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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004 .
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______.
Commission File Number: 0-23336
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 incorporation or organization) (I.R.S. Employer Identification No.)
354 Industry Drive, Auburn, Alabama 36830
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(Address of principal executive offices) (Zip Code)
(334) 502-9001
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
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None Not applicable
Securities registered pursuant to Section 12(g) of the Act:Common Stock, $0.01
par value
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss. 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. __
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No__
The aggregate market value of the registrant's voting stock held by
non-affiliates of the registrant as of June 30, 2004 was approximately
$128,605,410 (based on the last sale price of such stock on such date as
reported by The Nasdaq National Market and assuming, for the purpose of this
calculation only, that all of the registrant's directors and executive officers
are affiliates).
(Applicable only to corporate registrants) Indicate the number of shares
outstanding of each of the registrant's classes of common stock, as of the
latest practicable date: 80,103,668 as of 3/10/05
Documents incorporated by reference: None
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PRELIMINARY NOTE
This annual report contains historical information and forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995 with respect to our business, financial condition and results of
operations. The words "estimate," "project," "intend," "expect" and similar
expressions are intended to identify forward-looking statements. These
forward-looking statements are subject to risks and uncertainties that could
cause actual results to differ materially from those contemplated in such
forward-looking statements. Further, we operate in an industry sector where
securities values may be volatile and may be influenced by economic and other
factors beyond our control. In the context of the forward-looking information
provided in this annual report and in other reports, please refer to the
discussions of risk factors detailed in, as well as the other information
contained in, our other filings with the Securities and Exchange Commission.
Electric Fuel(R) is a registered trademark and Arotech(TM) is a
trademark of Arotech Corporation, formerly known as Electric Fuel Corporation.
All company and product names mentioned may be trademarks or registered
trademarks of their respective holders. Unless otherwise indicated, "we," "us,"
"our" and similar terms refer to Arotech and its subsidiaries.
PART I
ITEM 1. BUSINESS
General
We are a defense and security products and services company, engaged in
three business areas: high-level armoring for military, paramilitary and
commercial air and ground vehicles; interactive simulation for military, law
enforcement and commercial markets; and batteries and charging systems for the
military. Until September 17, 2003, we were known as Electric Fuel Corporation.
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:
>> We develop, manufacture and market advanced hi-tech multimedia and
interactive digital solutions for use-of-force and driving training
of military, law enforcement, security and other personnel through
our Simulation and Security Division:
o We provide simulators, systems engineering and
software products to the United States military,
government and private industry through our
subsidiary FAAC Incorporated, located in Ann Arbor,
Michigan ("FAAC"); and
o We provide specialized "use of force" training for
police, security personnel and the military through
our subsidiary IES Interactive Training, Inc.,
located in Littleton, Colorado ("IES").
>> We manufacture aviation armor and we utilize sophisticated
lightweight materials and advanced engineering processes to
armor vehicles through our Armor Division:
o We manufacturer ballistic and fragmentation armor
kits for rotary and fixed wing aircraft, marine
armor, personnel armor, military vehicles and
architectural applications, including both the
LEGUARD Tactical Leg Armor and the Armourfloat
Ballistic Floatation Device, which is a unique vest
that is certified by the U.S. Coast Guard, through
our subsidiary Armour of America, located in Los
Angeles, California, ("AoA"); and
o We use state-of-the-art lightweight ceramic
materials, special ballistic glass and advanced
engineering processes to fully armor vans and SUVs,
through our subsidiaries MDT Protective Industries,
Ltd., located in Lod, Israel ("MDT"), of which we own
75.5%, and MDT Armor Corporation, located in Auburn,
Alabama ("MDT Armor"), of which we own 88%.
>> We manufacture and sell lithium and Zinc-Air batteries for
defense and security products and other military applications
and we pioneer advancements in Zinc-Air technology for
electric vehicles through our Battery and Power Systems
Division
o We develop and sell rechargeable and primary lithium
batteries and smart chargers to the military and to
private industry in the Middle East, Europe and Asia
through our subsidiary Epsilor Electronic Industries,
Ltd., located in Dimona, Israel (in Israel's Negev
desert area) ("Epsilor");
o We manufacture and sell Zinc-Air fuel cells,
batteries and chargers for the military, focusing on
applications that demand high energy and light
weight, through our subsidiary Electric Fuel Battery
Corporation, located in Auburn, Alabama ("EFB"); and
o We produce water-activated lifejacket lights for
commercial aviation and marine applications, and we
conduct our Electric Vehicle effort, through our
subsidiary Electric Fuel (E.F.L.) Ltd., located in
Beit Shemesh, Israel ("EFL").
Background
We were incorporated in Delaware in 1990 under the name "Electric Fuel
Corporation," and we changed our name to "Arotech Corporation" on September 17,
2003. Unless the context requires otherwise, all references to us refer
collectively to Arotech Corporation and Arotech's wholly-owned Israeli
subsidiaries, EFL and Epsilor; Arotech's majority-owned Israeli subsidiaries,
MDT and MDT Armor; and Arotech's wholly-owned United States subsidiaries, EFB,
IES, FAAC and AoA.
For financial information concerning the business segments in which we
operate, see Note 18 of the Notes to the Consolidated Financial Statements. For
financial information about geographic areas in which we engage in business, see
Note 18.c of the Notes to the Consolidated Financial Statements.
Facilities
Our principal executive offices have recently been re-located to EFB's
premises at 354 Industry Drive, Auburn, Alabama 36830, and our telephone number
at our executive offices is (334) 502-9001. Our corporate website is
www.arotech.com. Our periodic reports to the Securities Exchange Commission, as
well as recent filings relating to transactions in our securities by our
executive officers and directors, that have been filed with the Securities and
Exchange Commission in EDGAR format are made available through hyperlinks
located on the investor relations page of our website, at
http://www.arotech.com/compro/investor.html, as soon as reasonably practicable
after such material is electronically filed with or furnished to the SEC.
Reference to our websites does not constitute incorporation of any of the
information thereon or linked thereto into this annual report.
2
The offices and facilities of three of our principal 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 the
members of our senior management work extensively out of EFL's facilities. IES's
offices and facilities are located in Littleton, Colorado, FAAC's home offices
and facilities are located in Ann Arbor, Michigan, AoA's offices and facilities
are located in Los Angeles, California, and the offices and facilities of EFB
and MDT Armor are located in Auburn, Alabama.
Simulation and Security Division
We develop, manufacture and market advanced hi-tech multimedia and
interactive digital solutions for use-of-force and driving training of military,
law enforcement, security and other personnel through our Simulation and
Security Division, the largest of our three divisions. During 2004, 2003 and
2002 revenues from our Simulation and Security Division were approximately $21.5
million, $8.0 million and $2.0 million, respectively (on a pro forma basis,
assuming we had owned all components of our Simulation and Security Division
since January 1, 2002, revenues in 2004, 2003 and 2002 would have been
approximately $21.5 million, $17.9 million and $20.3 million, respectively).
Vehicle Simulators
We provide simulators, systems engineering and software products to the
United States military, government and private industry through our wholly-owned
subsidiary, FAAC Corporation, based in Ann Arbor, Michigan. Our fully
interactive driver-training systems feature state-of-the-art vehicle simulator
technology enabling training in situation awareness, risk analysis and decision
making, emergency reaction and avoidance procedures, and conscientious equipment
operation. We have an installed base of over 220 simulators that have
successfully trained over 100,000 drivers. Our customer base includes all
branches of the U.S. Department of Defense, state and local governments, and
commercial entities.
INTRODUCTION
We conduct our business in two primary areas: Vehicle Simulations,
which focuses on the development and delivery of complete driving simulations
for a wide range of vehicle types - such as trucks, automobiles, buses, fire
trucks, police cars, ambulances, airport ground vehicles, and military vehicles
- - for commercial, governmental and foreign customers; and Military Operations,
which conducts tactical air and land combat analysis and develops analytical
models, simulations, and "turnkey" training systems for the U.S. military. In
2004, Vehicle Simulations accounted for approximately 80% of our vehicle
simulation revenues, and Military Operations accounted for approximately 20% of
our vehicle simulation revenues.
In the area of Military Operations, we are a premier developer of
validated, high fidelity analytical models and simulations of tactical air and
land warfare for all branches of the Department of Defense and its related
industrial contractors. Our simulations are found in systems ranging from
instrumented air combat and maneuver ranges (such as Top Gun) to full task
training devices such as the F-18 Weapon Tactics Trainer. We are also the
leading supplier of wheeled vehicle simulators to the U.S. Armed Forces for
mission-critical vehicle training.
We supply on-board software to support weapon launch decisions for the
F-15, F-18, and Joint Strike Fighter (JSF) fighter aircraft. Pilots benefit by
having highly accurate presentations of their weapon's capabilities, including
susceptibility to target defensive reactions. We designed and developed an
instructor operator station, mission operator station and real-time, database
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driven electronic combat environment for the special operational forces aircrew
training system. The special operational forces aircrew training system provides
a full range of aircrew training, including initial qualification, mission
qualification, continuation, and upgrade training, as well as combat mission
rehearsal.
Simulators are cost-effective solutions, enabling users to reduce
overall aircraft and ground vehicle usage, vehicle maintenance costs, fuel
costs, repairs, and spares expenditures. For example, our Medium Tactical
Vehicle Replacement (MTVR) simulators have reduced total driver training time by
35%. Many customers have reduced actual "behind-the-wheel" time by up to 50%
while still maintaining or improving safety. Additionally, for customers with
multiple simulators, the corresponding increase in the student to instructor
ratio has reduced instructor cost per student.
The implementation of our vehicle simulators has led to measurable
benefits. North American Van Lines, one of our earliest vehicle simulator
customers, has shown a 22% reduction in preventable accidents since it began
using our simulators. The German Army, one of our earliest Military Vehicle
customers, showed better driver testing scores in 14 of 18 driver skills
compared to classroom and live driver training results. Additionally, the New
York City Transit Authority documented a 43% reduction in preventable accidents
over its first six months of use and has reduced its driver hiring and training
"washout" by 50%.
Simulators can produce more drastic situations than can traditional
training, which inherently produces drivers that are more skilled in diverse
driving conditions. For example, while many first-time drivers will learn to
drive during the summer months, they are not trained to drive in wintry
conditions. Simulators can produce these and other situations, such as a tire
blowout or having to react to a driver cutting off the trainee, effectively
preparing the driver for adverse conditions.
We believe that we have held a 100% market share in U.S. military
wheeled simulators since 1999 and hold a market share in excess of 50% in U.S.
commercial wheeled vehicle simulators.
PRODUCT LINES
Below is a description of our vehicle simulator products and product
lines.
Vehicle Simulations
Military Vehicles
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Military Vehicles comprise the majority of our vehicle simulation
business. Military vehicle simulators are highly realistic vehicle simulators
that include variable reactive traffic and road conditions, the capacity to
customize driving conditions to be geography-specific, and training in hazardous
and emergency conditions. We have several large contracts and task orders in the
Military Vehicles business, including (i) the MTVR contract to develop vehicle
simulators and related training services for the U.S. Marine Corps; (ii) a
series of scheduled General Services Administration purchases of simulators with
the U.S. Army to supply 78 simulators for 25 training sites; (iii) a two-year
contract with the U.S. Navy Seabees to supply eight simulators for three
training sites; and (iv) a ten-year, task order contract to develop a series of
Common Driver Trainers for the U.S. Army, the first task order of which is for
nine Stryker simulators. We estimate that our software trained 12,000 soldiers
at ten sites in 2004.
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Our military vehicle simulators provide complete training capabilities,
based on integrated, effective simulation solutions, to military vehicle
operators in the U.S. Armed Forces. Our flagship military vehicle simulation
product is our MTVR Operator Driver Simulator, developed for the USMC. The MTVR
ODS concept is centered on a pod of up to six Student Training Stations (STS)
and a single controlling Instructor Operator Station (IOS). The STS
realistically simulates the form, fit, and feel of the MTVR vehicle. The
high-fidelity version of the STS consists of a modified production cab unit
mounted on a full six-degree-of-freedom motion platform. The STS provides a
field of view of over 180-degrees into a realistically depicted virtual world,
simulating a variety of on-road and off-road conditions. The IOS is the main
simulation control point supporting the instructor's role in simulator training.
The IOS initializes and configures the attached STS, conducts training
scenarios, assesses student performance, and maintains scenarios and approved
curriculum.
Our software solution provides a complete operator training curriculum
based upon integrated simulation training. Military vehicle simulators enable
students to learn proper operational techniques under all terrain, weather,
road, and traffic conditions. Instructors can use simulators as the primary
instructional device, quantitatively evaluating student performance under
controlled, repeatable scenarios. This monitoring, combined with the ability to
create hazardous and potentially dangerous situations without risk to man or
material, results in well-trained students at significantly less cost than
through the use of traditional training techniques. In addition to standard
on-road driver training, our military vehicle simulators can provide training in
such tasks as:
>> Off-road driving on severe slopes, including muddy or
swampy terrain;
>> Night vision goggle and blackout conditions;
>> Convoy training; and
>> The use of the Central Tire Inflation System in
response to changing terrain.
In addition to simulation systems, we offer on-site operator and
maintenance staff, train-the-trainer courses, curriculum development, scenario
development, system maintenance, software upgrades, and warranty packages to our
U.S. Armed Forces customers.
Commercial Vehicles
The Commercial Vehicles business is comprised of technology similar to
that of the Military Vehicles product line and also is customized to reflect the
specific vehicle being simulated. We serve four primary customer bases in the
Commercial Vehicles business: transit, municipal, airport, and corporate
customers.
Transit
Transit customers represent an attractive customer base as they
generally have access to their own funds, which often exempts them from the
lengthy and complex process of requesting funds from a governing body. We have
provided bus simulators to fourteen leading transit authorities, including the
New York City Transit Authority, Washington, D.C. Metro, Dallas Area Rapid
Transit, and the Chicago Transit Authority. We have also provided a rail
simulator to Houston Metro and we were competitively awarded a major rail
simulator program with New York City Transit.
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Municipal
We target municipal customers in police departments, hospitals, fire
departments, and departments of transportation for sales of our municipal
product. Our customers include the Mexico Department of Education, California
Department of Transportation, and the Fire Department of New York. We are
developing an industry advisory group focusing on the municipal market to
identify and address customer needs. Additionally, we have developed a simulator
module to extend the simulation once police, fire, or emergency medical service
personnel reach the incident location. We believe that this represents another
of our bases of differentiation over our competition.
Airport
We were a pioneer in providing simulation software to airports to
facilitate training personnel in adverse conditions, including the Detroit and
Toronto airports.
Corporate
We target corporate fleets and "for-hire" haulers as customers of the
corporate simulator product. These customers use simulators to train personnel
effectively as well as to avoid the brand damage that could be associated with
poor driver performance. To date, we have provided simulators to customers such
as Schlumberger Oil Services, Kramer Entertainment, and North American Van
Lines.
Military Operations
We provide air combat range software, missile launch envelope decision
support software, the SimBuilder(TM) simulation software product, and Weapon
System Trainer software through the Military Operations business line.
Air Combat Range Software
We serve the U.S. Air Force Air Combat Training System and U.S. Navy
Tactical Aircrew Training System with our air combat training range software.
Air combat training ranges allow pilots to train and evaluate new tactics in a
controlled airborne environment. Air "battles" are extremely realistic, with our
software determining the outcome of weapon engagements based on launch
conditions and the target aircraft defensive reactions.
Missile Launch Envelope Software
Onboard weapon decision-making software enables pilots to assimilate
the complex information presented to them in F-15, F-18 and Joint Strike Fighter
(JSF) fighter aircraft. We provide our missile launch envelope software to the
U.S. Navy and Air Force through our subcontracting relationships with Boeing and
Raytheon.
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Weapon System Trainer Software
We have successfully transitioned software from U.S. Navy Tactical
Aircrew Training Systems to over 15 Weapon Systems Trainers built by prime
contractors such as L-3, Boeing, Northrop Grumman, and Lockheed Martin.
SimBuilder(TM)
The SimBuilder(TM) simulation software product is designed to provide
weapons simulation models for use in training environments for launched weapons.
This software enables foreign end-users to use weapons simulation models similar
to the U.S. military without classified U.S. weapons data. Militaries of
Australia, the United Arab Emirates, Canada, Taiwan, and Singapore currently use
SimBuilders(TM).
MARKETING
Our sales and marketing effort focuses on developing new business
opportunities as well as generating follow-on sales of simulators and upgrades.
Through FAAC, we currently employ four dedicated sales representatives who focus
on Commercial Vehicles, Military Operations, and Military Vehicles
opportunities. Furthermore, two additional employees spend a significant portion
of their time in sales. Various members of FAAC's senior management serve as
effective sales representatives in the generation of municipal, military, and
corporate business. We also retain the services of four independent consultants
who act as marketing agents on our behalf. These representatives are largely
commission-based agents who focus on particular products and/or regions (such as
airport customers, Texas, California, and Eglin Air Force Base). Finally, we
have four customers that have agreements wherein the companies support our
marketing efforts and market our products themselves in exchange for commissions
and/or free upgrade services.
Our sales representatives are salaried employees with minimal
commission-based revenue. Independent consultants generally do not receive a
base salary and receive 5% to 10% commissions on the amount of business that
they generate each year. The majority of our sales representatives have
engineering backgrounds that they leverage to anticipate the technical needs of
our dynamic customer base and targeted markets. Additionally, the program
manager and service department assist us in gaining repeat business.
Developing a pipeline of follow-on work is one of the tasks for all
program managers. We have a long history of repeat and follow-on work with
programs such as F-15 and F-18 ZAP (over 20 contracts with Boeing), the U.S.
Navy Tactical Aircrew Training System (a series of 6 sequential contracts over
the last 25 years), and F-18 Weapon Tactics Trainer (series of 20 contracts with
the simulator manufacturer).
We also aggressively pursue several marketing initiatives to complement
our experienced sales force. Our most successful marketing strategy includes the
formation of industry advisory groups. Such advisory groups, which consist of
simulation users within select industries, conduct regular seminars to educate
transit and similar agencies on the benefits and challenges of simulation-based
training, as well as to share training concepts, curriculums, and experiences.
These sessions not only serve as excellent sales and marketing tools to generate
orders but also have created significant goodwill with customers. We believe
that these industry advisory groups have proven to be particularly successful in
cooperative industries, such as transit, where users are self-funded and do not
compete with one another.
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CUSTOMERS
We have long-term relationships, many of over ten years' duration, with
the U.S. Air Force, U.S. Navy, U.S. Army, and most major Department of Defense
training and simulation prime contractors and related subcontractors. The
quality of our customer relationships is illustrated by the multiple program
contract awards we have earned with many of our customers. For example, under a
series of 20 subcontracts over 15 years, we have provided the tactical
environment and F-18 weapons and avionics models for the F/A-18 Weapons Tactics
Trainer. We have served as a subcontractor for the F/A-18 WTT through three
distinct prime contractor tenures.
COMPETITION
Our technical excellence, superior product reliability, and high
customer satisfaction have enabled us to develop market leadership and an
attractive competitive position. Several potential competitors in the military
segment are large, diversified defense and aerospace conglomerates who do not
focus on our specific niches. As such, we are able to serve certain large
military contracts through strategic agreements with these organizations or can
compete directly with these organizations based on our strength in developing
higher quality software solutions. In commercial market applications, we compete
against smaller, less sophisticated software companies.
We differentiate ourselves from our competition on several bases:
>> Leading Technology - We believe that we offer
better-developed, more dynamic software than our
competitors. Additionally, we incorporate leading
graphics and motion-cueing technologies in our
systems to provide customers with the most realistic
simulation experience on the market.
>> Long History in the Simulation Software Business - As
a market leader in the simulation software business
for more than thirty years, FAAC's professionals
understand customer requirements and operating
environments. Thus, we build our software to meet and
exceed demanding customers' expectations.
>> Low-Cost Research and Development Capabilities for
New Products - Our customers benefit from government
and commercial funding of research and development
and the low cost of subsequent adaptation. As such,
internally funded new product development costs have
been less than $100,000 per year since 1999.
>> Service Reputation - We are known for providing
better service than the competition, a characteristic
that drives new business within our chosen markets.
>> Standardized Development Processes - We generally
deliver our products to market more quickly than our
competition and at higher quality due to our
standardized development processes.
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Below is a description of our competition organized by product lines.
Vehicle Simulations
Military Vehicles
FAAC has been the sole provider of wheeled vehicle simulation solutions
to the U.S. military since 1999. Our devotion to developing realistic,
comprehensive products for a wide range of vehicle types positions us as the
preferred simulation provider within this market niche. Our strategy of
identifying a training need, isolating government funds, and then developing a
customized training solution has led to considerable successes. This approach,
which differs from the "build first and market later" strategy employed by a
number of our competitors, effectively identifies market opportunities and
provides a better product to the military customer. Diversified defense
companies and commercial simulation providers have attempted to enter the
military wheeled vehicle market but have been unsuccessful thus far. Although we
believe that market penetration by these companies is ultimately inevitable, the
established FAAC brand, understanding of customer requirements, and engineering
expertise provide us with a competitive advantage in this market segment. Our
primary competitors for military vehicle simulation solutions include Lockheed
Martin Corporation's Information & Technology Services Group, L-3 Communications
Holdings, Raydon Corporation, and the Cubic Defense Applications division of
Cubic Corporation.
Commercial Vehicles
A handful of simulation product and service companies currently compete
with our targeted commercial driving simulator markets. However, our marketing
and development of selected commercial market segments has positioned us as a
leading provider of commercial simulation solutions. Competition within each
market segment varies, but the following companies generally participate in
selected driving simulator market opportunities: L-3 Communications Holdings,
Doron Precision Systems, Lockheed-Martin Corporation's LMIS Division, Global
SIM, and USADriveSafe, Inc.
Military Operations
Currently no significant competitors participate in the market for our
tactical environment software, and there are essentially no independent
competitors that exist in the market for our decision support software.
Competition for software to support tactical environment requirements in
aircraft weapon systems trainers comes from the manufacturers of the simulators
themselves and from a handful of companies who produce tactical environment
software. Our primary competitors for training range software, decision support
software, and weapons system trainer software solutions include Lockheed Martin
Corporation, L-3 Communications Holdings, Raytheon Company, Science Applications
International Corporation, Dynetics, Inc., and Georgia Tech Research Institute.
Use-of-Force Training
We are a leading provider of interactive, multimedia, fully digital
training simulators for law enforcement, security, military and similar
applications. With a customer base of over 700 customers in over twenty
countries around the world, we are a leader in the supply of simulation training
products to military, law enforcement and corporate client communities. We
believe, based on our general knowledge of the size of the interactive
use-of-force market, our specific knowledge of the extent of our sales, and
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discussions we have held with customers at trade shows, etc., that we provide
more than 35% of the worldwide market for government and military judgment
training simulators. We conduct our interactive training activities through our
subsidiary IES Interactive Training, Inc. ("IES"), a Delaware corporation based
in Littleton, Colorado.
INTRODUCTION
We offer consumers the following interactive training products and
services:
>> Range 3000 - providing use-of-force simulation for
military and law enforcement. We believe that the
Range 3000 is the most technologically advanced
judgment training simulator in the world.
>> A2Z Classroom Trainer - a state-of-the-art computer
based training (CBT) system that allows students to
interact with realistic interactive scenarios
projected life-size in the classroom.
>> Range FDU (Firearms Diagnostic Unit) - a unique
combination of training and interactive technologies
that give instructors a first-person perspective of
what trainees are seeing and doing when firing a
weapon.
>> Milo (Multiple Interactive Learning/training
Objectives) - a simulator designed with "plug in"
modules to customize the training system to meet end
user needs.
