totaled $33.4
million, compared to $13.2 million in the comparable period in 2003, an increase
of $20.2 million, or 152%. 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; and
> Revenues generated by FAAC ($9.4 million), Epsilor ($3.9 million)
and AoA ($1.3 million) in the first nine months of 2004 that were not
present in the corresponding period of 2003.
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AROTECH CORPORATION
These revenues were offset to some extent by
> Decreased revenues from our IES subsidiary.
In the first nine months of 2004, revenues were $13.3 million for the
Simulation, Training and Consulting Division (compared to $5.8 million in the
first nine months of 2003, an increase of $7.5 million, or 130%, due primarily
to the added revenues of FAAC, offset to some extent by decreased revenues from
IES); $8.0 million for the Battery and Power Systems Division (compared to $4.7
million in the first nine months of 2003, an increase of $3.3 million, or 71%,
due primarily to the added revenues of Epsilor ($3.9 million), offset to some
extent by decreased revenues from our Zinc-Air military batteries); and $12.1
million for the Armored Vehicle Division (compared to $2.8 million in the first
nine months of 2003, an increase of $9.3 million, or 335%, due primarily to
increased revenues from MDT Armor and to the added revenues of AoA).
Cost of revenues and gross profit. Cost of revenues totaled $22.7 million
during the first nine months of 2004, compared to $8.4 million in the first nine
months of 2003, an increase of $14.3 million, or 171%, due primarily to
increased sales in all divisions.
Direct expenses for our three divisions during the first nine months of
2004 were $11.9 million for the Simulation, Training and Consulting Division
(compared to $5.1 million in the first nine months of 2003, an increase of $6.8
million, or 132%, due primarily to the added expenses of FAAC, offset to some
extent by decreased expenses by IES); $7.5 million for the Battery and Power
Systems Division (compared to $4.3 million in the first nine months of 2003, an
increase of $3.1 million, or 72%, due primarily to the added expenses of
Epsilor; and $10.7 million for the Armored Vehicle Division (compared to $2.8
million in the first nine months of 2003, an increase of $7.8 million, or 276%,
due primarily to increased revenues from MDT Armor and to the added expenses of
AoA ($759,000).
Gross profit was $10.7 million during the first nine months of 2004,
compared to $4.9 million during the first nine months of 2003, an increase of
$5.8 million, or 120%. This increase was the direct result of all factors
presented above, most notably the presence of FAAC, Epsilor and AoA in our
results and the increase in vehicle armoring revenues from MDT Armor.
Research and development expenses. Research and development expenses for
the first nine months of 2004 were $1.3 million, compared to $763,000 during the
first nine months of 2003, an increase of $540,000, or 71%. This increase was
the result of the inclusion of the research and development expenses of FAAC and
Epsilor in our results this nine months.
Sales and marketing expenses. Sales and marketing expenses for the first
nine months of 2004 were $3.4 million, compared to $2.4 million the first nine
months of 2003, an increase of $1.0 million, or 43%. This increase was primarily
attributable to the inclusion of the sales and marketing expenses of FAAC,
Epsilor and AoA in our results for 2004.
Those expenses were offset to some extent by a decrease in expenses
related to our security consulting business in the U.S., a decrease in expenses
related to our military batteries field and a decrease in IES sales and
marketing expenses.
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AROTECH CORPORATION
General and administrative expenses. General and administrative expenses
for the first nine months of 2004 were $7.6 million compared to $3.5 million in
the first nine months of 2003, an increase of $4.1 million, or 119%. This
increase was primarily attributable to the following factors:
> The inclusion of the general and administrative expenses of FAAC,
Epsilor and AoA in our results for 2004;
> Expenses in 2004 in connection with grant of options and shares to
employees that were not present in 2003; and
> Increases in other general and administrative expenses in comparison
to 2003, such as employee accruals, travel expenses, audit fees and
expenses related to due diligence performed in connection to certain
potential acquisitions; and
> We incurred expenses in connection with new activities by our Arocon
and MDT Armor subsidiaries.
Financial expenses, net. Financial expenses, net of interest income and
exchange differentials, totaled approximately $2.1 million in the first nine
months of 2004 compared to $1.2 million in the first nine months of 2003, a
difference of $912,000 or 75%. This difference was due primarily to amortization
of debt discount 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 some of our subsidiaries that operated at a
net profit during 2004, we were able to offset federal taxes against our losses
carry forward. We recorded a total of $287,000 in tax expenses in the first nine
months of 2004, with respect to certain of our subsidiaries that operated at a
net profit during 2004 and we are not able to offset their taxes against our
loss carry forward and with respect to state taxes. In the first nine months of
2003, tax expenses were written with respect to MDT's taxable income.
Amortization of intangible assets. Amortization of intangible assets
totaled $1.7 million in the first nine months of 2004, compared to $727,000 in
the first nine months of 2003, an increase of $1.0 million, or 138%. Of this
increase, $678,000 of this amortization was attributable to FAAC, $426,000 was
attributable to Epsilor and $213,000 was attributable to AoA. The expenses were
offset to some extent by a decrease in IES's and MDT's amortization expenses in
2004.
Net loss before deemed dividend of common stock to certain stockholders.
Due to the factors cited above, we reported a net loss of $5.8 million in the
first nine months of 2004, compared to a net loss of $3.8 million the first nine
months of 2003, an increase of $2.0 million.
Net loss after deemed dividend of common stock to certain stockholders was
$9.1 million due to a deemed dividend of $3.3 million (see Notes 10.a. and 11.b.
to the financial statements) compared to $4.0 million in the first nine months
of 2003 due to a deemed dividend of $267,000 in the first nine months of 2003.
39
AROTECH CORPORATION
Liquidity and Capital Resources
As of September 30, 2004, we had $4.6 million in cash, $13.2 million in
restricted collateral securities and cash deposits due within one year, $1.0
million in long-term restricted securities and deposits, and $129,000 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, Epsilor and AoA, and working capital needed in our other segments.
We used available funds in the third 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 nine months ended September 30, 2004 by $1.1 million
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
net fixed assets amounted to $4.5 million at quarter end.
Net cash used in operating activities from continuing operations for the
nine months ended September 30, 2004 and 2003 was $1.0 million and $2.4 million,
respectively, a decrease of $1.4 million. This decrease was primarily the result
of an increase in our adjusted profits in 2004 (profit in statement of
operations less non-cash charges such as depreciation, amortization, non-cash
financial expenses and non-cash expenses related to options and warrants).
Net cash used in investing activities for the nine months ended September
30, 2004 and 2003 was $52.2 million and $936,000, an increase of $51.3 million.
This increase was primarily the result of our investment in the acquisition of
FAAC, Epsilor and AoA in 2004.
Net cash provided by financing activities for the nine months ended
September 30, 2004 and 2003 was $44.3 million and $4.9 million, respectively, an
increase of $39.4 million. This increase was primarily the result of higher
amounts of funds raised through sales of our securities in 2004 compared to
2003.
During the nine months ended September 30, 2004, certain of our employees
exercised options under our registered employee stock option plan. The proceeds
to us from the exercised options were approximately $1.1 million.
As of September 30, 2004, we had (based on the contractual amount of the
debt and not on the accounting valuation of the debt) approximately $7.5 million
in long term bank and certificated debt outstanding, of which $5.3 million was
convertible debt, and approximately $1.25 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, and contain certain other affirmative and negative
covenants. We do not believe that these covenants will materially limit our
ability to undertake future financings.
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AROTECH CORPORATION
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.
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 or exercisable 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 September 30, 2004, we had an accumulated deficit of
approximately $115.8 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 $7.5
million as of September 30, 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.
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AROTECH CORPORATION
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.
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 and AoA in August 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.
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AROTECH CORPORATION
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.
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, Epsilor and AoA,
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.
As a result of our acquisitions, we are currently experiencing a period of
significant 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.
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AROTECH CORPORATION
A significant portion of our business is dependent on government
contracts.
Many of the customers of IES, FAAC and AoA 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.
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.
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AROTECH CORPORATION
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.
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.
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.
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AROTECH CORPORATION
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.
Some of the components of our products pose potential safety risks which
could create potential liability exposure for us.
Some of the components of our products contain elements that are known to
pose potential safety risks. 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
and AoA, 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.
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.
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AROTECH CORPORATION
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.
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.
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AROTECH CORPORATION
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, FAAC and AoA
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.
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;
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AROTECH CORPORATION
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.
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.
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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 November 10, 2004, we had 79,096,283 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.
Exercise of our warrants, options and convertible debt could adversely
affect our stock price and will be dilutive.