>> Summit Training International - providing relevant,
cost-effective professional training services and
interactive courseware for law enforcement,
corrections and corporate clients.
>> IES Studio Productions - providing cutting edge
multimedia video services for law enforcement,
military and security agencies, utilizing the newest
equipment to create the training services required by
the most demanding authorities.
Our products feature state of the art all digital video formats,
ultra-advanced laser-based lane detection for optimal accuracy and performance,
customer-based authoring of training scenarios, and 95% COTS (commercial
off-the-shelf)-based system.
PRODUCTS
Below is a description of each of the core products and services in the
IES line.
Range 3000 "Use of Force" Simulator
We believe that the Range 3000, which was launched in late 2002,
combines the most powerful operational hardware and software available, and
delivers performance unobtainable by any competing product presently on the
market.
The Range 3000 simulator allows training with respect to the full "Use
of Force" continuum. Training can be done on an individual basis, or as many as
four members of a team can participate simultaneously and be scored and recorded
individually. Topics of training include (but are not limited to):
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>> Officer's Presence and Demeanor - Picture-on-picture
digital recordings of the trainee's actions allows
visual review of the trainee's reaction, body
language and weapons handling during the course of
the scenario, which then can be played back for
debriefing of the trainee's actions.
>> Verbalization - Correct phrases, timing, manner and
sequence of an officer's dialogue is integrated
within the platform of the system, allowing the
situation to escalate or de-escalate through the
officer's own words in the context of the scenario
and in conjunction with the trainer.
>> Less-Than-Lethal Training - Training in the use of
non-lethal devices such as Taser, OC (pepper spray),
batons and other devices can be used with the video
training scenarios with appropriate reactions of
each.
>> Soft Hand Tactics - Low level physical control
tactics with the use of additional equipment such as
take-down dummies can be used.
>> Firearms Training and Basic Marksmanship - Either
utilizing laser based training weapons or in
conjunction with a live-fire screen, the use of "Live
Ammunition" training can be employed on the system.
The interactive training scenarios are projected either through single
or multiple screens and projectors, allowing us to immerse a trainee in
true-to-life training scenarios and incorporating one or all the above training
issues in the "Use of Force" continuum.
A2Z Classroom Trainer
The A2Z is a state-of-the-art Computer Based Training (CBT) system that
allows students to interact with realistic interactive scenarios projected
life-size in the classroom.
Using individual hand-held keypads, the students can answer true/false
or multiple choice questions. Based on the student's performance, the scenario
will branch and unfold to a virtually unlimited variety of different possible
outcomes of the student's actions. The system logs and automatically scores each
and every trainee's response and answer. At the end of the scenario, the system
displays a session results summary from which the trainer can debrief the class.
The advanced A2Z Courseware Authoring Tools allow the trainer easily to
create complete customized interactive courses and scenarios.
The Authoring Tools harness advances in digital video and multimedia,
allowing the trainer to capture video and graphics from any source. The A2Z
allows the trainer to combine his or her insight, experience and skills to
recreate a realistic learning environment. The A2Z Training System is based on
the well-known PC-Pentium technology and Windows XPTM operated. The menu and
mouse operation make the A2Z user-friendly.
The individual keypads are connected "wirelessly." The system is
completely portable and may be setup within a matter of minutes.
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Key advantages:
>> Provides repeatable training to a standard based on
established policy
>> Quick dissemination and reinforcement of correct
behavior and policies
>> Helps reduce liability
>> More efficient than "traditional and redundant"
role-playing methods
>> Realistic scenarios instead of outdated "play-acting"
>> Interactive training of up to 250 students
simultaneously with wireless keypads
>> Easy Self-Authoring of interactive training content
>> PC-Pentium platform facilitates low cost of ownership
>> Easy to use Windows XP-based software
>> Easy to deploy in any classroom
Range FDU
The Range FDU (firearm diagnostics unit) is a unique combination of
training and interactive technologies that gives instructors a first-person
perspective of what trainees are seeing and doing when firing a weapon. The
Range FDU is the only firearms training technology of its kind.
With the Range FDU, firearms instructors can see the trainees' actual
sight alignment to the target as well as measure trigger pressure against proper
trigger pressure graphs, making corrective instruction simple and effective. In
addition, the Range FDU records a trainee's recoil control, grip and stance -
allowing the instructor to playback the information in slow motion or real time
to better analyze the trainee's actions and more accurately diagnose any
deficiencies.
The Range FDU also has the ability to record the firearm instruction
session to either DVD or VHS, allowing both the trainee and the instructor to
review it at a later time. Trainees now have a diagnostic tool that they can
learn from, even after their training has been completed. In addition,
instructors can build a library for each trainee to record progress.
The Range FDU provides the following benefits:
>> Fall of shot feedback
>> Trigger pressure analysis
>> Recoil control, grip and stance assessment
>> Sight alignment
>> Sight picture analysis and target reacquisition
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Milo
Milo (Multiple Interactive Learning/training Objectives) is a simulator
designed with "plug in" modules to customize the trainings system to meet end
user needs, and is designed to expand the market for sales of our IES products
to include organizations involved in all aspects of public safety, and not just
law enforcement.
Professional Conferences and Courseware
We provide relevant, cost-effective professional training seminars,
consulting services, and interactive courseware for law enforcement,
corrections, and corporate clients through Summit Training International (STI),
a wholly-owned subsidiary of IES. The emphasis and goal of our conferences and
courseware is to create a "total training" environment designed to address the
cutting edge issues faced today. We provide conferences throughout the United
States, and develop courseware dealing with these important topics. The
incorporation of IES Interactive Systems in our conferences creates an intense
learning environment and adds to the realism of the trainee's experience.
Conferences
We have provided conferences throughout the United States, on such
topics as:
>> Recruiting and Retention of Law Enforcement and
Corrections Personnel
>> Ethics and Integrity
>> Issues of Hate Crimes
>> Traffic Stops and Use of Force
>> Community and Corporate Partnerships for Public
Safety
>> Creating a Safe School Environment
In addition to these national and regional conferences, we design and
produce training to address specific department issues. We have a distinguished
cadre of instructors that allows adaptation of programs to make them
specifically focused for a more intense learning experience. The A2Z Classroom
Trainer is incorporated into the "live" presentation creating a stimulating
interactive training experience.
Courseware
We develop courseware for use exclusively with IES's interactive
systems. Courses are designed to addresses specific department issues, and can
be customized to fit each agency's needs. These courses are available in boxed
sets that provide the customer with a turn-key training session. The A2Z
Classroom Trainer and the Range 3000 XP-4 are used to deliver the curriculum and
create a virtual world that the trainees respond and react to. Strategic
relationships with high profile companies such as H&K Firearms, and Taser
International, provide customers with training that deals with cutting edge
issues facing law enforcement today. The incorporation of our courseware library
along with simulation systems allows training to remain consistent and
effective, giving customers more value for their training dollar.
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IES Studio Productions
Through IES Studio Productions, a division of IES, we provide
multimedia video services for law enforcement, military and security agencies,
and others and create interactive courseware and interactive scenarios for the
Range 3000, Video Training Scenarios and all types of video production services.
With the latest in media equipment, we provide all media and marketing services
to IES Interactive Training in-house.
MARKETING
We market our IES products and services to domestic and international
law enforcement, military and other federal agencies and to various companies
that serve them, through attendance and presentations at conferences, exhibits
at trade shows, seminars at law enforcement academies and government agencies,
through its web pages on the Internet, and to its compiled database of prospect
and customer names. Our IES salespeople are also its marketing team. We believe
that this is effective for several reasons: (1) customers appreciate talking
directly with salespeople who can answer a wide range of technical questions
about methods and features, (2) our salespeople benefit from direct customer
contact through gaining an appreciation for the environment and problems of the
customer, and (3) the relationships we build through peer-to-peer contact are
useful in the military, police and federal agency market.
We also uses our IES web pages on our Internet site for such activities
as providing product information and software updates.
We market augmentative and alternative law enforcement products through
a network of employee representatives and independent resellers. These products
include but are not limited to products manufactured by:
>> Bristlecone Products
>> Fox Valley Technical College
>> Taser Inc.
>> Force Science Research Center
>> H&K Training Centers
At the present time we have six sales representatives based in Denver,
eight domestic independent distributors, and twenty-five independent resellers /
representatives overseas. We also have three inside sales/support persons who
answer telephone inquiries on IES's 800 line and Internet, and who can also
provide technical support. Additional outside salespersons and independent
dealers and resellers are being actively recruited at this time.
We typically participate in over thirty industry conferences annually,
held throughout the United States and in other countries, that are attended by
our potential customers and their respective purchasing and budgeting decision
makers. A significant percentage of our sales of IES products, both software and
hardware, are sold through leads developed at these shows.
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We and others in the industry demonstrate products at these conferences
and present technical papers that describe the application of their technologies
and the effectiveness of their products. We also advertise in selected
publications of interest to potential customers.
CUSTOMERS
Most of the customers for our IES products are law enforcement
agencies, both in the United States (federal, state and local) and worldwide.
Purchasers of IES products have included (in the United States) the FBI, the
Secret Service, the Bureau of Alcohol, Tobacco and Firearms, the Customs
Service, the Federal Protective Service, the Border Patrol, the Bureau of
Engraving and Printing, the Coast Guard, the Federal Law Enforcement Training
Centers, the Department of Health and Human Services, the California Department
of Corrections, NASA, police departments in Texas (Houston), Michigan (Detroit),
D.C., California (Fresno and the California Highway Patrol), Massachusetts
(Brookline), Virginia (Newport News and the State Police Academy), Arizona
(Maricopa County), universities and nuclear power plants, as well as
international users such as the Israeli Defense Forces, the German National
Police, the Royal Thailand Army, the Hong Kong Police, the Russian Security
Police, users in Mexico and the United Kingdom, and over 700 other training
departments worldwide.
The mix of customers has historically been approximately 40% city and
state agencies, 30% federal agencies, and 30% international.
COMPETITION
We compete against a number of established companies that provide
similar products and services, many of which have financial, technical,
marketing, sales, manufacturing, distribution and other resources significantly
greater than ours. There are also companies whose products do not compete
directly, but are sometimes closely related. Firearms Training Systems, Inc.,
Advanced Interactive Systems, Inc., and LaserShot Inc. are IES's main
competitors.
We believe the key factors in our competing successfully in this field
will be our ability to develop simulation software and related products and
services to effectively train law enforcement and military to today's standards,
our ability to develop and maintain a proprietary technologically advanced
hardware, and our ability to develop and maintain relationships with departments
and government agencies.
Armor Division
We manufacture aviation and other armor and we armor vehicles through
our Armor Division. During 2004, 2003 and 2002 revenues from our Armor Division
were approximately $18.0 million, $3.4 million and $2.7 million, respectively
(on a pro forma basis, assuming we had owned all components of our Armor
Division since January 1, 2002, revenues in 2004, 2003 and 2002 would have been
approximately $29.2 million, $10.9 million and $13.3 million, respectively).
Aircraft Armoring
INTRODUCTION
We are an innovative manufacturer of lightweight personal, vehicle,
aviation, architectural and marine ballistic armoring. Our Armor Division has
years of battlefield and commercial protection experience and has provided life
saving protection under the most extreme conditions. Through our subsidiary
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Armour of America, located in Los Angeles, California, we manufacturer ballistic
and fragmentation armor kits for rotary and fixed wing aircraft, marine armor,
personnel armor, military vehicles, architectural applications, including both
the LEGUARD Tactical Leg Armor and the Armourfloat Ballistic Floatation Device,
which is a unique armored floatation vest that is certified by the U.S. Coast
Guard.
For over thirty years, AoA has delivered ballistic armor equipment to
users worldwide. Initially, AoA designed and manufactured "soft" ballistic armor
only, such as covert and overt ballistic vests, military assault vests, tactical
vests and specially designed vests for military and law enforcement users both
in the U.S. and abroad. By 1982, AoA had started to design and manufacture
"hard" ballistic armor to stop military rifle fire up to and including .50
caliber Armor Piercing Incendiary (API) and European 12.7 mm API rounds. This
"hard" ballistic armor is used as chest protection for the full line of personal
vests, as well as on fixed wing aircraft (airplanes) and rotary wing aircraft
(helicopters), military ships, military vehicles and architectural applications.
Our proprietary designs have been developed to meet a wide variety of
customer and industry needs.
THE ARMORING PROCESS
Each hard armor kit starts out with detailed templates generated at the
aircraft or vehicle, with close fitting around pedals, consoles and other
obstructions. These templates are converted into wood patterns that are exact
three-dimensional reproductions of the armor to be manufactured, including as to
the thickness. These patterns are fitted back into the user's aircraft or
vehicle and approved. At this point, fiberglass over wood production molds are
produced for each part, which will guarantee that each production panel will be
exactly the same and fit perfectly within the kit. In addition, each kit has a
complete set of installation hardware that includes everything required to
install the armor kit to the aircraft or vehicle. This total kit package allows
the armor to be installed at any location with a minimum of tools required.
Soft armor is manufactured in the same manner as hard armor. Detailed
cut and sew patterns are developed from the requirements driven by the customer.
These requirements are normally dealing with collar height, placement of pockets
and location of plate pockets. Once these patterns are completed, two processes
start simultaneously. The first involves spreading multiple plies of ballistic
material on a special cutting table. The material is then dusted with pattern
powder to mark the packs for cutting. After each pack is cut to size, it is
routed to the sew shop for stitching. At the same time, nylon covers are being
cut and sewn using sew patterns made from the cut patterns. Upon completion of
both the ballistic pack and the cover, the pack is inserted into the cover and
sewn closed.
PRODUCTS LINES
We produce two kinds of armor, soft armor and hard armor, to support
customer armor requirements. Soft armor, which is capable of protecting against
all handguns and 9mm sub guns, is used in our ballistic and fragmentation vest,
military vehicle, marine, architectural and special application armor lines.
Hard armor, which is capable of protecting against rifle fire up to 50cal/12.7mm
API, is used in our ballistic chest plate, aircraft, military vehicle, marine
and architectural armor lines. Within these two basic kinds of armor, we offer
the product lines listed below.
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Fixed and Rotary Wing Aircraft Armor Systems
We design and manufacture ballistic armor systems for a wide variety of
fixed and rotary wing aircraft. These systems are in the form of kits, with
individual contoured panels which cover the entire aircraft's floor, walls,
seats, bulkheads, walls, oxygen containers, avionics and doors. All of our
ballistic armor kits include a complete installation hardware kit containing all
items required for installation. The supplied hardware is designed for each
individual application in accordance with the installation hardware
certification, which has been provided by Lockheed-Martin. Additionally, the
fixed and rotary wing aircraft kits have been certified, by an independent test
facility that is approved by the FAA, to meet flammability requirements of
FAA/FAR 25.853, 12 Second Vertical Test and MIL-STD-810 Environmental Testing.
These kits have been sold to both the original airframe manufacturers
and end users worldwide. Armor kits for rotary wing aircraft including Bell
Helicopter's B206, B212, B407, B412, B427, and UH-1H; Boeing's CH-46 and CH-47;
MD Helicopter's MD 500, MD 600, and MD 900; Agusta Helicopter's A109;
Eurocopter's EC-120, EC-135, BK117, and BO-105; Aerospatiale's AS 330, AS 332,
and AS 355; Sikorsky's UH-60 and S-61; MIL MI-8 and MI-17; Robinson's R-22 and
R-44; and Kaman's K-MAX.
Fixed wing aircraft kits include Lockheed's C-130H, C-130J , and P-3;
Boeing's C-17; Alenia's G-222 and C-27J; Ayers' T-65; Rockwell's OV-10; CASA CN
235 and CN 295; and special configurations of the Citation, Beechcraft and
Cessna models.
Military Vehicles Armor Kits
For the military vehicle market, we provide ballistic armor kits to
protect against fragmentation and rifle fire, up to 50cal API for Humvees, 2
1/2- and 5-ton trucks, HEMTT wreckers and various construction vehicles. These
kits offer varying levels of protection for doors, floors, fuel tanks, air
bottles, cargo beds, troop seat backs, critical components and glass. To date,
we have protected vehicles deployed in Iraq, Afghanistan, and Kuwait. All of the
provided kits are designed for easy field level installation and include
required hardware and instructions.
Marine Armor Kits
For the marine market, we manufacture armor kits for the gun mounts on
naval ships and riverine patrol boats. During Operation Desert Storm, we
designed and manufactured .50 cal AP ballistic panels and deck mount brackets
for the U.S. Navy. Since then, we have designed and manufactured armor to fit
both the .50 cal and 25mm gun mounts on frigates, destroyers, cruisers and
aircraft carriers. The result of this effort is that we have delivered armor
systems to individual ships in the class and currently are pursuing armoring
additional classes of ships throughout the Navy Command.
Additionally, we have designed program-specific armor for riverine and
small boats throughout the world. While the majority of these armoring programs
were limited to a small number of boats, the areas of coverage included complete
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coverage of the exterior walls of the wheel house, forward and aft gun
placements, fire boxes, fuel tanks and engines. Unlike designing armor kits for
aircraft, this type of armoring requires unique installation methods to allow
for interference caused by surface mounted hardware and the impact of "green
water" impacting the armor during rough weather.
Ballistic Vests and Plates and Body Armor
We manufacture a complete line of personal body armor, including
concealable, external and special application armor. The concealable armor vest
offers complete front, side and back protection using soft, lightweight, high
strength proprietary woven ballistic fabrics.
Our external vest line includes assault, tactical, riot, stab and
T-panel designs. Each of these designs can be modified to meet the individual
wearer of customer's requirements. Special application vests include the
Armourfloat, which to our knowledge is currently the only ballistic/floatation
vest approved by the U.S. Coast Guard; the Zip Out armor jacket, which offers
covert protection in both a lightweight jacket or vest design; and our
helicopter vest, which incorporates a unique protection/comfort design.
We offer a complete line of personal body armor including concealable
ballistic vests, military vests and external tactical vests as well as a line of
products specially designed for U.S. Navy Seal Teams and various law enforcement
agencies in the United States and overseas. Our hard ballistic armor, designed
to stop military rifle fire up to and including .50 caliber and European 12.7 mm
Armor Piercing Incendiary (API) rounds, is used primarily on fixed and rotary
wing aircraft, military ships and military vehicles, as well as in architectural
applications.
We have designed and manufactured special operations personal armor
including ballistic hand held shields and the LEGUARD(R) Tactical Leg Armor,
which offers complete front protection for the lower thigh, knee, shin and
instep.
Other Armor for Specialty Applications
In addition to aircraft, marine, vehicle and vest armor, we also
manufacture ballistic and fragmentation blankets and curtains for numerous
specialty applications. These applications include operator protection around
test equipment; rupture protection of pressure vessels, mechanical failure of
production machinery and high pressure piping. Additionally, we have supplied
armor for office use in protection of occupants from blast and glass fragments
of windows and isolation of security rooms from surrounding environments.
SALES, MARKETING AND CUSTOMERS
We maintain broad relationships throughout the aerospace and defense
communities, including U.S. federal, state and local government and law
enforcement agencies, along with many foreign government end users and
procurement agencies.
We have developed what we believe to be an effective approach in
marketing our ballistic armor products worldwide. We market our products
directly to both the original airframe manufacturer, such as Alenia, Agusta,
Bell-Textron, Boeing, EADS (Eurocopter), Lockheed-Martin and MD Helicopter, as
well as, aircraft completion operations and end users worldwide. We maintain a
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strong presence in Europe, Southeast Asia, Asia, Central America and South
America, utilizing key representatives located in each country.
Because of our constant contact with both engineering and marketing at
the various airframe manufacturers, we have access to their new and existing
model aircraft so that we can always update and/or design new ballistic armor
kits to protect the flight deck, cabin, bulkhead and engine areas as required.
At the request of an airframe manufacturer or end user, we send a
technical representative to meet the customer at the aircraft to review the
layout of areas to be armored, develop templates if required and to determine
any unique characteristics that the customer or end user desires incorporated
into the armor. After the templates are converted to full size armor mock-up
panels, they are taken back to the aircraft for review and approval by either
the OEM or the user prior to production. This approach has proven to be the most
effective in obtaining both OEM certification of each of our systems and in
ensuring that our ballistic armor systems meet or exceed the end users'
operational and ballistic demands.
Our commercial customers include Bell Helicopter, MD Helicopter,
Robinson Helicopter, Sikorsky Helicopter, Schweitzer Helicopter, Agusta, and
Lockheed-Martin in the United States, as well as Eurocopter (Germany), Alenia
Aerospazio (Italy), EADS (Spain), and Bell (Canada).
Our U.S. military customers include NAVSEA, NAVAIR, Army, Coast Guard,
Marines, State Department, Border Patrol, and various SEAL and Small Boat Units.
Our foreign military customers include the air forces of New Zealand,
Australia, Thailand, Malaysia, Spain, Belgium, Sweden, Norway, Italy, Sri Lanka,
Indonesia, Brazil, Argentina, and Turkey; the navies of Singapore, Thailand,
Malaysia, Ecuador, Mexico, Colombia, Spain, Australia, and Japan; the armies of
Thailand, Malaysia, Sri Lanka, Colombia, Mexico, Ecuador, Venezuela and Peru.
MANUFACTURING
Our manufacturing facilities are located in Los Angeles, California,
and are divided into hard and soft armor production areas. Dedicated cells are
established for machining, pressing, cutting, molding, lay-up, assembly and
creation of the hard armor panels. The soft armor production are has cells for
cutting, sewing and packaging. All of our hard armor is manufactured using
AoA-designed production molds, which ensure proper fit of each panel into the
total ballistic armor kit.
AoA's entire administrative and manufacturing operations are directed
and controlled by procedures conforming to ISO 9001-2000. AoA has been certified
as ISO 9001-2000 in December 2003 and was successfully recertified in December
2004.
COMPETITION
Aircraft armor competition includes LAST Armor (a division of
Foster-Miller, Inc.), Simula Inc. (a subsidiary of Armor Holdings, Inc.), and
Protective Materials Company (a division of The Protective Group, Inc.).
Military vehicle armor competition includes: O'Gara-Hess & Eisenhardt (a
subsidiary of Armor Holdings, Inc.), ArmorWorks Harl Facility, Protective
19
Materials Company, and Ceradyne, Inc. Ballistic vests competition includes:
Point Blank Body Armor, Inc. (a subsidiary of DHB Industries, Inc.), Second
Chance Body Armor, Inc., Protective Materials Company, American Body Armor (a
subsidiary of Armor Holdings, Inc.), Protech Armor Systems (a subsidiary of
Armor Holdings, Inc.) and Safariland, Ltd. (a subsidiary of Armor Holdings,
Inc.). Marine armor competition includes Protective Materials Company.
Vehicle Armoring
INTRODUCTION
We specialize in using state-of-the-art lightweight ceramic materials,
special ballistic glass and advanced engineering processes to fully armor vans
and SUVs through our majority-owned subsidiaries, MDT Protective Industries
Ltd., located in Lod, Israel, and MDT Armor Corporation, located in Auburn,
Alabama. We are a leading supplier to the Israeli military, Israeli special
forces and special services. Our products have been proven in intensive
battlefield situations and under actual terrorist attack conditions, and are
designed to meet the demanding requirements of governmental and private sector
customers worldwide.
We have acquired many years of battlefield experience in Israel. Our
vehicles have provided proven life-saving protection for their passengers in
incidents of rock throwing, handgun and assault rifle attack at point-blank
range, roadside bombings and suicide bombings. In fact, to our knowledge an
MDT-armored vehicle has never experienced bullet penetration into a vehicle
cabin under attack. We also use our technology to protect vehicles against
vandalism.
In 2003, we established MDT Armor's operations in a new facility in
Auburn, Alabama. Soon thereafter, the United States General Services
Administration (GSA) awarded us a five-year contract for vehicle armoring,
establishing a pricing schedule for armoring of GM Suburban and Toyota Land
Cruiser SUVs and of GM Savana/Express passenger vans. With this contract, these
armored vehicles became available for purchase directly by all federal agencies
beginning December 1, 2003, and we received our first U.S. orders for vehicle
armoring products during 2004.
THE ARMORING PROCESS
Armoring a vehicle involves much more than just adding "armor plates."
It includes professional and secure installation of a variety of armor
components - inside doors, behind dashboards, and all other areas of passenger
and engine compartments. We use overlapping sections to ensure protection from
all angles, and install armored glass in the windshield and windows. We have
developed certain unique features, such as new window operation mechanisms that
can raise windows rapidly despite their increased weight, gun ports, run-flat
tires, and more. We developed the majority of the materials that we use in-house
or in conjunction with Israeli companies specializing in protective materials.
In order to armor a vehicle, we first disassemble the vehicle and
remove the interior paneling, passenger seats, doors, windows, etc. We then
fortify the entire body of the vehicle, including the walls, pillars, floors,
roof and other critical components, and reinforce the door hinges. We achieve
firewall protection from frontal assault with carefully designed overlapping
armor. Options, such as air-conditioning, seating modifications and run-flat
tires, are also available. We fix the armoring into the shell of the vehicle,
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ensuring that the installation and finishing is according to the standards set
for that particular model. We then reassemble the vehicle as close to its
original appearance as possible.
Once we have ensured full vehicle protection, we place a premium on
retaining the original vehicle's look and feel to the extent possible, including
enabling full serviceability of the vehicle, thereby rendering the armoring
process "invisible." We work with our customers to understand their
requirements, and together with the customer develop an optimized armoring
solution. A flexible design-to-cost process helps evaluate tradeoffs between
heavy and light materials and various levels of protection.
By working within the vehicle manufacturer's specifications, we
maintain stability, handling, center-of-gravity and overall integrity. Our
methods minimize impact on payload, and do not obstruct the driver's or
passengers' views. In many cases all the original warranties provided by the
manufacturer are still in effect.
ARMORING MATERIALS
We offer a variety of armoring materials, optimized to the customer's
requirements. We use ballistic steel, composite materials (including Kevlar(R),
Dyneema(R) and composite armor steel) as well as special ceramics, together with
special armored glass. We use advanced engineering techniques and "light"
composite materials, and avoid, to the extent possible, using traditional
"heavy" materials such as armored steel because of the added weight, which
impairs the driving performance and handling of the vehicle. We also sell
certain kinds of vehicles pre-armored.
All materials that we use meet not only international ballistic
standards, but also the far more stringent requirements set down by the Israeli
military, the Israeli Ministries of Defense and Transport, and the Israel
Standards Institute. Our facilities have also been granted the ISO 9001:200
quality standards award.
PRODUCTS AND SERVICES
We armor a variety of vehicles for both commercial and military
markets.
In the military market, we armor:
>> The David, an Ultra Light Armored Vehicle based on a
Land Rover or Mercedes platform;
>> Command vehicles (such as the Land Rover Defender
110); and
>> Pickup trucks such as the Defender 130.
In the commercial market, we armor:
>> Sports utility vehicles (such as the GM Suburban, the
Toyota Land Cruiser and the Land Rover Defender);
>> Trucks, such as the Ford F550;
>> Passenger vans (such as the Chevrolet Express, the
General Motors Savana and the Ford Econoline); and
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>> Small buses (based on vehicles in the Mercedes-Benz
Vario and Sprinter lines).
In 2004, we began to purchase some types of vehicles and armor them in
order to be able to sell pre-armored vehicles.
SALES, MARKETING AND CUSTOMERS
Most of our vehicle armoring business has historically come from
Israel, although we have armored vehicles under contracts from companies in
Yugoslavia, Mexico, Colombia, South Africa, Nigeria and Singapore. Our principal
customer at present is the Israeli Ministry of Defense. Other customers include
Israeli and American government ministries and agencies, private companies,
medical services and private clients. In the United States, we armor vehicles
for U.S. operations in Iraq.
In Israel, we market our vehicle armoring through vehicle importers,
both pursuant to marketing agreements and otherwise, and directly to private
customers in the public and private sectors. Most sales are through vehicle
importers. In the U.S., vehicles are sold to the Army or to businesses operating
in Iraq.
We hold exclusive armoring contracts with Israel's sole General Motors
and Chevrolet distributors. This means that these distributors will continue to
honor the original vehicle warranty on armored versions of vehicles sold by them
only if the armoring was done by us.
COMPETITION
The global armored car industry is highly fragmented. Major suppliers
include both vehicle manufacturers and aftermarket specialists. As a highly
labor-intensive process, vehicle armoring is numerically dominated by relatively
small businesses. Industry estimates place the number of companies doing vehicle
armoring in the range of around 500 suppliers globally. While certain large
companies may armor several hundred cars annually, most of these companies are
smaller operations that may armor in the range of five to fifty cars per year.
Among vehicle manufacturers, Mercedes-Benz has the largest
vehicle-armoring market share, estimated in 2003 at around 7% of the global
market. Among aftermarket specialists, the largest share of the vehicle-armoring
market is held by O'Gara-Hess & Eisenhardt, a subsidiary of Armor Holdings, Inc.
Other aftermarket specialists include International Armoring Corp., Lasco, Texas
Armoring and Chicago Armor (Moloney). Many of these companies have financial,
technical, marketing, sales, manufacturing, distribution and other resources
significantly greater than ours.
We believe the key factor in our competing successfully in this field
will be our ability to penetrate new military and paramilitary markets outside
of Israel, particularly those operating in Iraq and Afghanistan.
Battery and Power Systems Division
We manufacture and sell lithium and Zinc-Air batteries for defense and
security products and other military applications and we pioneer advancements in
Zinc-Air technology for electric vehicles through our Battery and Power Systems
Division. During 2004, 2003 and 2002 revenues from our Battery and Power Systems
22
Division were approximately $10.5 million, $5.9 million and $1.7 million,
respectively (on a pro forma basis, assuming we had owned all components of our
Battery and Power Systems Division since January 1, 2002, revenues in 2004, 2003
and 2002 would have been approximately $10.5 million, $10.8 million and $6.5
million, respectively).
Lithium Batteries and Charging Systems for the Military
INTRODUCTION
We sell lithium batteries and charging systems to the military through
our subsidiary Epsilor Electronic Industries, Ltd., an Israeli corporation
established in 1985 that we purchased early in 2004.
We specialize in the design and manufacture of primary and rechargeable
batteries, related electronic circuits and associated chargers for military
applications. We have experience in working with government agencies, the
military and large corporations. Our technical team has significant expertise in
the fields of electrochemistry, electronics, software and battery design,
production, packaging and testing.
We intend to work to open a lithium battery production, research and
development, and marketing facility at our current Auburn premises. The goal is
to penetrate the military lithium battery market in the United States, and also
enable U.S.-produced lithium batteries to be sold using funding from the Foreign
Military Sales (FMS) program to countries such as Israel and Turkey. To
facilitate this technology transfer, we have hired Graydon C. Hansen, a seasoned
battery industry executive, to preside over the complete Auburn facility.
PRODUCTS
We currently produce over 50 different products in the following
categories:
>> Primary batteries;
>> Rechargeable batteries;
>> Smart chargers;
>> State of charge indicators; and
>> Control and monitoring battery circuits
Our lithium batteries are based on commercially-available battery cells
that we purchase from several leading suppliers, with proprietary energy
management circuitry and software. Our battery packs are designed to withstand
harsh environments, and have a track record of years of service in armies
worldwide.
We produce a wide range of primary batteries based on the following
chemistries: lithium sulfur dioxide, lithium manganese dioxide and alkaline. The
rechargeable battery chemistries that we employ are: nickel cadmium, nickel
metal hydride and lithium-ion. We manufacture single and multi-channel smart
chargers for nickel cadmium, nickel metal hydride and lithium-ion batteries.
23
We have designed a number of sophisticated state of charge indicators.
These are employed in our Epsilor products and are also sold as components to
other battery pack manufacturers. We also develop and manufacture control
systems for high rate primary battery-packs and monitoring systems for
rechargeable battery-packs.
MARKETS/APPLICATIONS
Our target markets for our lithium batteries are military and security
entities seeking high-end solutions for their power source needs. By their
nature, the sell-in cycles are long and the resultant entry barriers are high.
This is due to the high cost of developing custom designs and the long period
needed to qualify any product for military use.
Our present customers include:
>> Armed forces in the Middle East and Asia;
>> Military original equipment manufacturers (OEMs); and
>> Various battery manufacturers.
COMPETITION
The main competitors for our lithium battery products are Bren-tronics
Inc. in the United States, which controls much of the U.S. rechargeable market,
AEA Battery Systems (a wholly owned subsidiary of AEA Technology plc) in the
United Kingdom, which has the majority of the English military market, and
Ultralife Batteries, Inc. On the primary end of the market there are a host of
players who include the cell manufacturers themselves, including Saft S.A. and
Ultralife Batteries, Inc.
It should be noted that a number of OEMs, such as Motorola, have
internal engineering groups that can develop competitive products in-house.
However, on many occasions they outsource such activities in order to stabilize
their staffing level.
MARKETING
We market to our existing customers through direct sales. To generate
new customers and applications, we rely on our working relationship with a
selection of OEMs, with the intent of having these OEMs design our products into
their equipment, thereby creating a market with a high entry barrier. Another
avenue for market entry is via strategic relationships with major cell
manufacturers.
MANUFACTURING
Our battery production lines for military batteries and chargers have
been ISO-9001 certified since 1994. We believe that Epsilor's 19,000 square foot
facility in Dimona, Israel has the necessary capabilities and operations to
support our production cycle.
Zinc-Air Fuel Cells, Batteries and Chargers for the Military
INTRODUCTION
We base our strategy in the field of Zinc-Air military batteries on the
development and commercialization of our Zinc-Air fuel cell technology, as
applied in the batteries we produce for the U.S. Army's Communications and
Electronics Command (CECOM) through our subsidiary Electric Fuel Battery
24
Corporation. We will continue to seek new applications for our technology in
defense projects, wherever synergistic technology and business benefits may
exist. We intend to continue to develop our battery products for defense
agencies, and plan to sell our products either directly to such agencies or
through prime contractors. We will also look to extend our reach to military
markets outside the United States.
Since 1998 we have received and performed a series of contracts from
CECOM to develop and evaluate advanced primary Zinc-Air fuel cell packs.
Pursuant to these contracts, we developed and began selling in 2002 a 12/24
volt, 800 watt-hour battery pack for battlefield power, which is based on our
Zinc-Air fuel cell technology, weighs only six pounds and has approximately
twice the energy capacity per pound of the U.S. Army's standard lithium-sulfur
dioxide battery packs - the BA-8180/U battery.
In the second half of 2002, our five-year program with CECOM to develop
a Zinc-Air battery for battlefield power culminated in the assignment of a
National Stock Number and a $2.5 million delivery order for the newly designated
BA-8180/U battery. Subsequent to this initial $2.5 million delivery order, we
received additional follow-on orders from the Army.
Our batteries have been used in both Afghanistan (Operation Enduring
Freedom) and in Iraq (Operation Iraqi Freedom). In June of 2004, our BA-8180
Zinc-Air battery was recognized by the U.S Army Research, Development and
Engineering Command as one of the top ten inventions of 2003.
Our Zinc-Air fuel cells, batteries and chargers for the military are
manufactured through our Electric Fuel Battery Corporation subsidiary. In 2003,
our EFB facilities were granted ISO 9001 "Top Quality Standard" certification.
PRODUCTS
Zinc-Air Power Packs
BA-8180/U
Electric Fuel Zinc-Air power packs are lightweight, low-cost primary
Zinc-Air batteries with up to twice the energy capacity per pound of primary
lithium (LiSO2) battery packs, which are the most popular batteries used in the
US military today. Zinc-Air batteries are inherently safe in storage,
transportation, use, and disposal.
The BA-8180/U is a 12/24 volt, 800 watt-hour battery pack approximately
the size and weight of a notebook computer. The battery is based on a new
generation of lightweight, 30 ampere-hour cells developed by us over the last
five years with partial funding by CECOM. Each BA-8180/U battery pack contains
24 cells.
The battery has specific energy of up to 350 Wh/kg, which is
substantially higher than that of any competing disposable battery available to
the defense and security industries. By way of comparison, the BA-5590, a
popular LiSO2 battery pack, has only 175 Wh/kg. Specific energy, or energy
capacity per unit of weight, translates into longer operating times for
battery-powered electronic equipment, and greater portability as well. Because
of lower cost per watt-hour, the BA-8180/U can provide substantial cost savings
25
to the Army when deployed for longer missions, even for applications that are
not man-portable.
CECOM has assigned a National Stock Number (NSN) to our Zinc-Air
battery, making it possible to order and stock the battery for use by the Armed
Forces. CECOM also assigned the designation BA-8180/U to our Zinc-Air battery,
the first time an official US Army battery designation was ever assigned to a
Zinc-Air battery.
Based on extensive contacts with the US and foreign military agencies,
we believe that a significant market exists for the BA-8180/U both in the US
Armed Forces and abroad.
8140/U
The BA-8140/U is a new product that is presently being qualified and
that has begun to generate initial sales. The BA-8140/U is a smaller version of
our 8180/U, which we developed at the request of CECOM. It is approximately half
the size, weight and capacity of our 8180/U, and is appropriate for smaller
hand-held communications devices.
Adapters
The BA-8180/U is a battery, but in order to connect it or the 8140/U to
a specific piece of equipment, an adapter must be used. In order to provide
compatibility between the battery and various items of military equipment, we
supply various types of electrical interface adapters for the BA-8180/U and the
8140/U, including equipment-specific adapters for the AN/PRC-119 SINCGARS and
SINCGARS ASIP tactical radio sets, and a generic interface for items of
equipment that were designed to interface with a BA-5590 or equivalent battery.
Each of the three interfaces was also assigned a national stock number (NSN) by
CECOM. In addition, we are in the process of adding four more electrical
interfaces. These will address various applications, including other radios,
night vision, missile launchers and chemical detectors.
Hybrids
We have also developed interface adapters for other items of equipment
which require higher power than the BA-8180/U can provide by itself. For
example, we have developed a hybrid battery system comprising a BA-8180/U
battery pack and two small rechargeable lead-acid packs. Even with the weight of
the lead-acid batteries, this hybrid system powers a satellite communications
terminal for significantly longer than an equivalent weight of BA-5590 LiSO2
battery packs. We have also developed a hybrid system that incorporates
ultracapacitors.
Forward Field Chargers
One of the initial goals to develop high energy density and power
density Zinc-Air batteries was to deploy them as forward field chargers. It was
envisioned that a man portable power pack would be required by the dismounted
soldier to charge the range of rechargeable batteries now proliferating in the
military. A high efficiency forward field charger has been developed which
enables either a BB-390/U (NiMH) or a BB-2590/U (Li-ion) to receive multiple
charges from a single BA-8180/U. We are also in the process of developing a
forward field charger for the CSEL survival radio.
26
Other Zinc-Air Products
A fourth generation of Zinc-Air products is being developed for
applications where volume is critical, and/or where the power to energy ratio
needs to be significantly higher than that of the BA-8180/U. These "Gen4"
Zinc-Air products consist of an air cathode folded around a zinc electrode. Gen4
was originally developed for the Marine Corps Dragon Eye UAV, which requires up
to 200 W from a battery that fits into its sleek fuselage and which weighs less
than one kilogram. Along the way, it was recognized that the Gen4 design could
be applied to other battery missions requiring high power as well as energy
density, such as Land Warrior and Objective Force Warrior soldier systems, where
up to 300 Wh of energy are required of a 24 hour battery that must be worn
conformably, at minimal weight. For these systems the battery currently limits
functionality, and Gen4 zinc-air may be the enabling technology. During 2004, we
were awarded $1 million of congressional funds and CECOM funding for the first
phase of a three-phase BAA (Broad Agency Announcement, which is a simplified
form of government solicitation for basic research and development) to develop
this technology.
We are currently under contract, the second of its kind, with a U.S.
agency, and a multi-year program with an Israeli security agency, to demonstrate
the feasibility of Zinc-Air batteries for both unmanned aerial vehicles (UAV)
and micro-air vehicles (MAV) platforms, respectively. Flights have been
demonstrated with a 50W, 200Wh/kg battery for a 500g MAV.
MARKETS/APPLICATIONS
Being an external alternative to the popular lithium based BA-5590/U,
the BA-8180 can be used in many applications operated by the 5590. The BA-8180/U
can be used for a variety of military applications, including:
>> Tactical radios
>> SIGINT systems
>> Training systems
>> SATCOM radios
>> Nightscope power
>> Guidance systems
>> Surveillance systems
>> Sensors
CUSTOMERS
The principal customer for our Zinc-Air batteries during 2004 was the
U.S. Army's Communications-Electronics Command (CECOM).
COMPETITION
The BA-8180/U is the only Zinc-Air battery to hold a US Army battery
designation. It does, however, compete with other primary (disposable)
batteries, and primarily lithium based batteries. In some cases, primarily in
training missions, it will also compete with rechargeable batteries.
27
Zinc-Air batteries are inherently safer than primary lithium battery
packs in storage, transportation, use, and disposal, and are more cost
effective. They are lightweight, with up to twice the energy capacity per pound
of primary lithium battery packs. Zinc-Air batteries for the military are also
under development by Rayovac Corporation. Rayovac's military Zinc-Air batteries
utilize cylindrical cells, rather than the prismatic cells that we developed.
While cylindrical cells may provide higher specific power than our prismatic
cells, we believe they will generally have lower energy densities and be more
difficult to manufacture.
The most popular competing primary battery in use by the US Armed
Forces is the BA-5590, which uses lithium-sulfur dioxide (LiSO2) cells. The
largest suppliers of LiSO2 batteries to the US military are believed to be Saft
America Inc. and Eagle Picher Technologies LLC. The battery compartment of most
military communications equipment, as well as other military equipment, is
designed for the x90 family of batteries, of which the BA-5590 battery is the
most commonly deployed. Another primary battery in this family is the BA-5390,
which uses lithium-manganese dioxide (LiMnO2) cells. Suppliers of LiMnO2
batteries include Ultralife Batteries Inc., Saft and Eagle Picher.
Rechargeable batteries in the x90 family include lithium-ion and
nickel-metal hydride batteries which may be used in training missions in order
to save the higher costs associated with primary batteries. Because of the short
usage time per charge cycle, rechargeable batteries are not considered suitable
for use in combat.
Our BA-8180 does not fit inside the battery compartment of any military
equipment, and therefore is connected externally using an interface adapter that
we also sell to the Army. Our battery offers greatly extended mission time,
along with lower total mission cost, and these significant advantages often
greatly outweigh the slight inconvenience of fielding an external battery.
MANUFACTURING
We have established a battery factory for EFB at our new location in
Auburn, Alabama, where we have leased 15,000 square feet of light industrial
space from the city of Auburn. We also have production capabilities for some
battery components at the facility of EFL in Beit Shemesh, Israel. Both the
facilities in Auburn and those in Beit Shemesh have received ISO 9001 "Top
Quality Standard" certification.
Electric Vehicles
INTRODUCTION
We believe that electric buses represent a particularly important
market for electric vehicles in the United States. An all-electric, full-size
bus powered by the Electric Fuel system can provide to transit authorities a
full day's operating range for both heavy duty city and suburban routes in all
weather conditions. We conduct our electric vehicle activities through our
subsidiary Electric Fuel Ltd.
THE ELECTRIC FUEL ZINC-AIR ENERGY SYSTEM FOR ELECTRIC VEHICLES
The Electric Fuel Zinc-Air Energy System consists of:
28
>> an in-vehicle, Zinc-Air fuel cell unit consisting of
a series of Zinc-Air cells and refuelable zinc-fuel
anode cassettes using commercially-available zinc;
>> a battery exchange unit for fast vehicle turn-around
that is equivalent to the time needed to refuel a
diesel bus;
>> an automated battery refueling system for
mechanically replacing depleted zinc-fuel cassettes
with charged cassettes; and
>> a regeneration system for electrochemical recycling
and mechanical repacking of the discharged fuel
cassettes.
With its proprietary high-power air cathode and zinc anode
technologies, our Zinc-Air fuel cell delivers a unique combination of
high-energy density and high-power density, which together power electric
vehicles with speed, acceleration, driving range and driver convenience similar
to that of conventionally powered vehicles.
THE DEPARTMENT OF TRANSPORTATION-FEDERAL TRANSIT ADMINISTRATION
ZINC-AIR ALL ELECTRIC TRANSIT BUS PROGRAM
In the United States, our Zinc-Air technology is the focus of a
Zinc-Air All Electric Bus demonstration program the costs and expenditures of
which are 50% offset by subcontracting fees paid by the U.S. Department of
Transportation's Federal Transit Administration (FTA). The test program is
designed to prove that an all-electric bus can meet these and all other Los
Angeles and New York Municipal Transit Authority mass transit requirements
including requirements relating to performance, speed, acceleration and hill
climbing.
Phase IV of the program, which we began in October 2003, is a $1.5
million cost-shared program (half of which is funded by the FTA and the
remainder by the program partners, including us) that will explore steps
necessary for commercializing the all-electric zinc-air/ultracapacitor hybrid
bus. It will focus on continued optimization of the propulsion system developed
in previous phases, on additional vehicle and system testing, including testing
alternative advanced auxiliary battery technologies, and on evaluating
alternative zinc anodes, which are more commercially available in North America.
COMPETITION
We believe that our products must be available at a price that is
competitive with alternative technologies, particularly those intended for use
in zero or low-emission vehicles. Besides other battery technologies, these
include hydrogen fuel cells, "hybrid systems" that combine an internal
combustion engine and battery technologies, and use of regular or low-pollution
fuels such as gasoline, diesel, compressed natural gas, liquefied natural gas,
ethanol and methanol. Other alternative technologies presently use costly
components, including use of flywheels and catalytic removal of pollutants.
These various technologies are at differing stages of development and any one of
them, or a new technology, may prove to be more cost effective, or otherwise
more readily acceptable by consumers, than the Electric Fuel Zinc-Air Energy
System for electric vehicles. In addition, the California Air Resource Board has
expressed to us concerns about the costs associated with the Zinc-Air
regeneration infrastructure as compared to battery technologies that use
electrical recharging.
29
Lifejacket Lights
PRODUCTS
In 1996, we began to produce and market lifejacket lights built with
our patented magnesium-cuprous chloride batteries, which are activated by
immersion in water (water-activated batteries), for the aviation and marine
safety and emergency markets. Additionally, in 2004 we added two new models to
our line of lifejacket light, based on lithium batteries. At present we have a
product line consisting of seven lifejacket light models, five for use with
marine life jackets and two for use with aviation life vests, all of which work
in both freshwater and seawater. Each of our lifejacket lights is certified for
use by relevant governmental agencies under various U.S. and international
regulations. We manufacture, assemble and package all our lifejacket lights
through EFL in our factory in Beit Shemesh, Israel.
MARKETING
We market our marine safety products through our own network of
distributors in Europe, the United States, Asia and Oceania. We market our
lights to the commercial aviation industry through The Burkett Company of
Houston, Texas, which receives a commission on sales.
COMPETITION
Two of the largest manufacturers of aviation and marine safety
products, including TSO and SOLAS-approved lifejacket lights, are ACR
Electronics Inc. of Hollywood, Florida, and Pains Wessex McMurdo Ltd. of
England. Other significant competitors in the marine market include Daniamant
Aps of Denmark, and SIC of Italy.