As of November 10, 2004, there were outstanding warrants to purchase a
total of 17,251,020 shares of our common stock at a weighted average exercise
price of $1.55 per share, options to purchase a total of 8,994,130 shares of our
common stock at a weighted average exercise price of $1.32 per share, of which
5,905,336 were vested, at a weighted average exercise price of $1.46 per share,
and outstanding debentures convertible into a total of 3,786,732 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.
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.
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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.
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.
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.
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AROTECH CORPORATION
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.
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, and we occasionally 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 foreign currencies. We do not hold or
issue derivative financial instruments for trading or speculative purposes
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ITEM 4. CONTROLS AND PROCEDURES.
As of the end of the third 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
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 September 30, 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.
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, beginning with
our Annual Report on Form 10-K for the fiscal year ending December 31, 2004, we
will be required to furnish a report by management on our internal control over
financial reporting. Such report will contain, among other matters, an
assessment of the effectiveness of our internal control over financial reporting
as of December 31, 2004, including a statement as to whether or not our internal
control over financial reporting is effective. This assessment must include
disclosure of any material weaknesses in our internal control over financial
reporting identified by management. Such report must also contain a statement
that our auditors have issued an attestation report on management's assessment
of such internal controls. Public Company Oversight Board Auditing Standard No.
2 provides the professional standards and related performance guidance for
auditors to attest to, and report on, management's assessment of the
effectiveness of internal control over financial reporting under Section 404.
While we currently believe that our internal control over financial
reporting is effective, we are still performing the system and process
documentation and evaluation needed to comply with Section 404, which is both
costly and challenging. During this process, if our management identifies one or
more material weaknesses in our internal control over financial reporting, we
will be unable to assert that such internal control is effective. If we are
unable to assert that our internal control over financial reporting is effective
as of December 31, 2004 (or if our auditors are unable to attest that our
management's report is fairly stated or are unable to express an opinion on the
effectiveness of our internal controls), we could lose investor confidence in
the accuracy and completeness of our financial reports, which could have an
adverse effect on our stock price.
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While we currently anticipate being able to satisfy the requirements of
Section 404 in a timely fashion, we cannot be certain as to the timing of
completion of our evaluation, testing and any required remediation, especially
with respect to certain entities that we have acquired during 2004, due in large
part to the fact that there is no precedent available by which to measure
compliance with the new Auditing Standard No. 2.
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PART II
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Issuance of Warrants to Investors
In July 2004, warrants to purchase 8,814,235 shares of common stock,
having an aggregate exercise price of $16,494,194, were exercised. In connection
with this exercise, we issued to those exercising warrants an aggregate of
8,717,265 new five-year warrants to purchase shares of common stock at an
exercise price of $1.38 per share.
We issued the above new 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 shares of common stock currently bear
restrictive legends permitting transfer thereof only upon registration or an
exemption under the Act.
ITEM 5. OTHER INFORMATION.
We will be holding a Special Meeting of Stockholders on Tuesday, December
14, 2004, to consider and act upon a proposal to ratify, for purposes of NASD
Marketplace Rule 4350(i)(1)(C)(ii), the issuance in July 2004 of five-year
warrants to purchase up to 8,717,265 shares of our common stock at a price of
$1.38 per share. We mailed our Notice and Proxy Statement for the 2004 Special
Meeting of Stockholders on or about November 8, 2004.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) The following documents are filed as exhibits to this report:
Exhibit Number Description
-------------- -----------
*10.1...........Securities Purchase Agreement dated July 15, 2004
**10.2...........Stock Purchase Agreement dated as of July 15, 2004
between Arotech Corporation and Armour of America,
Incorporated and its sole shareholder
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
- ------------------------------------
* Incorporated by reference to our Current Report on Form 8-K filed on July
15, 2004
** Incorporated by reference to our Quarterly Report on Form 10-Q for the
quarter ended June 30, 2004, filed on August 16, 2004
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(b) The following reports on Form 8-K or Form 8-K/A were filed or
furnished during the third quarter of 2004:
Date Filed Item Reported
---------- -------------
July 15, 2004.............Item 5 - Other Events and Regulation FD Disclosure;
and Item 7 - Financial Statements, Pro Forma
Financial Information and Exhibits
August 10, 2004...........Item 7 - Financial Statements, Pro Forma Financial
Information and Exhibits; and Item 12 - Results of
Operations and Financial Condition (furnished but
not filed)
August 23, 2004...........Item 2.01 - Completion of Acquisition or Disposition
of Assets; and Item 9.01 - Financial Statements and
Exhibits
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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: November 22, 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)
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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