Backlog
We generally sell our products under standard purchase orders. Orders
constituting our backlog are subject to changes in delivery schedules and are
typically cancelable by our customers until a specified time prior to the
scheduled delivery date. Accordingly, our backlog is not necessarily an accurate
indication of future sales. As of December 31, 2004 and 2003, our backlog for
the following years was approximately $25.0 million and $17.2 million,
respectively, divided among our divisions as follows (backlog attributable to
subsidiaries acquired after December 31, 2003 is given as it stood at such date
in the books of the seller, prior to the acquisition):
Division 2004 2003
- ------------------------------------------------------------------- ------------------
Simulation and Security Division............... $ 12,691,000 $ 6,600,000
Battery and Power Systems Division............. 8,325,000 9,630,000
Armor Division................................. 4,002,000 931,000
------------------- ------------------
TOTAL: ................................... $ 25,018,000 $ 17,161,000
=================== ==================
Major Customers
During 2004, including all of our divisions, Bechtel Corporation
accounted for approximately 24% of our revenues and various branches of the
United States military accounted for approximately 13% of our revenues.
30
Patents and Trade Secrets
We rely on certain proprietary technology and seek to protect our
interests through a combination of patents, trademarks, copyrights, know-how,
trade secrets and security measures, including confidentiality agreements. Our
policy generally is to secure protection for significant innovations to the
fullest extent practicable. Further, we seek to expand and improve the
technological base and individual features of our products through ongoing
research and development programs.
We rely on the laws of unfair competition and trade secrets to protect
our proprietary rights. We attempt to protect our trade secrets and other
proprietary information through confidentiality and non-disclosure agreements
with customers, suppliers, employees and consultants, and through other security
measures. However, we may be unable to detect the unauthorized use of, or take
appropriate steps to enforce our intellectual property rights. Effective trade
secret protection may not be available in every country in which we offer or
intend to offer our products and services to the same extent as in the United
States. Failure to adequately protect our intellectual property could harm or
even destroy our brands and impair our ability to compete effectively. Further,
enforcing our intellectual property rights could result in the expenditure of
significant financial and managerial resources and may not prove successful.
Although we intend to protect our rights vigorously, there can be no assurance
that these measures will be successful.
Research and Development
Research and development is conducted by IES in Denver, Colorado; by
FAAC in Ann Arbor, Michigan; by EFB in Auburn, Alabama; by Epsilor in Dimona,
Israel; and by EFB and EFL in Beit Shemesh, Israel. During the years ended
December 31, 2004, 2003 and 2002, our gross research and product development
expenditures were approximately $1.7 million, $1.1 million and $2.2 million,
respectively, including research and development in discontinued operations.
During these periods, the Office of the Chief Scientist of the Israel Ministry
of Industry and Trade (the "Chief Scientist") participated in our research and
development efforts relating to our consumer battery business, thereby reducing
our gross research and product development expenditures in the amounts of
approximately $0, $26,000 and $49,000 for the years 2004, 2003 and 2002,
respectively.
EFL has certain contingent royalty obligations to Chief Scientist and
the Israel-U.S. Binational Industrial Research and Development Foundation (BIRD,
which apply (in respect of continuing operations) only to our Electric Vehicle
program. As of December 31, 2004, our total outstanding contingent liability in
this connection was approximately $10.9 million.
Employees
As of February 28, 2005, we had 291 full-time employees worldwide. Of
these employees, 4 hold doctoral degrees and 21 hold other advanced degrees. Of
the total, 33 employees were engaged in product research and development, 199
were engaged in production and operations, 16 were engaged in marketing and
sales, and 43 were engaged in general and administrative functions. Our success
will depend in large part on our ability to attract and retain skilled and
experienced employees.
31
We and our employees are not parties to any collective bargaining
agreements. However, as certain of our employees are located in Israel and
employed by EFL, MDT or Epsilor, certain provisions of the collective bargaining
agreements between the Histadrut (General Federation of Labor in Israel) and the
Coordination Bureau of Economic Organizations (including the Manufacturers'
Association of Israel) are applicable to EFL's, MDT's and Epsilor's employees by
order (the "Extension Order") of the Israeli Ministry of Labor and Welfare.
These provisions principally concern the length of the work day and the work
week, minimum wages for workers, contributions to a pension fund, insurance for
work-related accidents, procedures for dismissing employees, determination of
severance pay and other conditions of employment, including certain automatic
salary adjustments based on changes in the Israeli CPI.
Israeli law generally requires severance pay upon the retirement or
death of an employee or termination of employment without due cause;
additionally, some of our senior employees have special severance arrangements,
certain of which are described under "Item 11. Executive Compensation -
Employment Contracts," below. We currently fund our ongoing severance
obligations by making monthly payments to approved severance funds or insurance
policies. In addition, Israeli employees and employers are required to pay
specified sums to the National Insurance Institute, which is similar to the
United States Social Security Administration. Since January 1, 1995, such
amounts also include payments for national health insurance. The payments to the
National Insurance Institute are approximately 15.6% of wages, of which the
employee contributes approximately 62% and the employer contributes
approximately 38%. The majority of the permanent employees of EFL, about a
quarter of the permanent employees of MDT, and one of the permanent employees of
Epsilor, are covered by "managers' insurance," which provides life and pension
insurance coverage with customary benefits to employees, including retirement
and severance benefits. We contribute 14.33% to 15.83% (depending on the
employee) of base wages to such plans and the permanent employees contribute 5%
of their base wages.
In 1993, an Israeli court held that companies that are subject to the
Extension Order are required to make pension contributions exclusively through
contributions to Mivtachim Social Institute of Employees Ltd., a pension fund
managed by the Histadrut. We subsequently reached an agreement with Mivtachim
with respect to providing coverage to certain production employees and bringing
ourselves into conformity with the court decision. The agreement does not
materially increase our pension costs or otherwise materially adversely affect
its operations. Mivtachim has agreed not to assert any claim against us with
respect to any of our past practices relating to this matter. Although the
arrangement does not bind employees with respect to instituting claims relating
to any nonconformity by us, we believe that the likelihood of the assertion of
claims by employees is low and that any potential claims by employees against
us, if successful, would not result in any material liability to us.
ITEM 2. PROPERTIES
Our world headquarters has been re-located to our Auburn, Alabama
facility, constituting approximately 30,000 square feet, which is leased from
the City of Auburn through December 2005, and for another three years thereafter
at a 10% rent increase.
Our management and administrative facilities and research, development
and production facilities for the manufacture and assembly of our Survivor
Locator Lights, constituting approximately 18,300 square feet, are located in
Beit Shemesh, Israel, located between Jerusalem and Tel-Aviv (within Israel's
pre-1967 borders). The lease for these facilities in Israel expires on December
32
31, 2007; we have the ability to terminate the lease every two years upon three
months' written notice. Moreover, we may terminate the lease at any time upon
twelve months written notice. Most of the members of our senior management,
including our Chief Executive Officer, our Chief Operating Officer, and our
Chief Financial Officer, work extensively out of our Beit Shemesh facility.
Our Epsilor subsidiary rents approximately 19,000 square feet of
factory, office and warehouse space in Dimona, Israel, in Israel's Negev desert
(within Israel's pre-1967 borders), on a month-to-month basis.
Our IES subsidiary rents approximately 8,900 square feet of office and
warehouse space in Littleton, Colorado, approximately ten miles outside of
Denver, pursuant to a lease expiring in September 2005, with an option to extend
the lease for an additional five years, or until September 2010. IES also holds
an option under certain circumstances to rent an additional 3,200 square feet of
contiguous space.
Our FAAC subsidiary rents approximately 17,800 square feet of office
and warehouse space in Ann Arbor, Michigan, pursuant to a lease expiring in
February 2010.
Our MDT subsidiary rents approximately 20,000 square feet of office
space in Lod, Israel, near Ben-Gurion International airport (within Israel's
pre-1967 borders) pursuant to a lease renewable on an annual basis.
We also have approximately 1,100 square feet at our former headquarters
at 250 West 57th Street in New York City, pursuant to an agreement of lease
expiring in June 2009. We are attempting to sublease this space, which will
require our landlord's consent. No assurance can be given that we will find
someone to sublease this space or that our landlord's consent to a sublease will
be forthcoming.
We believe that our existing facilities are adequate to meet our
current and foreseeable future needs.
ITEM 3. LEGAL PROCEEDINGS
As of the date of this filing, there were no material pending legal
proceedings against us, except as follows:
In December 2004, AoA filed an action in the United States Court of
Federal Claims against the United States Naval Air Systems Command (NAVAIR),
seeking approximately $2.2 million in damages for NAVAIR's alleged improper
termination of a contract for the design, test and manufacture of a lightweight
armor replacement system for the United States Marine Corps CH-46E rotor
helicopter. NAVAIR, in its answer, counterclaimed for approximately $2.1 million
in alleged reprocurement and administrative costs.
33
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held a Special Meeting of Stockholders on December 14, 2004. At that
meeting, the stockholders voted on the following matters with the following
results:
1. Ratifying, 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 Arotech Corporation common stock at a price of $1.38 per share:
Votes For Votes Against Abstentions Shares Not Voting
--------- ------------- ----------- -----------------
12,922,150 3,486,253 203,444 56,597,504
34
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is traded on the Nasdaq National Market. Our Nasdaq
ticker symbol is currently "ARTX"; prior to February 2003, our Nasdaq ticker
symbol was "EFCX." The following table sets forth, for the periods indicated,
the range of high and low sales prices of our common stock on the Nasdaq
National Market System:
Year Ended December 31, 2004 High Low
---- ---
Fourth Quarter.......................... $ 2.16 $ 1.50
Third Quarter........................... $ 2.14 $ 1.18
Second Quarter.......................... $ 4.34 $ 1.90
First Quarter........................... $ 2.53 $ 1.65
Year Ended December 31, 2003 High Low
---- ---
Fourth Quarter.......................... $ 2.86 $ 1.28
Third Quarter........................... $ 1.62 $ 0.81
Second Quarter.......................... $ 1.19 $ 0.49
First Quarter........................... $ 0.66 $ 0.43
As of February 28, 2005 we had approximately 322 holders of record of
our common stock.
Dividends
We have never paid any cash dividends on our common stock. The Board of
Directors presently intends to retain all earnings for use in our business. Any
future determination as to payment of dividends will depend upon our financial
condition and results of operations and such other factors as the Board of
Directors deems relevant.
Recent Sales of Unregistered Securities
Issuance of Restricted Stock to Certain Employees
In October 2004, we granted a total of 430,000 shares of our common
stock as stock bonuses to two employees. Under the terms of this grant, the sale
or other transfer of these shares is restricted for a period of two years from
the date of grant, and such shares automatically return to us if the employee
leaves our employ during such two-year period under circumstances that would not
entitle the employee to statutory severance under Israeli law (generally,
resignation without good cause or dismissal with good cause).
In December 2004, we granted a total of 310,000 shares of our common
stock as stock bonuses to five employees. Under the terms of this grant, the
sale or other transfer of these shares is restricted for a period of two years
from the date of grant, and such shares automatically return to us if the
employee leaves our employ during such two-year period under circumstances that
would not entitle the employee to statutory severance under Israeli law
(generally, resignation without good cause or dismissal with good cause).
35
We issued the above securities in reliance on the exemption from
registration provided by Section 4(2) of the Securities Act as transactions by
an issuer not involving a public offering. The issuance of these securities was
without the use of an underwriter, and the shares of common stock were issued
with restrictive legends permitting transfer thereof only upon registration or
an exemption under the Act.
Issuance of Stock to a Charity
In December 2004, we donated 40,000 shares of our common stock to a
charitable organization recognized by the Internal Revenue Service as tax-exempt
under Section 501(c)(3) of the Internal Revenue Code of 1986, as amended.
We issued the above securities in reliance on the exemption from
registration provided by Section 4(2) of the Securities Act as transactions by
an issuer not involving a public offering. The issuance of these securities was
without the use of an underwriter, and the shares of common stock were issued
with restrictive legends permitting transfer thereof only upon registration or
an exemption under the Act.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial information set forth below with respect to the
consolidated statement of operations for each of the five fiscal years in the
period ended December 31, 2004, and with respect to the balance sheets at the
end of each such fiscal year has been derived from our consolidated financial
statements.
The results of operations, including revenue, operating expenses, and
financial income, of the consumer battery segment for the years ended December
31, 2003, 2002, 2001 and 2000 have been reclassified in the accompanying
statements of operations as discontinued operations. Our accompanying
consolidated balance sheets at December 31, 2003, 2002, 2001 and 2000 give
effect to the assets of the consumer battery business as discontinued operations
within current assets and liabilities. Thus, the financial information presented
herein includes only continuing operations.
As discussed in Note 1.b. to the Consolidated Financial Statements
contained in Item 8 of this Report, the Consolidated Financial Statements at
December 31, 2003 and for the year then ended have been restated for the matters
set forth therein.
The financial information set forth below is qualified by and should be
read in conjunction with the Consolidated Financial Statements contained in Item
8 of this Report and the notes thereto and "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations," below.
36
Year Ended December 31,
------------------------------------------------------------------------------
--------------- --------------- -------------- --------------- ---------------
2000 2001 2002 2003** 2004
---- ---- ---- ---- ----
(dollars in thousands, except per share data)
Statement of Operations Data:
Revenues........................................ $ 1,490 $ 2,094 $ 6,407 $ 17,326 $ 49,954
---------- ----------- ---------- ---------- ----------
Research and development expenses and costs of
revenues...................................... 1,985 2,448 5,108 12,141 35,742
Selling, general and administrative expenses
and their impairment and amortization of
intangible assets............................. 3,434 3,934 5,982 10,255 18,394
---------- ---------- ---------- ----------- ----------
Operating loss.................................. (3,929) (4,288) (4,683) (5,070) (4,182)
Financial income (expenses), net................ 544 263 100 4,039 4,229
---------- ---------- ---------- ---------- ----------
Loss before minority interest in (loss)
earnings of subsidiary and tax expenses....... (3,385) (4,026) (4,583) (9,109) (8,411)
Taxes on income................................. - - - (396) (586)
Minority interest in (loss) earnings of
subsidiary.................................... - - (355) 157 (45)
---------- ---------- ----------- ---------- -----------
Loss from continuing operations................. (3,385) (4,026) (4,938) (9,348) (9,042)
Income (loss) from discontinued operations...... (8,596) (13,261) (13,566) 110 -
----------- ----------- ----------- ---------- ----------
Net loss for the period......................... (11,981) (17,287) (18,504) (9,238) (9,042)
Deemed dividend to certain stockholders of
common stock.................................. - (1,197) - (350) (3,329)
---------- ----------- ---------- ----------- -----------
Net loss attributable to stockholders of common
stock ........................................ $ (11,981) $ (18,483) $ (18,504) $ (9,588) $ (12,371)
=========== =========== =========== =========== ===========
Basic and diluted net loss per share from
continuing operations......................... $ (0.18) $ (0.21) $ (0.15) $ (0.24) $ (0.13)
=========== =========== =========== =========== ===========
Loss per share for combined operations.......... $ (0.62) $ (0.76) $ (0.57) $ (0.25) $ (0.18)
=========== =========== =========== =========== ===========
Weighted average number of common shares used
in computing basic and diluted net loss per
share (in thousands).......................... 19,243 24,200 32,382 38,890 69,933
As At December 31,
------------------------------------------------------------------------------
--------------- --------------- -------------- --------------- ---------------
2000 2001 2002 2003** 2004
---- ---- ---- ------ ----
------------------------------------------------------------------------------
(dollars in thousands)
Balance Sheet Data:
Cash, cash equivalents, investments in
marketable debt securities and restricted
collateral deposits........................... $ 11,596 $ 12,672 $ 2,091 $ 14,391 $ 13,832
Receivables and other assets*................... 13,771 11,515 7,895 8,898 25,746
Property and equipment, net of depreciation..... 2,289 2,221 2,555 2,293 4,601
Goodwill and other intangible assets, net....... - - 7,522 7,440 54,113
---------- ---------- ---------- ---------- ----------
Total assets.................................... $ 27,656 $ 26,408 $ 20,063 $ 33,022 $ 98,292
========== ========== ========== ========== ==========
Current liabilities*............................ $ 4,787 $ 3,874 $ 7,272 $ 6,710 $ 26,381
Long-term liabilities***........................ 2,791 3,126 3,753 4,686 6,438
Stockholders' equity............................ 20,078 19,408 9,038 21,626 65,473
---------- ---------- ---------- ----------- ----------
Total liabilities and stockholders equity*...... $ 27,656 $ 26,408 $ 20,063 $ 33,022 $ 98,292
========== ========== ========== ========== ==========
- ------------------------------------
*Includes assets and liabilities, as applicable, from discontinued operations.
**Restated (see Note 1.b. of Notes to Consolidated Financial Statements).
***Includes minority interest.
37
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
The following Management's Discussion and Analysis of Financial
Condition and Results of Operations contains forward-looking statements that
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.
The following discussion and analysis should be read in conjunction
with the Consolidated Financial Statements contained in Item 8 of this report,
and the notes thereto. 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.
General
We are a defense and security products and services company, engaged in
three business areas: interactive simulation for military, law enforcement and
commercial markets; batteries and charging systems for the military; and
high-level armoring for military, paramilitary and commercial vehicles. Until
September 17, 2003, we were known as Electric Fuel Corporation. We operate in
three business units:
>> we develop, manufacture and market advanced hi-tech multimedia
and interactive digital solutions for use-of-force and driving
training of military, law enforcement, security and other
personnel, as well as offering security consulting and other
services (our Simulation, Security and Consulting Division);
>> we manufacture aviation armor and we utilize sophisticated
lightweight materials and advanced engineering processes to
armor vehicles (our Armoring Division); and
>> we manufacture and sell Zinc-Air and lithium batteries for
defense and security products and other military applications
and we pioneer advancements in Zinc-Air battery technology for
electric vehicles (our Battery and Power Systems Division).
During 2004, we acquired three new businesses: FAAC Corporation,
located in Ann Arbor, Michigan, which provides simulators, systems engineering
and software products to the United States military, government and private
industry (which we have placed in our Simulation and Security Division); Epsilor
Electronic Industries, Ltd., located in Dimona, Israel, which develops and sells
rechargeable and primary lithium batteries and smart chargers to the military
38
and to private industry in the Middle East, Europe and Asia (which we have
placed in our Battery and Power Systems Division); and Armour of America,
Incorporated, 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 blankets and a unique
ballistic/flotation vest (ArmourFloat) that is U.S. Coast Guard-certified, which
we have placed in our Armor Division. Prior to the acquisition of FAAC and
Epsilor, we were organized into two divisions: Defense and Security Products
(consisting of IES, MDT and MDT Armor), and Electric Fuel Batteries (consisting
of EFL and EFB). Our financial results for 2003 do not include the activities of
FAAC, Epsilor or AoA and therefore are not directly comparable to our financial
results for 2004.
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 of 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 reclassified 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. These
restatements did 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 the valuation of warrants granted in the litigation
settlement described in Note 14.f.6. of the Notes to Consolidated Financial
Statements for the year ended December 31, 2004.
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 associated with our convertible debentures. As a result of
this review, we found errors which increased our financial expenses in the
amount of $568,000 for the year ended December 31, 2003. The errors were related
to the amortization of debt discount attributable to the warrants and the
related convertible debentures, whereby we understated the amount of
amortization for the year ended December 31, 2003 attributable to certain of the
convertible debentures.
Similar errors were also noted in our interim financial statements in
the three-month period ended June 30, 2003, the nine-month period ended
September 30, 2003, and the three- and six-month periods ended March 31 and June
30, 2004.
The impacts of these restatements with respect to the year ended
December 31, 2003 are summarized below:
39
Statement of Operations Data:
For the Year ended December 31, 2003
-----------------------------------------------------------
Previously
Reported Adjustment As Restated
----------------- ----------------- -----------------
General and administrative expenses.............. $ 6,196,779 $ (338,903) $ 5,857,876
Operating loss................................... 5,408,932 (338,903) 5,070,029
Financial expenses, net.......................... 3,470,459 568,250 4,038,709
Loss from continuing operations.................. 9,118,684 229,347 9,348,031
----------------- ----------------- -----------------
Net loss......................................... 9,008,274 229,347 9,237,621
Deemed dividend to certain stockholders of
common stock................................. - 350,000 350,000
----------------- ----------------- -----------------
Net loss attributable to common stockholders..... $ 9,008,274 $ 579,347 $ 9,587,621
================= ================= =================
Basic and diluted net loss per share from
continuing operations.......................... $ 0.23 $ 0.01 $ 0.24
================= ================= =================
Basic and diluted net loss per share............. $ 0.23 $ 0.02 $ 0.25
================= ================= =================
Balance Sheet Data:
As of December 31, 2003
-----------------------------------------------------------------------
Previously Reported Adjustment As Restated
--------------------- --------------------- ---------------------
Other accounts payable and accrued $ 4,180,411 $ (150,000) $ 4,030,411
expenses..........................
Total current liabilities............ 6,859,752 (150,000) 6,709,752
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 Year ended December 31, 2003
-----------------------------------------------------------
Previously
Reported Adjustment As Restated
----------------- ----------------- -----------------
Net loss......................................... $ 9,008,274 $ 229,347 $ 9,237,621
Stock based compensation related to repricing of
warrants granted to investors and the grant of
new warrants................................... 388,403 (188,903) 199,500
Increase in other accounts payable and accrued
expenses....................................... 1,827,668 (150,000) 1,677,668
Amortization of compensation related to
beneficial conversion feature and warrants
issued to holders of convertible debentures.... 3,359,987 568,250 3,928,237
40
Critical Accounting Policies
The preparation of financial statements requires us to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period.
On an ongoing basis, we evaluate our estimates and judgments, including those
related to revenue recognition, allowance for bad debts, inventory,
contingencies and warranty reserves, impairment of intangible assets and
goodwill. We base our estimates and judgments on historical experience and on
various other factors that we believe to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Under different assumptions or conditions, actual results may differ
from these estimates.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
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.
A portion of our revenue is derived from license agreements that entail
the customization of FAAC's simulators to the customer's specific requirements.
Revenues from initial license fees for such arrangements are recognized in
accordance with Statement of Position 81-1 "Accounting for Performance of
Construction - Type and Certain Production - Type Contracts" based on the
percentage of completion method over the period from signing of the license
through to customer acceptance, as such simulators require significant
modification or customization that takes time to complete. 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.
41
We account for our other revenues from IES simulators in accordance
with the provisions of SOP 97-2, "Software Revenue Recognition," issued by the
American Institute of Certified Public Accountants and as amended by SOP 98-4
and SOP 98-9 and related interpretations. We exercise judgment and use estimates
in connection with the determination of the amount of software license and
services revenues to be recognized in each accounting period.
We assess whether collection is probable at the time of the transaction
based on a number of factors, including the customer's past transaction history
and credit worthiness. If we determine that the collection of the fee is not
probable, we defer the fee and recognize revenue at the time collection becomes
probable, which is generally upon the receipt of cash.
Allowance for Doubtful Accounts
We make judgments as to our ability to collect outstanding receivables
and provide allowances for the portion of receivables when collection becomes
doubtful. Provisions are made based upon a specific review of all significant
outstanding receivables. In determining the provision, we analyze our historical
collection experience and current economic trends. We reassess these allowances
each accounting period. Historically, our actual losses and credits have been
consistent with these provisions. If actual payment experience with our
customers is different than our estimates, adjustments to these allowances may
be necessary resulting in additional charges to our statement of operations.
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 than 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.
We have provided a valuation allowance on the majority of our net
deferred tax assets, which includes federal and foreign net operating loss
carryforwards, because of the uncertainty regarding their realization. Our
accounting for deferred taxes under Statement of Financial Accounting Standards
No. 109, "Accounting for Income Taxes" ("Statement 109"), involves the
evaluation of a number of factors concerning the realizability of our deferred
tax assets. In concluding that a valuation allowance was required, we primarily
considered such factors as our history of operating losses and expected future
losses in certain jurisdictions and the nature of our deferred tax assets. The
Company and its subsidiaries provide valuation allowances in respect of deferred
tax assets resulting principally from the carryforward of tax losses. Management
currently believes that it is more likely than not that the deferred tax
regarding the carryforward of losses and certain accrued expenses will not be
realized in the foreseeable future. The company does not provide for US Federal
Income taxes on the undistributed earnings of its foreign subsidiaries because
such earnings are re-invested and, in the opinion of management, will continue
to be re-invested indefinitely.
42
In addition, we operate within multiple taxing jurisdictions and may be
subject to audits in these jurisdictions. These audits can involve complex
issues that may require an extended period of time for resolution. In
management's opinion, adequate provisions for income taxes have been made.
Inventories
Our policy for valuation of inventory and commitments to purchase
inventory, including the determination of obsolete or excess inventory, requires
us to perform a detailed assessment of inventory at each balance sheet date,
which includes a review of, among other factors, an estimate of future demand
for products within specific time horizons, valuation of existing inventory, as
well as product lifecycle and product development plans. The estimates of future
demand that we use in the valuation of inventory are the basis for our revenue
forecast, which is also used for our short-term manufacturing plans. Inventory
reserves are also provided to cover risks arising from slow-moving items. We
write down our inventory for estimated obsolescence or unmarketable inventory
equal to the difference between the cost of inventory and the estimated market
value based on assumptions about future demand and market conditions. We may be
required to record additional inventory write-down if actual market conditions
are less favorable than those projected by our management. For fiscal 2004, no
significant changes were made to the underlying assumptions related to estimates
of inventory valuation or the methodology applied.
Goodwill
Under Financial Accounting Standards Board Statement No. 142, "Goodwill
and Other Intangible Assets" (SFAS 142), goodwill and intangible assets deemed
to have indefinite lives are no longer amortized but are subject to annual
impairment tests based on estimated fair value in accordance with SFAS 142.
In June 2004, we completed our annual impairment test and assessed the
carrying value of goodwill as required by SFAS 142. The goodwill impairment test
compared the carrying value of the Company's reporting units with the fair value
at that date. Because the market capitalization exceeded the carrying value
significantly, no impairment arose.
We determine fair value using discounted cash flow analysis. This type
of analysis requires us to make assumptions and estimates regarding industry
economic factors and the profitability of future business strategies. It is our
policy to conduct impairment testing based on our current business strategy in
light of present industry and economic conditions, as well as future
expectations. In assessing the recoverability of our goodwill, we may be
required to make assumptions regarding estimated future cash flows and other
factors to determine the fair value of the respective assets. This process is
subjective and requires judgment at many points throughout the analysis. If our
estimates or their related assumptions change in subsequent periods or if actual
cash flows are below our estimates, we may be required to record impairment
charges for these assets not previously recorded.
Other Intangible Assets
Other intangible assets are amortized to the Statement of Operations
over the period during which benefits are expected to accrue, currently
estimated at two to ten years.
43
We recorded a $320,000 impairment charge in 2004 in respect of certain
technology acquired from Bristlecone in 2003.
The determination of the value of such intangible assets requires us to
make assumptions regarding future business conditions and operating results in
order to estimate future cash flows and other factors to determine the fair
value of the respective assets. If these estimates or the related assumptions
change in the future, we could be required to record additional impairment
charges.
Contingencies
We are from time to time involved in legal proceedings and other
claims. We are required to assess the likelihood of any adverse judgments or
outcomes to these matters, as well as potential ranges of probable losses. We
have not made any material changes in the accounting methodology used to
establish our self-insured liabilities during the past three fiscal years.
A determination of the amount of reserves required, if any, for any
contingencies are made after careful analysis of each individual issue. The
required reserves may change due to future developments in each matter or
changes in approach, such as a change in the settlement strategy in dealing with
any contingencies, which may result in higher net loss.
If actual results are not consistent with our assumptions and
judgments, we may be exposed to gains or losses that could be material.
Warranty Reserves
Upon shipment of products to our customers, we provide for the
estimated cost to repair or replace products that may be returned under
warranty. Our warranty period is typically twelve months from the date of
shipment to the end user customer. For existing products, the reserve is
estimated based on actual historical experience. For new products, the warranty
reserve is based on historical experience of similar products until such time as
sufficient historical data has been collected on the new product. Factors that
may impact our warranty costs in the future include our reliance on our contract
manufacturer to provide quality products and the fact that our products are
complex and may contain undetected defects, errors or failures in either the
hardware or the software.
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.
44
Recent Developments
CECOM IDIQ Order
In March 2005 we received a new Firm Fixed Price, Indefinite Delivery,
Indefinite Quantity (IDIQ) order from the U.S. Army's Communications Electronic
Command (CECOM) to supply up to $24 million in zinc-air batteries and adaptors
to the Department of Defense over the next three years. Under the new contract,
EFB will be enabled to deliver the BA-8180/U zinc-air battery and the three
existing interface adapters. In addition, a new battery, the BA-8140/U, and four
new adapters are included in this contract and have been ordered for First
Article Testing (FAT).
Executive Summary
The following executive summary includes discussion of our new
subsidiaries, FAAC Incorporated, Epsilor Electronic Industries, Ltd. and Armour
of America Incorporated, that we purchased in 2004.
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, unless otherwise noted) are as follows:
>> Our Simulation, Security and Consulting Division, consisting
of:
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 IES Interactive Training, Inc., located in Littleton,
Colorado, which provides specialized "use of force"
training for police, security personnel and the
military ("IES").
>> Our Armor Division, consisting of:
o Armour of America, located in Los Angeles,
California, which manufacturers ballistic and
fragmentation armor kits for rotary and fixed wing
aircraft, marine armor, personnel armor, military
vehicles and architectural applications, including
both the LEGUARD Tactical Leg Armor and the
Armourfloat Ballistic Floatation Device, which is a
unique vest that is certified by the U.S. Coast Guard
("AoA");
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 SUVs, and is a leading supplier to the
Israeli military, Israeli special forces and special
services ("MDT") (75.5% owned); and
45
o MDT Armor Corporation, located in Auburn, Alabama,
which conducts MDT's United States activities ("MDT
Armor") (88% owned).
>> Our Battery and Power Systems Division, consisting of:
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");
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"); 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").
Overview of Results of Operations
We incurred significant operating losses for the years ended December
31, 2004, 2003 and 2002. While we expect to continue to derive revenues from the
sale of products that we manufacture and the services that we provide, there can
be no assurance that we will be able to achieve or maintain profitability on a
consistent basis.
During 2003 and 2004, we substantially increased our revenues and
reduced our net loss, from $18.5 million in 2002 to $9.2 million in 2003 to $9.0
million in 2004. 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 products manufactured by the
subsidiaries we acquired in 2002 and 2004.
We succeeded during 2004 in moving Arotech to a positive EBITDA
situation, for the first time in our history. We are focused on continuing this
success in 2005 and beyond, and ultimately on achieving profitability. In this
connection, we note that most of our business lines historically have had weaker
first halves than second halves, and weaker first quarters than second quarters.
We expect this to be the case for 2005 as well.
A portion of our operating loss during 2004 and 2003 arose as a result
of non-cash charges. These charges were primarily related to our acquisitions,
financings and issuances of restricted shares and options to employees. Because
we anticipate continuing certain of these activities during 2005, we expect to
continue to incur such non-cash charges in the future.
46
ACQUISITIONS
In acquisition of subsidiaries, part of the purchase price is allocated
to intangible assets and goodwill, Amortization of intangible assets related to
acquisition of subsidiaries is recorded based on the estimated expected life of
the assets. Accordingly, for a period of time following an acquisition, we incur
a non-cash charge related to amortization of intangible assets in the amount of
a fraction (based on the useful life of the intangible assets) of the amount
recorded as intangible assets. Such amortization charges will continue during
2005. We are required to review intangible assets for impairment whenever events
or changes in circumstances indicate that carrying amount of the assets may not
be recoverable. If we determine, through the impairment review process, that
intangible asset has been impaired, we must record the impairment charge in our
statement of operations.
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.
As a result of the application of the above accounting rule, we
incurred non-cash charges for amortization of intangible assets and impairment
in the amount of $2.8 million during 2004. See "Critical Accounting Policies -
Other Intangible Assets," above.
FINANCINGS
The non-cash charges that relate to our financings occurred in
connection with our issuance of convertible debentures with warrants, and in
connection with our repricing of certain warrants and grants of new warrants.
When we issue convertible debentures, we record a discount 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 debt discount for financial
expenses that is amortized ratably over the term of the convertible debentures;
when the convertible debentures are converted, the entire remaining unamortized
debt discount is immediately recognized in the quarter in which the convertible
debentures are converted. 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 amortization of debt discount attributable
to beneficial conversion feature in the amount of $4.1 million during 2004.
Additionally, in an effort to improve our cash situation and our
shareholders' equity, and in order to reduce the number of our outstanding
warrants, during 2003 and 2004 we induced holders of certain of our warrants to
exercise their warrants by lowering the exercise price of the warrants to
approximately market value in exchange for immediate exercise of such warrants,
and by issuing to such investors a lower number of new warrants at a higher
exercise price. Under such circumstances, we record a deemed dividend in an
amount determined based upon the fair value of the new warrants. As and to the
extent that we engage in similar warrant repricings and issuances in the future,
we would incur similar non-cash charges.
47
As a result of the application of the above accounting rule, we
recorded a deemed dividend related to warrants repricing and grant of new
warrants in the amount of $3.3 million during 2004.
RESTRICTED SHARE AND OPTION ISSUANCES
During 2004, we issued restricted shares to certain of our employees.
These shares were issued as stock bonuses, and are restricted for a period of
two years from the date of issuance. Relevant accounting rules provide that the
aggregate amount of the difference between the purchase price of the restricted
shares (in this case, generally zero) and the market price of the shares on the
date of grant is taken as a general and administrative expense, amortized over
the life of the period of the restriction.
Additionally, during 2003 and 2004 we issued options to employees that
were subject to shareholder approval of a new stock option plan. While the
options were issued at the market price of our stock on the respective dates of
issuance, they were not considered by applicable accounting rules to have been
finally issued until the date shareholder approval for the new stock option plan
was obtained. In the interim, the market price of our stock had risen, and thus
the options were deemed to have been issued at a below-market price. We were
therefore required to take as a general and administrative expense the aggregate
difference between the option exercise prices of the options and the market
price of the shares on the date shareholder approval was obtained, amortized
over the vesting periods of the options.
As a result of the application of the above accounting rules, we
incurred non-cash charges related to stock-based compensation in the amount of
$884,000 during 2004.
Overview of Financial Condition and Operating Performance
We shut down our money-losing consumer battery operations and began
acquiring new businesses in the defense and security field in 2002. Thereafter,
we concentrated on eliminating our operating deficit and moving Arotech to
cash-flow positive operations, a goal we achieved for the first time in our
history in the second half of 2004. In order to do this, we focused on acquiring
businesses with strong revenues and profitable operations.
In our Simulation and Security Division, revenues grew from
approximately $8.0 million in 2003 to $21.5 million in 2004 (on a pro forma
basis, assuming we had owned all components of our Simulation and Security
Division since January 1, 2003, revenues would have grown from approximately
$17.9 million in 2003 to $21.5 million in 2004). We attribute this to a number
of substantial orders, such as orders from the U.S. Army and the Chicago Transit
Authority. As of December 31, 2004, our backlog for our Simulation and Security
Division totaled $12.7 million.
Our Armor Division had record revenues during 2004, with revenues
growing from approximately $3.4 million in 2003 to $18.0 million in 2004 (on a
pro forma basis, assuming we had owned all components of our Armor Division
since January 1, 2003, revenues would have grown from approximately $10.9
million in 2003 to $29.2 million in 2004). Much of this growth was attributable
to armoring orders connected with the war in Iraq. As of December 31, 2004, our
backlog for our Armor Division totaled $4.0 million.
48
In our Battery and Power Systems Division, revenues grew from
approximately $5.9 million in 2003 to $10.5 million in 2004 (on a pro forma
basis, assuming we had owned all components of our Battery and Power Systems
Division since January 1, 2003, revenues would have fallen from approximately
$10.8 million in 2003 to $10.5 million in 2004). As of December 31, 2004, our
backlog for our Battery and Power Systems Division totaled $8.3 million.
Results of Operations
Preliminary Note
SUMMARY
Results of operations for the year ended December 31, 2004 include the
results of FAAC, Epsilor and AoA for the periods following our acquisition of
each such company during 2004. However, the results of these subsidiaries were
not included in our operating results for the year ended December 31, 2003.
Accordingly, the following year-to-year comparisons should not necessarily be
relied upon as indications of future performance.
Following is a table summarizing our results of operations for the
years ended December 31, 2004 and 2003, after which we present a narrative
discussion and analysis:
Year Ended December 31,
-----------------------------------------
2004 2003*
-------------------- -------------------
Revenues:
Simulation and Security Division........................... $ 21,464,406 1.$ 8,022,026
Armor Division............................................. 17,988,687 3,435,716
Battery and Power Systems Division......................... 10,500,753 5,868,899
-------------------- -------------------
$ 49,953,846 $ 17,326,641
Cost of revenues:
Simulation and Security Division........................... $ 11,739,690 $ 3,944,701
Armor Division............................................. 15,449,084 2,621,550
Battery and Power Systems Division......................... 6,822,320 4,521,589
-------------------- -------------------
$ 34,011,094 $ 11,087,840
Research and development expenses:
Simulation and Security Division........................... $ 395,636 $ 132,615
Armor Division............................................. 17,065 84,186
Battery and Power Systems Division......................... 1,318,678 836,607
-------------------- -------------------
$ 1,731,379 $ 1,053,408
Sales and marketing expenses:
Simulation and Security Division........................... $ 3,185,001 $ 2,237,386
Armor Division............................................. 565,981 180,631
Battery and Power Systems Division......................... 1,171,235 926,872
All Other.................................................. - 187,747
-------------------- -------------------
$ 4,922,217 $ 3,532,636
General and administrative expenses:
Simulation and Security Division........................... $ 2,852,969 $ 1,001,404
Armor Division............................................. 1,323,982 518,053
Battery and Power Systems Division......................... 965,058 188,655
All Other.................................................. 5,514,857 4,149,764
-------------------- -------------------
$ 10,656,866 $ 5,857,876
49
Year Ended December 31,
-----------------------------------------
2004 2003*
-------------------- -------------------
Financial expense (income):
Simulation and Security Division........................... $ 27,842 $ (119,750)
Armor Division............................................. 13,503 (19,918)
Battery and Power Systems Division......................... 54,511 7,936
All Other.................................................. 4,133,109 4,170,441
-------------------- -------------------
$ 4,228,965 $ 4,038,709
Tax expenses:
Simulation and Security Division........................... $ 77,811 $ 30,130
Armor Division............................................. 134,949 363,173
Battery and Power Systems Division......................... 320,878 -
All Other.................................................. 52,471 2,890
-------------------- -------------------
$ 586,109 $ 396,193
Amortization of intangible assets and impairment losses:
Simulation and Security Division........................... $ 1,643,682 $ 720,410
Armor Division............................................. 661,914 144,500
Battery and Power Systems Division......................... 509,239 -
-------------------- -------------------
$ 2,814,835 $ 864,910
Minority interest in loss (profit) of subsidiaries:
Simulation and Security Division........................... $ - $ -
Armor Division............................................. (44,694) 156,900
Battery and Power Systems Division......................... - -
-------------------- -------------------
$ (44,694) $ 156,900
Loss from continuing operations:
Simulation and Security Division........................... $ 1,541,775 $ 75,130
Armor Division............................................. (222,485) (299,559)
Battery and Power Systems Division......................... (661,166) (612,760)
All Other.................................................. (9,700,437) (8,510,842)
-------------------- -------------------
$ (9,042,313) $ (9,348,031)
Income from discontinued operations:
Simulation and Security Division........................... $ - $ -
Armor Division............................................. - -
Battery and Power Systems Division......................... - 110,410
-------------------- -------------------
$ - $ 110,410
Net loss:
Simulation and Security Division........................... $ 1,541,775 $ 75,130
Armor Division............................................. (222,485) (299,559)
Battery and Power Systems Division......................... (661,166) (502,350)
All Other.................................................. (9,700,437) (8,510,842)
-------------------- -------------------
$ (9,042,313) $ (9,237,621)
==================== ===================
- -----------------------------
* Restated (see Note 1.b. of Notes to Consolidated Financial Statements).
ADJUSTED EBITDA
In this Item, we use the term "Adjusted EBITDA." Each reference to
Adjusted EBITDA herein is qualified by reference to, and should be read in
conjunction with, this section and the reconciliation contained herein.
Adjusted EBITDA, as used herein, is defined as earnings before income
taxes, interest expenses, depreciation and amortization, as adjusted to
eliminate certain non-cash charges. Adjusted EBITDA is provided solely as a
supplemental disclosure because we believe that it enhances overall
understanding of our current financial performance and our progress toward
cash-flow break even and toward GAAP profitability.
50
Adjusted EBITDA is a non-GAAP financial measure as defined in SEC
Regulation G. Adjusted EBITDA is presented because it is a widely accepted
financial indicator used by investors and analysts to analyze and compare
companies on the basis of cash-flow break even and debt service capability. We
use Adjusted EBITDA to set targets and monitor and assess financial performance.
Adjusted EBITDA should not be considered in isolation. It is not intended to
represent cash flows for the periods presented, nor has it been presented as an
alternative to net loss as an indicator of operating performance or to cash flow
as a measure of liquidity.
The most nearly comparable GAAP measure to Adjusted EBITDA is net
income or loss. Following is a reconciliation between our net loss and our
Adjusted EBITDA for the years ended December 31, 2004, 2003 and 2002:
ADJUSTED EBITDA
- -------------------------------------------------------------------------------------------------------------------
2004 2003* 2002
------------------ ----------------- ----------------
Net loss from continuing operations before deemed dividend $ (9,042,313) $ (9,348,031) $ (4,938,152)
to certain shareholders (GAAP measure)....................
Add back:
Interest expense (income), net (after deduction of minority
interest)................................................. 4,226,312 4,039,950 (99,150)
Taxes (after deduction of minority interest)................ 555,507 240,039 -
Depreciation of fixed assets................................ 1,199,465 730,159 473,739
Amortization of inventory adjustment to market values with
the acquisition of one of our subsidiaries............... 920,544 - -
Amortization of intangible assets, capitalized software
costs and technology impairment........................... 2,888,226 879,312 649,543
------------------ ----------------- ----------------
EBITDA (non-GAAP measure)................................... $ 747,741 $ (3,458,571) $ (3,914,020)
================== ================= ================
Add back certain non-cash charges:
Write-down of promissory notes.............................. - - 394,452
Expenses attributed on issuance of shares to consultants
and as a donation......................................... 89,078 333,627 -
Expenses attributed on issuance of warrants and options to
employees, directors and consultants...................... 662,392 276,045 19,000
Expenses attributed on issuance of shares to employees...... 212,424 - -
Markdown of loans to shareholders........................... 45,253 - -
Non-cash portion of settlement agreement.................... - 688,642 -
------------------ ----------------- ----------------
ADJUSTED EBITDA (non-GAAP measure).......................... $ 1,756,888 $ (2,160,257) $ (3,500,568)
================== ================= ================
- ---------------------
*Restated (see Note 1.b. of Notes to Consolidated Financial Statements).
The Adjusted EBITDA information presented herein may not be comparable
to similarly titled measures employed by other companies
Fiscal Year 2004 compared to Fiscal Year 2003
Revenues. During 2004, we recognized revenues as follows:
>> From the sale of interactive training systems and
from the provision of warranty services in connection
with such systems (FAAC and IES);
>> From payments under armor contracts and for service
and repair of armored vehicles (AoA and MDT);
>> From the sale of batteries, chargers and adapters to
the military, and under certain development contracts
with the U.S. Army (EFB and Epsilor);
51
>> From the sale of lifejacket lights (EFL); and
>> From subcontracting fees received in connection with
Phase III of the United States Department of
Transportation (DOT) electric bus program, which
began in October 2003 and was completed in March
2004. Phase IV of the DOT program, which began in
October 2004, did not result in any revenues during
2004 (EFL).
Revenues from continuing operations for the year ended December 31,
2004 totaled $50.0 million, compared to $17.3 million for 2003, an increase of
$32.6 million, or 188%. This increase was primarily attributable to the
following factors:
>> Increased revenues from vehicle armoring; and
>> Revenues generated by FAAC, Epsilor and AoA in 2004
that were not present in 2003.
These increases were offset to some extent by decreased revenues from
sales of interactive use-of-force training systems and decreased revenues from
sales of our Zinc-Air military batteries.
In 2004, revenues were $21.5 million for the Simulation and Security
Division (compared to $8.0 million in 2003, an increase of $13.4 million, or
168%, due primarily to the added revenues from sales of driver training systems
since we acquired FAAC (approximately $16.5 million), offset to some extent by
decreased revenues from use-of-force training systems); $18.0 million for the
Armor Division (compared to $3.4 million in 2003, an increase of $14.6 million,
or 424%, due primarily to increased revenues from vehicle armoring and to the
added revenues from aircraft armoring since we acquired AoA); and $10.5 million
for the Battery and Power Systems Division (compared to $5.9 million in 2003, an
increase of $4.6 million, or 79%, due primarily to the added revenues from sales
of lithium batteries and chargers since we acquired Epsilor (approximately $5.3
million), offset to some extent by decreased revenues from our Zinc-Air military
batteries).
Cost of revenues and gross profit. Cost of revenues totaled $34.0
million during 2004, compared to $11.1 million in 2003, an increase of $22.9
million, or 207%, due to increased cost of goods sold, particularly in the Armor
Division (partly as a result of our beginning to sell pre-armored vehicles in
2004, which requires us to purchase vehicles for pre-armoring) and in the
Simulation and Security Division, as well as the inclusion of the cost of goods
of FAAC, Epsilor and AoA in our results for 2004 but not 2003.
Direct expenses for our three divisions during 2004 were $17.9 million
for the Simulation and Security Division (compared to $7.3 million in 2003, an
increase of $10.6 million, or 145%, due primarily to the addition of expenses
associated with sales of driver training systems through FAAC (approximately
$12.0 million), offset to some extent by decreased expenses associated with the
sales of use-of-force training systems); $16.4 million for the Armor Division
(compared to $3.6 million in 2003, an increase of $12.9 million, or 359%, due
primarily to increased expenses associated with sales of vehicle armoring (a
$12.1 million increase in 2004, including the expenses of purchasing vehicles
for pre-armoring in 2004, which was not present in 2003), and to the addition
beginning in August 2004 of expenses associated with sales of aircraft armoring
through our new subsidiary AoA); and $10.0 million for the Battery and Power
52
Systems Division (compared to $5.9 million in 2003, an increase of $4.0 million,
or 68%, due primarily to the addition of expenses associated with sales of
lithium batteries and chargers through our new Epsilor subsidiary ($4.2
million), offset to some extent by decreased expenses associated with the sales
of Zinc-Air military batteries).
Gross profit was $15.9 million during 2004, compared to $6.2 million
during 2003, an increase of $9.7 million, or 155%. This increase was the direct
result of all factors presented above, most notably the inclusion of FAAC,
Epsilor and AoA in our results for 2004 ($10.2 million), as well as the
increased revenues from vehicle armoring ($1.6 million), offset to some extent
by a decrease of $2.0 million in gross profit from IES.
Research and development expenses. Research and development expenses
for 2004 were $1.7 million, compared to $1.1 million in 2003, an increase of
$678,000, or 64%. This increase was primarily the result of the inclusion of the
research and development expenses of FAAC, Epsilor and AoA in our results in
2004 ($533,000) and increased research and development expenses of EFL and EFB.
Sales and marketing expenses. Sales and marketing expenses for 2004
were $4.9 million, compared to $3.5 million in 2003, an increase of $1.4
million, or 39%. This increase was primarily attributable to the inclusion of
the sales and marketing expenses of FAAC, Epsilor and AoA in our results for
2004 ($2.0 million), offset to some extent by a decrease of $600,000 in expenses
related to our military batteries and a decrease in sales and marketing expenses
related to interactive use-of-force training.
General and administrative expenses. General and administrative
expenses for 2004 were $10.7 million, compared to $5.9 million in 2003, an
increase of $4.8 million, or 82%. 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 ($2.4 million);
>> Expenses in 2004 in connection with grant of options
and shares to employees that were not present in 2003
($830,000);
>> Costs associated with our compliance with Section 404
of the Sarbanes-Oxley Act of 2002 that were not
present in 2003 ($150,000); and
>> Increases in other general and administrative
expenses, such as employee salaries and bonuses,
travel expenses, audit fees, director fees, legal
fees, and expenses related to due diligence performed
in connection to certain potential acquisitions, that
were not present in 2003.
We are not anticipating a reduction in our general and administrative
expenses in the coming year, and we expect that our travel expenses, audit fees,
legal fees, and due diligence expenses will continue or increase to the extent
that we continue to pursue acquisitions in the future.
53
These increases were offset to some extent by:
>> Expenses in 2003 in connection with a litigation
settlement agreement that were not present in 2004
($700,000); and
>> Amortization of legal and consulting expenses in 2003
in connection with our convertible debentures that
were lower (by $260,000) than in 2004.
Adjusted EBITDA. Due to the factors cited above, we had Adjusted EBITDA
of $1.8 million in 2004, compared to Adjusted EBITDA of $(2.2) million in 2003.
For an explanation of Adjusted EBITDA, a non-GAAP measure, and a reconciliation
with the most nearly comparable GAAP measure, see "Results of Operations -
Preliminary Note - Adjusted EBITDA," above.
Financial expenses, net. Financial expense, net of interest income and
exchange differentials, totaled approximately $4.2 million in 2004 compared to
$4.0 million in 2003, an increase of $190,000, or 5%. This difference was due
primarily to amortization of debt discount related to the issuance of
convertible debentures and their conversion, 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 net
operating loss carry forwards. We recorded a total of $586,000 in tax expenses
in 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 net
operating loss carry forwards and with respect to state taxes. In 2003, tax
expenses were recorded with respect to MDT's taxable income. Out of the $586,000
tax expense that we recorded in 2004, $84,000 was related to prior years and
$(37,000) represented income from deferred taxes, net.
Amortization of intangible assets. Amortization of intangible assets
totaled $2.8 million in 2004, compared to $865,000 in 2003, an increase of $1.9
million, or 225%, resulting from the inclusion of the amortization of the
intangible assets of FAAC, Epsilor and AoA in our results in 2004 and impairment
in the amount of $320,000 of technology previously purchased by IES from
Bristlecone Technologies.
Net loss before deemed dividend of common stock to certain
stockholders. Due to the factors cited above, we reported a net loss of $9.0
million in 2004, compared to a net loss of $9.2 million in 2003, a decrease of
$195,000, or 2%.
Net loss after deemed dividend of common stock to certain stockholders
was $12.4 million due to a deemed dividend of $3.3 million (see Notes 14.f.4.
and 14.f.5. to the financial statements) compared to $9.6 million in 2003, an
increase of 2.8 million, or 29%.
Fiscal Year 2003 compared to Fiscal Year 2002
Revenues. During 2003, we (through our subsidiaries) recognized
revenues as follows:
>> IES recognized revenues from the sale of interactive
use-of-force training systems and from the provision
of warranty services in connection with such systems;
54
>> MDT recognized revenues from payments under vehicle
armoring contracts and for service and repair of
armored vehicles;
>> EFB recognized revenues from the sale of batteries
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 III of the United States
Department of Transportation (DOT) electric bus
program, which began in October 2002 and was
completed in March 2004. Phase IV of the DOT program,
which began in October 2003, did not result in any
revenues during 2003.
Revenues from continuing operations for the year ended December 31,
2003 totaled $17.3 million, compared to $6.4 million for 2002, an increase of
$10.9 million, or 170%. This increase was primarily the result of increased
sales attributable to IES and EFB, as well as the inclusion of IES and MDT in
our results for the full year of 2003 but only part of 2002.
In 2003, revenues were $8.0 million for the Simulation and Security
Division (compared to $2.0 million in 2002, an increase of $6.0 million, or
305%, due primarily to the inclusion of IES in our results for the full year of
2003 but only part of 2002), $5.9 million for the Battery and Power Systems
Division (compared to $1.7 million in the comparable period in 2002, an increase
of $4.2 million, or 249%, due primarily to increased sales to the U.S. Army on
the part of EFB), and $3.4 million for the Armor Division (compared to $2.7
million in 2002, an increase of $691,000, or 25%, due primarily to the inclusion
of MDT in our results for the full year of 2003 but only part of 2002).
Cost of revenues and gross profit. Cost of revenues totaled $11.1
million during 2003, compared to $4.4 million in 2002, an increase of $6.7
million, or 151%, due to increased cost of goods sold, particularly by IES and
EFB, as well as the inclusion of IES and MDT in our results for the full year of
2003 but only part of 2002.
Direct expenses for our three divisions during 2003 were $7.3 million
for the Simulation and Security Division (compared to $2.0 million in 2002, an
increase of $5.3 million, or 259%, due primarily to increased sales attributable
to the inclusion of IES in our results for the full year of 2003 but only part
of 2002), $5.9 million for the Battery and Power Systems Division (compared to
$3.1 million in the comparable period in 2002, an increase of $2.9 million, or
94%, due primarily to increased sales on the part of EFB to the U.S. Army), and
$3.6 million for the Armor Division (compared to $2.3 million in 2002, an
increase of $1.3 million, or 55%, due primarily to the inclusion of MDT in our
results for the full year of 2003 but only part of 2002).
Gross profit was $6.2 million during 2003, compared to $2.0 million
during 2002, an increase of $4.3 million, or 214%. This increase was the direct
result of all factors presented above, most notably the increased sales of IES
and EFB, as well as the inclusion of IES and MDT in our results for the full
year of 2003 but only part of 2002. In 2003, IES contributed $4.1 million to our
gross profit, EFB contributed $1.6 million, and MDT contributed $833,000.
55
Research and development expenses. Research and development expenses
for 2003 were $1.1 million, compared to $686,000 in 2002, an increase of
$367,000, or 54%. This increase was primarily because certain research and
development personnel who had worked on the discontinued consumer battery
operations during 2002 (the expenses of which are not reflected in the 2002
number above) were reassigned to military battery research and development in
2003.
Sales and marketing expenses. Sales and marketing expenses for 2003
were $3.5 million, compared to $1.3 million in 2002, an increase of $2.2
million, or 170%. This increase was primarily attributable to the following
factors:
>> The inclusion of the sales and marketing expenses of
IES and MDT in our results for the full year of 2003
but only part of 2002;
>> An increase in IES's sales activity during 2003,
which resulted in both increased sales and increased
sales and marketing expenses during 2003; and
>> We incurred expenses for consultants in the amount of
$810,000 in connection with our CECOM battery program
with the U.S. Army and $345,000 in connection with
our security consulting business.
General and administrative expenses. General and administrative
expenses for 2003 were $5.9 million, compared to $4.0 million in 2002, an
increase of $1.8 million, or 46%. This increase was primarily attributable to
the following factors:
>> The inclusion of the general and administrative
expenses of IES and MDT in our results for the full
year of 2003 but only part of 2002;
>> Expenses in 2003 in connection with a litigation
settlement agreement, in the amount of $714,000, that
were not present in 2002;
>> Expenses in 2003 in connection with warrant grants,
in the amount of $199,500, that were not present in
2002;
>> Legal and consulting expenses in 2003 in connection
with our convertible debentures, in the amount of
$484,000, that were not present in 2002; and
>> Expenses in 2003 in connection with the start-up of
our security consulting business in the United States
and with the beginning of operations of MDT Armor, in
the amount of $250,000, that were not present in
2002.
Adjusted EBITDA. Due to the factors cited above, we had Adjusted EBITDA
of $(2.2) million in 2003, compared to Adjusted EBITDA of $(3.5) million in
2002. For an explanation of Adjusted EBITDA, a non-GAAP measure, and a
reconciliation with the most nearly comparable GAAP measure, see "Results of
Operations - Preliminary Note - Adjusted EBITDA," above.
Financial income (expense). Financial expense totaled approximately
$4.0 million in 2003 compared to financial income of $100,000 in 2002, an
increase of $4.1 million. This increase was due primarily to amortization of
compensation related to the issuance of convertible debentures issued in
December 2002 and during 2003 in the amount of $3.9 million, and interest
expenses related to those debentures in the amount of $376,000.
56
Tax expenses. We and our Israeli subsidiary EFL incurred net operating
losses during 2003 and 2002 and, accordingly, we were not required to make any
provision for income taxes. MDT and IES had taxable income, and accordingly we
were required to make provision for income taxes in the amount of $396,000 in
2003. We were able to offset IES's federal taxes against our loss carryforwards.
In 2002 we did not accrue any tax expenses due to our belief that we would be
able to utilize our loss carryforwards against MDT's taxable income, estimation
was revised in 2003. Of the amount accrued in 2003, approximately $352,000 was
accrued on account of income in 2002.
Amortization of intangible assets and in-process research and
development. Amortization of intangible assets totaled $865,000 in 2003,
compared to $649,000 in 2002, an increase of $215,000, or 33%, resulting from
amortization of these assets subsequent to our acquisition of IES and MDT in
2002. Of this $215,000 increase, $169,000 was attributable to IES and $46,000
was attributable to MDT.
Loss from continuing operations. Due to the factors cited above, we
reported a net loss from continuing operations of $9.3 million in 2003, compared
to a net loss of $4.9 million in 2002, an increase of $4.4 million, or 90%.
Profit (loss) from discontinued operations. In the third quarter of
2002, we decided to discontinue operations relating to the retail sales of our
consumer battery products. Accordingly, all revenues and expenses related to
this segment have been presented in our consolidated statements of operations
for the years ended December 31, 2003 and 2002 in an item entitled "Loss from
discontinued operations."
Income from discontinued operations in 2003 was $110,000, compared to a
loss of $13.6 million in 2002, a decrease of $13.7 million. This decrease was
the result of the elimination of the losses from these discontinued operations
beginning with the fourth quarter of 2002. The income from discontinued
operations was primarily from cancellation of past accruals made unnecessary by
the closing of the discontinued operations.
Net loss before deemed dividend. Due to the factors cited above, we
reported a net loss before deemed dividend of $9.2 million in 2003, compared to
a net loss of $18.5 million in 2002, a decrease of $9.3 million, or 50%.
Net loss after deemed dividend of common stock to certain stockholders.
Due to the factors cited above, we reported a net loss after deemed dividend of
$9.6 million in 2003, compared to a net loss of $18.5 million in 2002, a
decrease of $8.9 million, or 48%.
Liquidity and Capital Resources
As of December 31, 2004, we had $6.7 million in cash, $7.0 million in
restricted collateral securities and restricted held-to-maturity securities due
within one year, $4.0 million in long-term restricted deposits, and $136,000 in
available-for-sale 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.
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We used available funds in 2004 primarily for acquisitions, sales and
marketing, continued research and development expenditures, and other working
capital needs. We increased our investment in fixed assets by $1.7 million
during the year ended December 31, 2004, primarily in the Battery and Power
Systems Division and in the Simulation and Security Division. Our net fixed
assets amounted to $4.6 million as at year end.
Net cash used in operating activities for 2004 and 2003 was $852,000
and $3.3 million, respectively, a decrease of $2.5 million, or 75%. This
decrease was primarily the result of an increase in our adjusted net income in
2004 (net income 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 2004 and 2003 was $50.5
million and $1.8 million, respectively, an increase of $48.7 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 2004 and 2003 was $44.4
million and $17.4 million, respectively, an increase of $27.0 million, or 156%.
This increase was primarily the result of higher amounts of funds raised through
sales of our securities in 2004 compared to 2003.
During 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.
We have approximately $5.5 million in long-term debt outstanding (not
including accrued severance pay), of which $4.5 million was related to
convertible debt (unamortized financial expenses related to the beneficial
conversion feature of these convertible debentures amounted to approximately
$2.8 million at year end), and approximately $13.7 million in short-term debt
(not including trade payables and other accounts payable), of which $13.4
million relates to the earn-out provision in connection with our acquisition of
FAAC.
Our debt agreements contain customary affirmative and negative
operations 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, as well as granting to our investors a right of first refusal
on any future financings, except for underwritten public offerings in excess of
$30 million. We do not believe that this right of first refusal will materially
limit our ability to undertake future financings.
Based on our internal forecasts, we believe that our present cash
position and anticipated cash flows from operations should be sufficient to
satisfy our current estimated cash requirements through at least the twelve
months. 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.
58
Effective Corporate Tax Rate
We and certain of our subsidiaries incurred net operating losses during
the years ended December 31, 2002, 2003 and 2004, and accordingly no provision
for income taxes was required. With respect to some of our U.S. subsidiaries
that operated at a net profit during 2004, we were able to offset federal taxes
against our net operating loss carryforward, which amounted to $23 million as of
December 31, 2004. These subsidiaries are, however, subject to state taxes that
cannot be offset against our net operating loss carryforward. With respect to
certain of our Israeli subsidiaries that operated at a net profit during 2004,
we were unable to offset their taxes against our net operating loss
carryforward, and we are therefore exposed to Israeli taxes, at a rate of up to
35% (less, in the case of companies that have "approved enterprise" status as
discussed in Note 15 to the Notes to Financial Statements).
As of December 31, 2004, we had a U.S. net operating loss carryforward
of approximately $23.0 million that is available to offset future taxable income
under certain circumstances, expiring primarily from 2009 through 2024, and
foreign net operating and capital loss carryforwards of approximately $87.0
million, which are available indefinitely to offset future taxable income under
certain circumstances.
Contractual Obligations
The following table lists our contractual obligations and commitments
as of December 31, 2004, not including trade payables and other accounts
payable:
Contractual Obligations Payment Due by Period
- ------------------------------ ------------------------------------------------------------------------------------
Total Less Than 1 Year 1-3 Years 3-5 Years More than 5 Years
- ------------------------------ ---------------- ---------------- ---------------- ---------------- ----------------
Long-term debt*.................$..5,558,391 $ - $ 5,558,391 $ - $ -
Short-term debt**...............$.13,766,677 $ 13,766,677 $ - $ - $ -
Operating lease obligations.....$..1,427,965 $ 762,636 $ 641,017 $ 24,312 $ -
Severance obligations***........$..1,642,801 $ 223,333 $ 1,240,871 $ - $ 178,597
- -------------------
* Includes convertible debentures in the gross amount of $4,537,500.
Unamortized financial expenses related to the beneficial conversion feature
of these convertible debentures amounted to $2,782,697 at year end.
** Includes sums owed in respect of an earn-out provision related to our
acquisition of FAAC, in the amount of $13.4 million.
*** Includes obligations related to special severance pay arrangements in
addition to the severance amounts due to certain employees pursuant to
Israeli severance pay law.
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 net losses since our inception.
Additionally, as of December 31, 2004, we had an accumulated deficit of
approximately $119.0 million. There can be no assurance that we will ever be
able to achieve or maintain profitability consistently or that our business will
continue to exist.
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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 $5.5
million as of December 31, 2004. Accordingly, we are subject to the risks
associated with indebtedness, including:
o we must dedicate a portion of our cash flows from
operations to pay debt service costs and, as a
result, we have less funds available for operations,
future acquisitions of consumer receivable
portfolios, and other purposes;
o it may be more difficult and expensive to obtain
additional funds through financings, if available at
all;
o we are more vulnerable to economic downturns and
fluctuations in interest rates, less able to
withstand competitive pressures and less flexible in
reacting to changes in our industry and general
economic conditions; and
o if we default under any of our existing debt
instruments or if our creditors demand payment of a
portion or all of our indebtedness, we may not have
sufficient funds to make such payments.
The occurrence of any of these events could materially adversely affect our
results of operations and financial condition and adversely affect our stock
price.
The agreements governing the terms of our debentures contain numerous
affirmative and negative covenants that limit the discretion of our management
with respect to certain business matters and place restrictions on us, including
obligations on our part to preserve and maintain our assets and restrictions on
our ability to incur or guarantee debt, to merge with or sell our assets to
another company, and to make significant capital expenditures without the
consent of the debenture holders. Our ability to comply with these and other
provisions of such agreements may be affected by changes in economic or business
conditions or other events beyond our control.
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.
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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, on acceptable terms, or at all. 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 new businesses.
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 relatively 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 these new businesses. If we are
unable to successfully operate these new businesses, our business, financial
condition and results of operations could be materially impaired.
Our acquisition strategy involves various risks.
Part of our strategy is to grow through the acquisition of companies
that will complement our existing operations or provide us with an entry into
markets we do not currently serve. Growth through acquisitions involves
substantial risks, including the risk of improper valuation of the acquired
business and the risk of inadequate integration. There can be no assurance that
suitable acquisition candidates will be available, that we will be able to
acquire or manage profitably such additional companies or that future
acquisitions will produce returns that justify our investments therein. In
addition, we may compete for acquisition and expansion opportunities with
companies that have significantly greater resources than we do. Furthermore,
acquisitions could disrupt our ongoing business, distract the attention of our
senior officers, 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
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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 acquisitions.
In light of our 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 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.
A significant portion of our business is dependent on government
contracts and reduction or reallocation of defense or law enforcement spending
could reduce our revenues.
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 or
law enforcement spending in the U.S. or other countries could reduce our
revenues and 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.
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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 reduce our revenues and have a material adverse effect on our future
results of operations and financial condition.
Our U.S. government contracts may be terminated at any time and may
contain other unfavorable provisions.
The U.S. government typically can terminate or modify any of its
contracts with us either for its convenience or if we default by failing to
perform under the terms of the applicable contract. A termination arising out of
our default could expose us to liability and have a material adverse effect on
our ability to re-compete for future contracts and orders. Our U.S. government
contracts contain provisions that allow the U.S. government to unilaterally
suspend us from receiving new contracts pending resolution of alleged violations
of procurement laws or regulations, reduce the value of existing contracts,
issue modifications to a contract and control and potentially prohibit the
export of our products, services and associated materials.
A negative audit by the U.S. government could adversely affect our
business, and we might not be reimbursed by the government for costs that we
have expended on our contracts.
Government agencies routinely audit government contracts. These
agencies review a contractor's performance on its contract, pricing practices,
cost structure and compliance with applicable laws, regulations and standards.
If we are audited, we will not be reimbursed for any costs found to be
improperly allocated to a specific contract, while we would be required to
refund any improper costs for which we had already been reimbursed. Therefore,
an audit could result in a substantial adjustment to our revenues. If a
government audit uncovers improper or illegal activities, we may be subject to
civil and criminal penalties and administrative sanctions, including termination
of contracts, forfeitures of profits, suspension of payments, fines and
suspension or debarment from doing business with United States government
agencies. We could suffer serious reputational harm if allegations of
impropriety were made against us. A governmental determination of impropriety or
illegality, or an allegation of impropriety, could have a material adverse
effect on our business, financial condition or results of operations.
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:
63
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.
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.
The loss of, or a significant reduction in, U.S. military business would
have a material adverse effect on us.
U.S. military contracts account for a significant portion of our
business. The U.S. military funds these contracts in annual increments. These
contracts require subsequent authorization and appropriation that may not occur
or that may be greater than or less than the total amount of the contract.
Changes in the U.S. military's budget, spending allocations and the timing of
such spending could adversely affect our ability to receive future contracts.
None of our contracts with the U.S. military has a minimum purchase commitment,
and the U.S. military generally has the right to cancel its contracts
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unilaterally without prior notice. We manufacture for the U.S. aircraft and land
vehicle armor systems, protective equipment for military personnel and other
technologies used to protect soldiers in a variety of life-threatening or
catastrophic situations, and batteries for communications devices. The loss of,
or a significant reduction in, U.S. military business for our aircraft and land
vehicle armor systems, other protective equipment, or batteries could have a
material adverse effect on our business, financial condition, results of
operations and liquidity.
A reduction of U.S. force levels in Iraq may affect our results of
operations.
Since the invasion of Iraq by the U.S. and other forces in March 2003,
we have received steadily increasing orders from the U.S. military for armoring
of vehicles and military batteries. These orders are the result, in substantial
part, from the particular combat situations encountered by the U.S. military in
Iraq. We cannot be certain, therefore, to what degree the U.S. military would
continue placing orders for our products if the U.S. military were to reduce its
force levels or withdraw completely from Iraq. A significant reduction in orders
from the U.S. military could have a material adverse effect on our business,
financial condition, results of operations and liquidity.
There are limited sources for some of our raw materials, which may
significantly curtail our manufacturing operations.
The raw materials that we use in manufacturing our armor products
include Kevlar(R), a patented product of E.I. du Pont de Nemours Co., Inc. We
purchase Kevlar in the form of woven cloth from various independent weaving
companies. In the event Du Pont and/or these independent weaving companies were
to cease, for any reason, to produce or sell Kevlar to us, we might be unable to
replace it with a material of like weight and strength, or at all. Thus, if our
supply of Kevlar were materially reduced or cut off or if there were a material
increase in the price of Kevlar, our manufacturing operations could be adversely
affected and our costs increased, and our business, financial condition and
results of operations could be materially adversely affected.
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, 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. 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.
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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.
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.
Many of our competitors have financial, technical, marketing, sales,
manufacturing, distribution and other resources significantly greater than ours.
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
66
technology. In the event of patent litigation, we cannot assure you that a court
would determine that we were the first creator of inventions covered by our
issued patents or pending patent applications or that we were the first to file
patent applications for those inventions. If existing or future third-party
patents containing broad claims were upheld by the courts or if we were found to
infringe third-party patents, we may not be able to obtain the required licenses
from the holders of such patents on acceptable terms, if at all. Failure to
obtain these licenses could cause delays in the introduction of our products or
necessitate costly attempts to design around such patents, or could foreclose
the development, manufacture or sale of our products. We could also incur
substantial costs in defending ourselves in patent infringement suits brought by
others and in prosecuting patent infringement suits against infringers.
We also rely on trade secrets and proprietary know-how that we seek to
protect, in part, through non-disclosure and confidentiality agreements with our
customers, employees, consultants, and entities with which we maintain strategic
relationships. We cannot assure you that these agreements will not be breached,
that we would have adequate remedies for any breach or that our trade secrets
will not otherwise become known or be independently developed by competitors.
We are dependent on key personnel and our business would suffer if we fail
to retain them.
We are highly dependent on the presidents of our IES, 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, and we may not be able to
renew such contract on terms acceptable to us, or at all. 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 2004, 2003 and 2002, without
taking account of revenues derived from discontinued operations, 19%, 42% and
56%, 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.
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Market-Related Risks
The price of our common stock is volatile.
The market price of our common stock has been volatile in the past and
may change rapidly in the future. The following factors, among others, may cause
significant volatility in our stock price:
o Announcements by us, our competitors or our
customers;
o The introduction of new or enhanced products and
services by us or our competitors;
o Changes in the perceived ability to commercialize our
technology compared to that of our competitors;
o Rumors relating to our competitors or us;
o Actual or anticipated fluctuations in our operating
results;
o The issuance of our securities, including warrants,
in connection with financings and acquisitions; 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
traded below $1.00 in the 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
68
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.
We expect our auditors to report a material weakness in our internal
controls. If we fail to achieve and maintain effective internal controls in
accordance with Section 404 of the Sarbanes-Oxley Act, we may not be able to
accurately report our financial results.
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, beginning
with this Annual Report on Form 10-K for the fiscal year ending December 31,
2004, we are required to furnish a report by our management on our internal
control over financial reporting.
Pursuant to Securities and Exchange Commission Release No. 34-50754,
which, subject to certain conditions, provides up to 45 additional days beyond
the due date of this Form 10-K for the filing of management's annual report on
internal control over financial reporting required by Item 308(a) of Regulation
S-K, and the related attestation report of the independent registered public
accounting firm, as required by Item 308(b) of Regulation S-K, management's
report on internal control over financial reporting and the associated report on
the audit of management's assessment of the effectiveness of the Company's
internal control over financial reporting as of December 31, 2004, are not filed
herein and are expected to be filed no later than May 2, 2005.
The internal control report must contain (i) a statement of
management's responsibility for establishing and maintaining adequate internal
control over financial reporting, (ii) a statement identifying the framework
used by management to conduct the required evaluation of the effectiveness of
our internal control over financial reporting, (iii) management's assessment of
the effectiveness of our internal control over financial reporting as of the end
of our most recent fiscal year, including a statement as to whether or not
internal control over financial reporting is effective, and (iv) a statement
that our independent registered public accounting firm has issued an attestation
report on management's assessment of internal control over financial reporting.
We expect that our auditors will inform us, although they have not yet
done so, that they identified significant deficiencies that constitute a
material weakness under standards established by the American Institute of
Certified Public Accountants (AICPA). A material weakness is a condition in
which the design or operation of one or more of the internal control components
does not reduce to a relatively low level the risk that misstatements caused by
error or fraud in amounts that would be material in relation to the financial
statements being audited may occur and not be detected within a timely period by
employees in the normal course of performing their assigned functions. We expect
that our auditors will report to us that at December 31, 2004, we had a
significant deficiency in our financial statement closing process and related
processes because the size our accounting and finance department and the press
69
of work related to our recent acquisitions caused us to be unable independently
to comply with the selection and application of generally accepted accounting
principles related to highly complex financial transactions applicable to equity
issuances and business combinations.
As a public company, we will have significant requirements for enhanced
financial reporting and internal controls. The process of designing and
implementing effective internal controls is a continuous effort that requires us
to anticipate and react to changes in our business and the economic and
regulatory environments and to expend significant resources to maintain a system
of internal controls that is adequate to satisfy our reporting obligations as a
public company. We cannot assure you that the measures we have taken or will
take to remediate any material weaknesses or that we will implement and maintain
adequate controls over our financial processes and reporting in the future as we
continue our rapid growth.
If we are unable to establish appropriate internal financial reporting
controls and procedures, it could cause us to fail to meet our reporting
obligations, result in material misstatements in our financial statements, harm
our operating results, cause investors to lose confidence in our reported
financial information and have a negative effect on the market price for shares
of our common stock.
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 February 28, 2005, we had 80,103,668 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 February 28, 2005, there were outstanding warrants to purchase a
total of 16,961,463 shares of our common stock at a weighted average exercise
price of $1.55 per share, options to purchase a total of 9,102,761 shares of our
common stock at a weighted average exercise price of $1.28 per share, of which
7,002,390 were vested, at a weighted average exercise price of $1.28 per share,
and outstanding debentures convertible into a total of 3,156,298 shares of our
common stock at a weighted average conversion price of $1.44 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.
70
Our certificate of incorporation and bylaws and Delaware law contain
provisions that could discourage a takeover.
Provisions of our amended and restated certificate of incorporation may
have the effect of making it more difficult for a third party to acquire, or of
discouraging a third party from attempting to acquire, control of us. These
provisions could limit the price that certain investors might be willing to pay
in the future for shares of our common stock. These provisions:
o divide our board of directors into three classes
serving staggered three-year terms;
o only permit removal of directors by stockholders "for
cause," and require the affirmative vote of at least
85% of the outstanding common stock to so remove; and
o allow us to issue preferred stock without any vote or
further action by the stockholders.
The classification system of electing directors and the removal
provision may tend to discourage a third-party from making a tender offer or
otherwise attempting to obtain control of us and may maintain the incumbency of
our board of directors, as the classification of the board of directors
increases the difficulty of replacing a majority of the directors. These
provisions may have the effect of deferring hostile takeovers, delaying changes
in our control or management, or may make it more difficult for stockholders to
take certain corporate actions. The amendment of any of these provisions would
require approval by holders of at least 85% of the outstanding common stock.
Israel-Related Risks
A significant portion of our operations takes place in Israel, and we
could be adversely affected by the economic, political and military conditions
in that region.
The offices and facilities of three of our subsidiaries, EFL, MDT and
Epsilor, are located in Israel (in Beit Shemesh, Lod and Dimona, respectively,
all of which are within Israel's pre-1967 borders). Most of our senior
management is located at EFL's facilities. Although we expect that most of our
sales will be made to customers outside Israel, we are nonetheless directly
affected by economic, political and military conditions in that country.
Accordingly, any major hostilities involving Israel or the interruption or
curtailment of trade between Israel and its present trading partners could have
a material adverse effect on our operations. Since the establishment of the
State of Israel in 1948, a number of armed conflicts have taken place between
Israel and its Arab neighbors and a state of hostility, varying in degree and
intensity, has led to security and economic problems for Israel.
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
71
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 22%
of our assets are located outside the United States. In addition, two of our
directors and most of our executive officers are residents of Israel and a
portion of the assets of such directors and executive officers are located
outside the United States.
There is doubt as to the enforceability of civil liabilities under the
Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as
amended, in original actions instituted in Israel. As a result, it may not be
possible for investors to enforce or effect service of process upon these
directors and executive officers or to judgments of U.S. courts predicated upon
the civil liability provisions of U.S. laws against our assets, as well as the
assets of these directors and executive officers. In addition, awards of
punitive damages in actions brought in the U.S. or elsewhere may be
unenforceable in Israel.
Exchange rate fluctuations between the U.S. dollar and the Israeli NIS may
negatively affect our earnings.
Although a substantial majority of our revenues and a substantial portion of our
expenses are denominated in U.S. dollars, a portion of our costs, including
personnel and facilities-related expenses, is incurred in New Israeli Shekels
(NIS). Inflation in Israel will have the effect of increasing the dollar cost of
our operations in Israel, unless it is offset on a timely basis by a devaluation
of the NIS relative to the dollar. In 2004, 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 7A. 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. We do not
currently have any significant interest rate exposure.
72
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 foreign exchange gains
and losses in 2005. 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 New Israeli Shekels.
Additionally, our MDT and Epsilor subsidiaries operate primarily in New Israeli
Shekels. 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. Please see "Impact of
Inflation and Currency Fluctuations," above and Note 2.b. to the Notes to the
Consolidated Financial Statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Financial Statements
Page
Consolidated Financial Statements
---------------------------------
Reports of Independent Registered Public Accounting Firms....................... F-2
Consolidated Balance Sheets..................................................... F-4
Consolidated Statements of Operations........................................... F-6
Statements of Changes in Shareholders' Equity................................... F-7
Consolidated Statements of Cash Flows........................................... F-10
Notes to Consolidated Financial Statements...................................... F-14
Supplementary Financial Data
----------------------------
Quarterly Financial Data (unaudited) for the two years ended December 31, 2004.. F-61
Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts................................. F-62
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
During the fourth quarter of 2004, our management, including the principal
executive officer and principal financial officer, evaluated 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 are intended 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. Any system of controls and procedures, no matter how well
designed and operated, can at best provide only reasonable assurance that the
objective of the system are met and management necessarily is required to apply
its judgment in evaluating the cost benefit relationship of possible controls
and procedures. 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 are intended to provide
only reasonable, not absolute, assurance that the above objectives have been
met.
73
Based on their evaluation as of December 31, 2004, and except as otherwise
described herein and below, our principal executive officer and principal
financial officer were able to conclude that our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934) were effective to ensure that the information required to
be disclosed by us in the reports that we file or submit under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in SEC rules and forms.
In light of the material weakness described below, our management
performed additional analyses and other post-closing procedures to ensure our
consolidated financial statements are prepared in accordance with generally
accepted accounting principles in the United States (U.S. GAAP). Accordingly,
management believes that the consolidated financial statements included in this
report fairly present in all material respects our financial position, results
of operations and cash flows for the periods presented.
Management's Report on Internal Control Over Financial Reporting
Our management, including our principal executive and financial officers,
have not yet completed the evaluation of the effectiveness of its internal
controls, pursuant to the requirements of Sarbanes-Oxley Section 404, as of the
end of the period covered by this Annual Report on Form 10-K for December 31,
2004. We are eligible for a 45-day extension of time allowed by the SEC for
companies of a certain size to file this report and the attestation. We have
elected to utilize this 45-day extension, and therefore, this Form 10-K does not
include these reports. We intend to file an amendment to this Form 10-K to
include (i) the report of management on internal control over financial
reporting and the associated report of our independent registered public
accounting firm as required by Section 404 of the Sarbanes-Oxley Act and (ii)
revised certifications as required by Section 906 of the Sarbanes-Oxley Act and
Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, once we have
completed our assessment of internal control over financial reporting and our
independent registered public accounting firm has completed their audit of our
assessment.
In accordance with the rules of the SEC, we did not assess the internal
control over financial reporting of Armour of America, Incorporated, which we
acquired in August 2004, financial statements of which reflect total assets of
2% of our consolidated assets as of December 31, 2004, and total revenues of 5%
of our consolidated revenues for the year then ended. In our Annual Report on
Form 10-K for the year ending December 31, 2005, we will be required to provide
an assessment of our compliance that takes into account an assessment of Armour
of America, Incorporated and all of our other currently existing subsidiaries as
of December 31, 2005.
For the reasons described below, we expect to disclose that there was a
material weakness in our internal controls at December 31, 2004. In addition, we
expect that such assessment will result in an adverse opinion of our Independent
Registered Public Accounting Firm on the effectiveness of our internal controls.
We note in this connection that our Independent Registered Public Accounting
Firm also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), our consolidated financial
statements and financial statement schedule as of and for the year ended
December 31, 2004, and their report dated March 24, 2005 expressed an
unqualified opinion with respect thereto.
On November 22, 2004, the Audit Committee of our Board of Directors, on
the recommendation of our management and after discussion with and based on a
new and revised review of accounting treatment by our Independent Registered
Public Accounting Firm, made an internal determination and concluded that our
Annual Report on Form 10-K for the year ended December 31, 2003, including the
financial statements that our Independent Registered Public Accounting Firm had
previously audited that are contained therein, contained certain errors related
to the re-pricing of warrants and grant of additional warrants to certain of our
investors and others and the amortization of debt discount arising from the
allocation of the debt discount between the convertible debentures and their
detachable warrants. The net effect of these errors, which generally related to
the timing and characterization of certain non-cash expenses, was (i) to
74
increase our net loss attributable to common stockholders for 2003 by
approximately $579,000 and to decrease our net loss for the first half of 2004
by approximately $608,000, and (ii) to decrease our net loss attributable to
common stockholders for the nine and three months ended September 30, 2004 by
approximately $1,583,778 and $976,129, respectively. The Audit Committee of our
Board of Directors therefore concluded to restate certain previously issued
financial statements contained in our Annual Report on Form 10-K for the year
ended December 31, 2003. The decision to restate these financial statements was
made by our Audit Committee, upon the recommendation of our management and with
the concurrence of our Independent Registered Public Accounting Firm.
As a result of the restatement referred to in the preceding paragraph, we
expect to conclude that (i) at December 31, 2004, we had a significant
deficiency in our financial statement closing process and related processes
because the size of our accounting and finance department and the volume of work
related to our recent acquisitions caused us to be unable independently to
comply with the selection and application of generally accepted accounting
principles related to highly complex financial transactions applicable to equity
issuances and business combinations, and (ii) that this deficiency constituted a
material weakness in internal controls as defined by the standards established
by the American Institute of Certified Public Accountants (AICPA). A material
weakness is a reportable condition in which the design or operation of one or
more internal control components does not reduce to a relatively low level the
risk that errors or fraud in amounts that would be material in relation to the
financial statements being audited may occur and not be detected within a timely
period by employees in the normal course of performing their assigned functions.
Accordingly, we have undertaken to take the following initiatives with
respect to our internal controls and procedures that we believe are reasonably
likely to improve and materially affect our internal control over financial
reporting. We anticipate that remediation will be continuing throughout fiscal
2005, during which we expect to continue pursuing appropriate corrective
actions, including the following:
>> Preparing appropriate written documentation of our financial control
procedures;
>> Adding additional qualified staff to our finance department;
>> Scheduling training for accounting staff to heighten awareness of
generally accepted accounting principles applicable to complex
transactions;
>> Strengthening our internal review procedures in conjunction with our
ongoing work to enhance our internal controls so as to enable us to
identify and adjust items proactively;
>> Engaging an outside accounting firm to support our Sarbanes-Oxley
Section 404 compliance activities and to provide technical expertise
in the selection and application of generally accepted accounting
principles related to complex transactions to identify areas that
require control or process improvements and to consult with us on
the appropriate accounting treatment applicable to complex
transactions; and
>> Implementing the recommendations of our outside accounting
consultants.
Our management and Audit Committee will monitor closely the implementation
of our remediation plan. The effectiveness of the steps we intend to implement
is subject to continued management review, as well as Audit Committee oversight,
and we may make additional changes to our internal control over financial
reporting.
We cannot assure you that we will not in the future identify further
material weaknesses in our internal control over financial reporting. We
currently are unable to determine when the above-mentioned material weaknesses
will be fully remediated. However, because remediation will not be completed
until we have added finance staff and strengthened pertinent controls, we
presently anticipate that we will report in our Quarterly Report on Form 10-Q
for the first quarter of fiscal 2005 that material weaknesses continue to exist.
75
Currently, we are not aware of any material weaknesses in our internal
control over financial reporting other than as described above. However, we are
continuing to evaluate and test our internal control over financial reporting.
There can be no assurance that, as a result of our ongoing evaluation of our
internal control over financial reporting, we will not identify additional
material weaknesses, or that our evaluation and testing of internal control over
financial reporting will be completed by the end of the 45-day extension period.
Changes in Internal Controls Over Financial Reporting
Except as noted above, there have been no changes in our internal control
over financial reporting that occurred during our last fiscal quarter to which
this Annual Report on Form 10-K relates that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
ITEM 9B. OTHER INFORMATION
None.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Executive Officers, Directors and Significant Employees
Executive Officers and Directors
Our executive officers and directors and their ages as of February 28,
2005 were as follows:
Name Age Position
---- --- --------
Robert S. Ehrlich........... 66 Chairman of the Board, President and Chief Executive Officer
Steven Esses.................. 41 Executive Vice President, Chief Operating Officer and Director
Avihai Shen................. 37 Vice President - Finance and Chief Financial Officer
Dr. Jay M. Eastman.......... 56 Director
Jack E. Rosenfeld........... 66 Director
Lawrence M. Miller.......... 58 Director
Bert W. Wasserman........... 72 Director
Edward J. Borey............. 54 Director
Our by-laws provide for a board of directors of one or more directors.
There are currently seven directors. Under the terms of our certificate of
incorporation, the board of directors is composed of three classes of similar
size, each elected in a different year, so that only one-third of the board of
directors is elected in any single year. Dr. Eastman and Mr. Esses are
designated Class I directors and have been elected for a term expiring in 2006
and until their successors are elected and qualified; Messrs. Rosenfeld and
Miller are designated Class II directors elected for a term expiring in 2005 and
until their successors are elected and qualified; and Messrs. Ehrlich, Wasserman
and Borey are designated Class III directors elected for a term that expires in
2007 and until their successors are elected and qualified. A majority of the
Board is "independent" under relevant SEC and Nasdaq regulations.
Robert S. Ehrlich has been our Chairman of the Board since January 1993
and our President and Chief Executive Officer since October 2002. From May 1991
until January 1993, Mr. Ehrlich was our Vice Chairman of the Board, and from May
1991 until October 2002 he was our Chief Financial Officer. Mr. Ehrlich was a
director of Eldat, Ltd., an Israeli manufacturer of electronic shelf labels,
from June 1999 to July 2003. From 1987 to June 2003, Mr. Ehrlich served as a
director of PSC Inc. ("PSCX"), a manufacturer and marketer of laser diode bar
code scanners, and, between April 1997 and June 2003, Mr. Ehrlich was the
chairman of the board of PSCX. PSCX filed a voluntary petition for relief under
Chapter 11 of the Bankruptcy Code in November 2002. Mr. Ehrlich received a B.S.
and J.D. from Columbia University in New York, New York.
Steven Esses has been a director since July 2002 and our Executive Vice
President since January 2003 and Chief Operating Officer since February 2003.
From 2000 until 2002, Mr. Esses was a principal with Stillwater Capital
Partners, Inc., a New York-based investment research and advisory company (hedge
fund) specializing in alternative investment strategies. During this time, Mr.
77
Esses also acted as an independent consultant to new and existing businesses in
the areas of finance and business development. From 1995 to 2000, Mr. Esses
founded Dunkin' Donuts in Israel and held the position of Managing Director and
CEO. Prior thereto, he was Director of Retail Jewelry Franchises with Hamilton
Jewelry, and before that he served as Executive Director of Operations for the
Conway Organization, a major off-price retailer with 17 locations.
Avihai Shen has been our Vice President - Finance since September 1999
and our Chief Financial Officer since October 2002, and served as our corporate
Secretary from September 1999 to December 2000. Mr. Shen was the CFO of
Commtouch Software Ltd., an internet company based in California that develops
e-mail solutions, from 1996 to early 1999, and worked previously at Ernst and
Young in Israel. Mr. Shen is a certified public accountant and has a B.A. in
Economics from Bar-Ilan University in Israel and an M.B.A. from the Hebrew
University of Jerusalem.
Dr. Jay M. Eastman has been one of our directors since October 1993.
Since November 1991, Dr. Eastman has served as President and Chief Executive
Officer of Lucid, Inc., which is developing laser technology applications for
medical diagnosis and treatment. Dr. Eastman served as Senior Vice President of
Strategic Planning of PSCX from December 1995 through October 1997. Dr. Eastman
is also a director of Dimension Technologies, Inc., a developer and manufacturer
of 3D displays for computer and video displays. From 1981 until January 1983,
Dr. Eastman was Director of the University of Rochester's Laboratory for Laser
Energetics, where he was a member of the staff from September 1975 to 1981. Dr.
Eastman holds a B.S. and a Ph.D. in Optics from the University of Rochester in
New York.
Jack E. Rosenfeld has been one of our directors since October 1993. Mr.
Rosenfeld was President and Chief Executive Officer of Potpourri Group Inc.
("Potpourri"), a specialty catalog direct marketer, from April 1998 until June
2003; from June 2003 until February 2005, Mr. Rosenfeld served as Chairman of
Potpourri's Board of Directors and as its CEO, and since February 2005, Mr.
Rosenfeld has been Executive Chairman of the Potpourri Board of Directors. Mr.
Rosenfeld was President and Chief Executive Officer of Hanover Direct, Inc.,
formerly Horn & Hardart Co., which operates a direct mail marketing business,
from September 1990 until December 1995, and had been President and Chief
Executive Officer of its direct marketing subsidiary, from May 1988 until
September 1990. Mr. Rosenfeld holds a B.A. from Cornell University in Ithaca,
New York and an LL.B. from Harvard University in Cambridge, Massachusetts.
Lawrence M. Miller was elected to the board of directors in November
1996. Mr. Miller has been a senior partner in the Washington D.C. law firm of
Schwartz, Woods and Miller since 1990. He served from August 1993 through May
1996 as a member of the board of directors of The Phoenix Resource Companies,
Inc., a publicly traded energy exploration and production company, and as a
member of the Audit and Compensation Committee of that board. That company was
merged into Apache Corporation in May 1996. Mr. Miller holds a B.A. from
Dickinson College in Carlisle, Pennsylvania and a J.D. with honors from George
Washington University in Washington, D.C. He is a member of the District of
Columbia bar.
Bert W. Wasserman has served as a director since February 2003. Mr.
Wasserman served as Executive Vice President and Chief Financial Officer of Time
Warner, Inc. from 1990 until his retirement in 1995 and served on the Board of
Directors of Time Warner, Inc. and its predecessor company, Warner
Communications, Inc. from 1981 to 1995. He joined Warner Communications, Inc. in
1966 and had been an officer of that company since 1970. Mr. Wasserman is
director of several investment companies in the Dreyfus Family of Funds. He is
78
also a director of Malibu Entertainment, Inc., Lillian Vernon Corporation and
InforMedix, Inc. Mr. Wasserman is a certified public accountant; he holds a B.A.
from Baruch College in New York City, of whose Board of Trustees he has served
as Vice President and President, and an LL.B from Brooklyn Law School.
Edward J. Borey has served as a director since December 2003. Mr. Borey
has been Chairman and Chief Executive Officer of WatchGuard Technologies, Inc.,
a leading provider of network security solutions (NasdaqNM: WGRD), since July
2004. From December 2000 to September 2003, Mr. Borey served as President, Chief
Executive Officer and a director of PSCX. PSCX filed a voluntary petition for
relief under Chapter 11 of the Bankruptcy Code in November 2002. Prior to
joining PSCX, Mr. Borey was President and CEO of TranSenda (May 2000 to December
2000). Previously, Mr. Borey held senior positions in the automated data
collection industry. At Intermec Technologies Corporation (1995-1999), he was
Executive Vice President and Chief Operating Officer and also Senior Vice
President/General Manager of the Intermec Media subsidiary. Currently, Mr. Borey
serves as a Board member at Mbrane (foremerly known as Centura Software), and he
is on the Advisory Board of TranSenda Software and NextRx. Mr. Borey holds a
B.S. in Economics from the State University of New York, College of Oswego; an
M.A. in Public Administration from the University of Oklahoma; and an M.B.A. in
Finance from Santa Clara University.
Committees of the Board of Directors
Our board of directors has an Audit Committee, a Compensation
Committee, a Nominating Committee and an Executive and Finance Committee.
Created in December 1993, the purpose of the Audit Committee is to
review with management and our independent auditors the scope and results of the
annual audit, the nature of any other services provided by the independent
auditors, changes in the accounting principles applied to the presentation of
our financial statements, and any comments by the independent auditors on our
policies and procedures with respect to internal accounting, auditing and
financial controls. The Audit Committee was established in accordance with
Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended. In
addition, the Audit Committee is charged with the responsibility for making
decisions on the engagement of independent auditors. As required by law, the
Audit Committee operates pursuant to a charter. The Audit Committee consists of
Messrs. Wasserman (Chair), Miller and Rosenfeld. We have determined that Mr.
Wasserman qualifies as an "audit committee financial expert" under applicable
SEC and Nasdaq regulations. Mr. Wasserman, as well as all the other members of
the Audit Committee, is "independent," as independence is defined in Rule
4200(a)(15) of the National Association of Securities Dealers' listing standards
and under Item 7(d)(3)(iv) of Schedule 14A of the proxy rules under the Exchange
Act.
The Compensation Committee, also created in December 1993, recommends
annual compensation arrangements for the Chief Executive Officer and Chief
Financial Officer and reviews annual compensation arrangements for all officers
and significant employees. The Compensation Committee consists of Dr. Eastman
(Chair) and Messrs. Wasserman and Rosenfeld, all of whom are independent
non-employee directors.
79
The Executive and Finance Committee, created in July 2001, exercises
the powers of the Board during the intervals between meetings of the Board, in
the management of the property, business and affairs of the Company (except with
respect to certain extraordinary transactions). The Executive and Finance
Committee consists of Messrs. Ehrlich (Chair), Miller, Borey and Esses.
The Nominating Committee, created in March 2003, identifies and
proposes candidates to serve as members of the Board of Directors. Proposed
nominees for membership on the Board of Directors submitted in writing by
stockholders to the Secretary of the Company will be brought to the attention of
the Nominating Committee. The Nominating Committee consists of Mr. Rosenfeld
(Chair), Dr. Eastman and Mr. Borey, all of whom are independent non-employee
directors. The Nominating Committee operates under a formal charter that governs
its duties. The Nominating Committee's charter is publicly available through a
hyperlink located on the investor relations page of our website, at
http://www.arotech.com/compro/investor.html.
Code of Ethics
We have adopted a Code of Ethics, as required by Nasdaq listing
standards and the rules of the SEC, that applies to our principal executive
officer, our principal financial officer, and our principal accounting officer.
The Code of Ethics is publicly available through a hyperlink located on the
investor relations page of our website, at
http://www.arotech.com/compro/investor.html. If we make substantive amendments
to the Code of Ethics or grant any waiver, including any implicit waiver, that
applies to anyone subject to the Code of Ethics, we will disclose the nature of
such amendment or waiver on the website or in a report on Form 8-K in accordance
with applicable Nasdaq and SEC rules.
Code of Conduct
We have adopted a general Code of Conduct, as required by Nasdaq
listing standards and the rules of the SEC, that applies to all of our
employees. The Code of Conduct is publicly available through a hyperlink located
on the investor relations page of our website, at
http://www.arotech.com/compro/investor.html.
Whistleblower Policy
We have adopted a Whistleblower Policy, as required by Nasdaq listing
standards, in order to ensure compliance with the provisions of the
Sarbanes-Oxley Act of 2002. The Whistleblower Policy is publicly available
through a hyperlink located on the investor relations page of our website, at
http://www.arotech.com/compro/investor.html. Employees with complaints about our
compliance with applicable legal and regulatory requirements relating to
accounting, auditing and internal control matters may submit their complaints in
person, by mail or other written communication or by telephone to our Complaint
Administrator. The Complaint Administrator can be contacted anonymously, by
submitting the form located on our corporate website at
http://arotech.com/compro/complaint.html. Complaints sent in this manner will
automatically be stripped of all computer-encoded information identifying the
originating e-mail address, and will then automatically be forwarded to the
Complaint Administrator's regular e-mail address at Arotech.
80
Director Compensation
Non-employee members of our board of directors are paid $2,500 (plus
expenses) for each board of directors meeting attended, $2,000 (plus expenses)
for each meeting of the audit committee of the board of directors attended, and
$1,000 (plus expenses) for each meeting of all other committees of the board of
directors attended. In addition, we have adopted a Non-Employee Director Stock
Option Plan pursuant to which non-employee directors receive an initial grant of
options to purchase 40,000 shares of our common stock upon the effective date of
such plan or upon the date of his or her election as a director. Thereafter,
non-employee directors will receive options to purchase 25,000 shares of our
common stock for each year of service on the board. All such options are granted
at fair market value and vest ratably over three years from the date of the
grant.
Significant Employees
Our significant employees as of February 28, 2005, and their ages as of
December 31, 2004, are as follows:
Name Age Position
---- --- --------
Arik Arad.......................... 52 Executive Vice President of Arotech and Chairman of IES
Jonathan Whartman.................. 50 Senior Vice President
Dr. Neal Naimer.................... 46 Vice President and Chief Technology Officer
William Graham..................... 46 Vice President of Government Affairs
Yoel Gilon......................... 52 Vice President - Electric Vehicle Technologies
Kim Kelly.......................... 40 Vice President - Corporate Communications
Yaakov Har-Oz...................... 47 Vice President, General Counsel and Secretary
Danny Waldner...................... 33 Controller
Greg Otte.......................... 45 President, IES Interactive Training, Inc.
Alan G. Jordan..................... 51 CEO, FAAC Incorporated
Yosef Bar.......................... 62 General Manager, MDT Protective Industries
Hezy Aspis......................... 54 General Manager, Epsilor Electronics Industries, Ltd.
John R. Nehmens.................... 53 Chief Operating Officer, Armour of America
Graydon Hansen..................... 46President, Electric Fuel Battery Corporation
Arik Arad has served as IES's Chairman since August 2003 and as an
Executive Vice President of Arotech since May 2004. Mr. Arad has served in the
military, law enforcement and private-sector security business, servicing
clientele from among the Fortune 500(TM) companies. In that capacity, Mr. Arad
has participated in the process of reassessing security requirements, security
design, security implementation, security training programs and proactive
security follow-up. Mr. Arad has been exposed to issues pertinent to companies
whose worldwide operations pose potential for terrorist activity. He has also
gained worldwide experience in securing major airports, shopping centers and
other high profile facilities. Mr. Arad served as a Lieutenant Colonel in the
Israel Defense Forces. Mr. Arad is a graduate of the International Seminar
Management Program (ISMP) of the Harvard Business School and holds a B.Sc. in
psychology and political sciences from the Haifa University in Israel.
81
Jonathan Whartman has been Senior Vice President since December 2000,
and Vice President of Marketing from 1994 to December 2000. From 1991 until
1994, Mr. Whartman was our Director of Special Projects. Mr. Whartman was also
Director of Marketing of Amtec from its inception in 1989 through the merger of
Amtec into Arotech in 1991. Before joining Amtec, Mr. Whartman was Manager of
Program Management at Luz, Program Manager for desk-top publishing at ITT Qume
in San Jose, California from 1986 to 1987, and Marketing Director at Kidron
Digital Systems, an Israeli computer developer, from 1982 to 1986. Mr. Whartman
holds a B.A. in Economics and an M.B.A. from the Hebrew University, Jerusalem,
Israel.
Dr. Neal Naimer has been a Vice President since June 1997 and our Chief
Technology Officer since December 2002. From 1989 to 1997, Dr. Naimer was
Director of Electrode Engineering of our Air Electrode development program. From
1987 to 1989, he was the Manager of the Chemical Vapor Deposition (Thin Films)
Group at Intel Electronics in Jerusalem, and was Project Manager of the photo
voltaic IR detector development program at Tadiran Semiconductor Devices in
Jerusalem from 1984 to 1987. Dr. Naimer was educated at University College of
London, England, where he received his B.Sc. in Chemical Engineering and a Ph.D.
in Chemical Engineering.
William Graham joined us as Vice President of Government Affairs in
January 2005, after twenty years of military service highlighted by multiple
commands and six years of Pentagon experience. During this time, Mr. Graham
interacted continuously with Senators and their staffs to develop and execute
the strategy for presenting the $300+ billion defense budget. After retiring
from the Army as a Colonel in 2001, Mr. Graham joined Washington Operations for
Time Domain Corporation (TDC) as a Director to help the company secure Pentagon
contracts and congressional support for those programs. Mr. Graham completed a
B.S. in General Engineering at the U.S. Military Academy (West Point) in 1980,
earned his masters from Central Michigan University in 1991 and was graduated
from the U.S. Army War College in 1999.
Yoel Gilon has been our Vice President - Electric Vehicle Technologies
since 2001; prior to that, he served as Director of Electric Vehicle
Technologies at our Beit Shemesh facility since joining us in 1994. From 1991 to
1994, Mr. Gilon was Project Development Manager at Ormat Industries. Previously,
Mr. Gilon was Vice President of System Engineering Development at Luz
Industries. Mr. Gilon holds a B.Sc. in Mathematics and Physics and a M.Sc. in
Mathematics from the Hebrew University of Jerusalem. He also holds a B.A. in
Fine Arts from the Bezalel Academy in Jerusalem.
Kim Kelly has served as our Vice President - Corporate Communications
since November 2004. From 1993 to 2004, Ms Kelly held a variety of positions at
ECI Telecom Ltd., a Nasdaq-listed company, including serving as ECI's Director
of Corporate Communications, where she played a significant role in ECI's
communications strategy, investor relations program and competitive intelligence
analysis. Ms Kelly holds a B.A. in Social Work from Bar-Ilan University in
Tel-Aviv and an M.B.A. from Ben-Gurion University in Beersheva, Israel.
82
Yaakov Har-Oz has served as our Vice President and General Counsel
since October 2000 and as our corporate Secretary since December 2000. From 1994
until October 2000, Mr. Har-Oz was a partner in the Jerusalem law firm of
Ben-Ze'ev, Hacohen & Co. Prior to moving to Israel in 1993, he was an
administrative law judge and in private law practice in New York. Mr. Har-Oz
holds a B.A. from Brandeis University in Waltham, Massachusetts and a J.D. from
Vanderbilt Law School (where he was an editor of the law review) in Nashville,
Tennessee. He is a member of the New York bar and the Israel Chamber of
Advocates.
Danny Waldner has served as our Controller since March 2000 and as our
chief accounting officer since October 2002. Prior thereto, Mr. Waldner was an
accountant at KPMG in Israel from 1996 to 2000. Mr. Waldner is a Certified
Public Accountant and holds a B.A. in Accounting and Business Administration and
an M.B.A. from the Rishon Lezion College of Administration in Israel, as well as
an LL.M from Bar-Ilan University in Tel-Aviv.
Greg Otte has served as IES's President since January 2001. From 1994
to 2001, Mr. Otte was in charge of IES's North American marketing efforts. Prior
to this, he was responsible for sales, product placement and national contracts
with Tuxall Uniform & Equipment, a national supplier of law enforcement
equipment. Mr. Otte holds a bachelor's degree in Marketing from the University
of Colorado.
Alan G. Jordan started at First Ann Arbor Corporation, the predecessor
of FAAC, in 1978 as a junior engineer. He subsequently was promoted to section
head, program manager, group head, director of operations, vice president, and
finally president, which position he has held for more than the past five years.
Effective January 1, 2005, Mr. Jordan stepped down as President, remaining FAAC
CEO. Prior to joining FAAC, Mr. Jordan was an engineer in the U.S. Navy civil
service. Mr. Jordan maintains Department of Defense "secret" clearance. Mr.
Jordan holds a bachelor's degree in Systems Science from Michigan State
University.
Yosef Bar established MDT Protective Industries in 1989 as one of the
first bulletproofing companies in Israel. Under the direction of Mr. Bar, MDT
moved from its initial emphasis on vandalism protection to bulletproofing not
just windshields but the entire vehicle, as a result of which MDT became
Israel's leader in the state-of-the art lightweight armoring of vehicles. Mr.
Bar served in the Israel Defense Forces, reaching the rank of Lieutenant Colonel
of the paratroop regiment with over 1,000 jumps to his credit. He also
participated in several anti-terrorism courses.
Hezy Aspis has headed Epsilor Electronic Industries, Ltd. since 1991.
Prior to this, he was an engineer with Tadiran Batteries Ltd., Israel's leading
lithium battery manufacturer. Mr. Aspis holds a B.Sc. in electric engineering
from the Technion Israel Institute of Technology in Haifa, Israel, and an M.B.A.
from Tel-Aviv University in Israel.
John R. Nehmens has served as General Manager of AoA since 1996, and as
Chief Operating Officer since 2004. Mr. Nehmens has over 28 years of direct
aerospace manufacturing experience, having owned his own air frame manufacturing
company for seven years. In addition, Mr. Nehmens spent 13 years at
Lockheed-Martin Company, the last three as Director of Quality Assurance. Mr.
Nehmens attended California Polytechnic College, Pomona, California, with a
major in international business.
83
Graydon Hansen has served as President of EFBC since January 2005.
Prior thereto, Mr. Hansen was Senior Vice President of Engineering with Elpac
Electronics, Inc. From March 2002 until February 2004, Mr. Hansen was Vice
President of Engineering at Trojan Battery Corporation, where his management
responsibilities included commercial product development and design activity,
plus leadership of the Quality and Production Engineering groups in all of
Trojan's manufacturing facilities. Previously, Mr. Hansen worked at Lockheed
Missiles and Space Company. Mr. Hansen holds a B.Sc. in electric engineering
from the University of California at Berkeley, and is a Registered Professional
Engineer.
Section 16(a) Beneficial Ownership Reporting Compliance
Under the securities laws of the United States, our directors, certain
of our officers and any persons holding more than ten percent of our common
stock are required to report their ownership of our common stock and any changes
in that ownership to the Securities and Exchange Commission. Specific due dates
for these reports have been established and we are required to report any
failure to file by these dates during 2004. We are not aware of any instances
during 2004, not previously disclosed by us, where such "reporting persons"
failed to file the required reports on or before the specified dates, except as
follows:
(i) Mr. Ehrlich was required to file a Form 4 on or prior to
December 12, 2004 in connection with his acquisition of 75,000
restricted shares on December 10, 2004. He reported this
transaction in a Form 4 filed on December 14, 2004.
Additionally, Mr. Ehrlich was required to file a Form 4 on or
prior to August 11, 2004 in connection with his receipt of
50,000 stock options on August 9, 2004. He reported this
transaction in a Form 5 filed on February 14, 2005.
(ii) Mr. Esses was required to file a Form 4 on or prior to April
10, 2004 in connection with his exercise and sale of 50,000
stock options on April 8, 2004. He reported this transaction
in a Form 4 filed on April 12, 2004.
(iii) Mr. Shen was required to file a Form 4 on or prior to December
12, 2004 in connection with his acquisition of 30,000
restricted shares on December 10, 2004. He reported this
transaction in a Form 4 filed on December 14, 2004.
Additionally, Mr. Shen was required to file a Form 4 on or
prior to August 11, 2004 in connection with his receipt of
18,750 stock options on August 9, 2004. He reported this
transaction in a Form 5 filed on February 14, 2005.
ITEM 11. EXECUTIVE COMPENSATION
Cash and Other Compensation
General
Our Chief Executive Officer and the other highest paid executive
officers (of which there were two) who were compensated at a rate of more than
$100,000 in salary and bonuses during the year ended December 31, 2004
(collectively, the "Named Executive Officers") are Israeli residents, and thus
certain elements of the compensation that we pay them is structured as is
customary in Israel.
84
During 2004, 2003 and 2002, compensation to our Named Executive
Officers took several forms:
>> cash salary;
>> bonus, some of which was paid in cash in the year in
which it was earned and some of which was accrued in
the year in which it was earned but paid in cash in a
subsequent year;
>> cash reimbursement for taxes paid by the Named
Executive Officer and reimbursed by us in accordance
with Israeli tax regulations;
>> accruals (but not cash payments) in respect of
contractual termination compensation in excess of the
Israeli statutory minimum;
>> accruals (but not cash payments) in respect of
pension plans, which consist of a savings plan, life
insurance and statutory severance pay benefits, and a
continuing education fund (as is customary in
Israel);
>> stock options, including (in the case of 2002)
options issued in exchange for a waiver of salary
under the "options-for-salary" program discussed in
more detail below
>> grants of restricted stock, where the sale of such
stock is prohibited for a period of two years and
such stock is forfeit to us should the Named
Executive Officer's employment be terminated for
cause, as defined in such Executive's employment
agreement (e.g., fraud, reckless or willful
misconduct, etc.); and
>> other benefits, primarily consisting of annual
statutory holiday pay.
The specific amounts of each form of compensation paid to each Named
Executive Officer appear in the summary compensation table and the notes thereto
appearing under "Summary Compensation Table," below.
Summary Compensation Table
The following table, which should be read in conjunction with the
explanations provided above, shows the compensation that we paid (or accrued),
in connection with services rendered for 2004, 2003 and 2002, to our Named
Executive Officers.
Annual Compensation Long Term Compensation
-------------------------------------------------------------------
Securities Restricted
Tax Underlying Stock
Name and Principal Position Year Salary Bonus Reimbursement Options Awards(2)
Robert S. Ehrlich 2004 $ 275,907 $ 175,000 $ 29,103 50,000 $ 626,350
Chairman of the Board, 2003 $ 259,989 $ 180,000(4) $ 27,211 2,035,000 0
President, Chief 2002 $ 202,962 $ 99,750 $ 15,232 262,500(6) $ 0
Executive Officer and
director
All Other Compensation
---------------------------------------
Changes in
Accruals for
Sick Days, Payment to
Vacation Days Pension and
and Termination, Education
Name and Principal Position Compensation Funds Others
Robert S. Ehrlich $ 133,898(3) $ 48,477 $ 19,893
Chairman of the Board, $ 80,713(5) $ 48,228 $ 678
President, Chief $ 170,691(7) $ 22,256 $ 654
Executive Officer and
director
85
Annual Compensation Long Term Compensation All Other Compensation
-------------------------------------------------------------------------------------------------------
Changes in
Accruals for
Sick Days, Payment to
Securities Restricted Vacation Days Pension and
Tax Underlying Stock and Termination, Education
Name and Principal Position Year Salary Bonus Reimbursement Options Awards(2) Compensation Funds Others
Steven Esses 2004 $ 65,506(8)$ 106,000(9)$ 25,273 0 $221,100 $ 3,759(12) $ 12,116 $ 12,940
Executive Vice President, 2003 $ 0 $ 0 $ 0 1,035,000 $ 0 $ 0 $ 0 $ 0
Chief Operating Officer 2002 $ 0 $ 0 $ 0 0 $ 0 $ 0 $ 0 $ 120,480(11)
and director*
Avihai Shen 2004 $ 155,845 $ 97,000 $ 6,407 18,750 $54,900 $ 34,972(12) $ 26,889 $ 476
Vice President - Finance and 2003 $ 123,988 $ 0 $ 8,653 608,750 $ 0 $ 6,471(13) $ 23,133 $ 463
Chief Financial Officer 2002 $ 93,641 $ 0 $ 18,857 48,935 $ 0 $ 9,847(14) $ 20,394 $ 6,894(15)
- -------------------------------------
* Mr. Esses became an executive officer in January 2003. His compensation as
an officer during 2003 consisted solely of stock options. Prior to January
2003, Mr. Esses was a director (from July 2002), in which position he
received certain compensation as a consultant, in addition to the stock
options and per-meeting fees payable to directors generally (which is not
reflected above).
(1) We paid the amounts reported for each named executive officer in U.S.
dollars and/or New Israeli Shekels (NIS). We have translated amounts paid
in NIS into U.S. dollars at the exchange rate of NIS into U.S. dollars at
the time of payment or accrual.
(2) Based on the closing market price of our stock on the Nasdaq Stock
Exchange the date of grant multiplied by the number of shares awarded. As
of December 31, 2004, our Named Executive Officers held 635,000 restricted
shares. Of these shares, the restrictions on 530,000 shares are scheduled
to expire on August 4, 2006, and the restrictions on 105,000 are scheduled
to expire on December 8, 2006. The value of the restricted shares held by
our Named Executive Officers on December 31, 2004, based on the closing
price of our stock on the Nasdaq Stock Exchange on that date. was
$902,350.
(3) Of this amount, $76,766 represents our accrual for severance pay that
would be payable to Mr. Ehrlich upon a "change of control" or upon the
occurrence of certain other events; $28,603 represents the increase of the
accrual for vacation redeemable by Mr. Ehrlich; and $28,529 represents the
increase of our accrual for severance pay that would be payable to Mr.
Ehrlich under the laws of the State of Israel if we were to terminate his
employment.
(4) We paid Mr. Ehrlich $180,000 during 2004 in satisfaction of his bonus from
2003 to which he was entitled according to his contract. Of this amount,
we accrued $99,750 for Mr. Ehrlich in satisfaction of the 2003 bonus to
which he was entitled according to his contract; the remainder was the
result of the approval in 2004 by the Compensation Committee of a higher
bonus for 2003 than Mr. Ehrlich's contractual minimum.
(5) Of this amount, $92,075 represents our accrual for severance pay that
would be payable to Mr. Ehrlich upon a "change of control" or upon the
occurrence of certain other events; $3,451 represents the increase of the
accrual for sick leave and vacation redeemable by Mr. Ehrlich; and
$(14,813) represents the decrease of our accrual for severance pay that
would be payable to Mr. Ehrlich under the laws of the State of Israel if
we were to terminate his employment.
(6) Of this amount, 262,500 options were in exchange for a total of $105,000
in salary waived by Mr. Ehrlich during 2002 pursuant to the
options-for-salary program instituted by us beginning in May 2001. See
"Options-for-Salary Program," below.
(7) Of this amount, $109,935 represents our accrual for severance pay that
would be payable to Mr. Ehrlich upon a "change of control" or upon the
occurrence of certain other events; $17,571 represents the increase of the
accrual for sick leave and vacation redeemable by Mr. Ehrlich; and $43,725
represents the increase of our accrual for severance pay that would be
payable to Mr. Ehrlich under the laws of the State of Israel if we were to
terminate his employment.
(8) Does not include $208,100 that we paid in consulting fees to Sampen
Corporation, a New York corporation owned by members of Steven Esses's
immediate family from which Mr. Esses receives a salary. See "Item 13.
Certain Relationships and Related Transactions - Consulting Agreement with
Sampen Corporation," below.
(9) Does not include $110,000 that we paid as a bonus to Sampen Corporation, a
New York corporation owned by members of Steven Esses's immediate family
from which Mr. Esses receives a salary. See "Item 13. Certain
Relationships and Related Transactions - Consulting Agreement with Sampen
Corporation," below.
86
(10) Represents the increase of the accrual for vacation redeemable by Mr.
Esses.
(11) Represents consulting fees paid in 2002.
(12) Of this amount, $21,568 represents the increase in our accrual for
vacation redeemable by Mr. Shen; and $13,404 represents the increase of
our accrual for severance pay that would be payable to Mr. Shen under the
laws of the State of Israel if we were to terminate his employment.
(13) Of this amount, $8,369 represents the increase of the accrual for vacation
redeemable by Mr. Shen; and $(1,628) represents the decrease of our
accrual for severance pay that would be payable to Mr. Shen under the laws
of the State of Israel if we were to terminate his employment.
(14) Of this amount, $1,062 represents the increase of the accrual for vacation
redeemable by Mr. Shen; and $8,785 represents the increase of our accrual
for severance pay that would be payable to Mr. Shen under the laws of the
State of Israel if we were to terminate his employment.
(15) Of this amount, $6,500 represents the value of shares issued to Mr. Shen
as a stock bonus and $394 represents other benefits that we paid to Mr.
Shen in 2002.
Executive Loans
In 1999, 2000 and 2002, we extended certain loans to our Named
Executive Officers. These loans are summarized in the following table, and are
further described under "Item 13. Certain Relationships and Related Transactions
- - Officer Loans," below.
Original Amount
Principal Outstanding
Name of Borrower Date of Loan Amount of Loan as of 12/31/04 Terms of Loan
---------------- ------------ -------------- -------------- -------------
Robert S. Ehrlich....... 12/28/99 $ 167,975 $ 201,570 Ten-year non-recourse loan to purchase our
stock, secured by the shares of stock
purchased.
Robert S. Ehrlich....... 02/09/00 $ 789,991 $ 684,006 Twenty-five-year non-recourse loan to
purchase our stock, secured by the
shares of stock purchased.
Robert S. Ehrlich....... 06/10/02 $ 36,500 $ 38,719 Twenty-five-year non-recourse loan to
purchase our stock, secured by the
shares of stock purchased.
Options-for-Salary Program
Between May 2001 and December 2002, we conducted an options-for-salary
program designed to conserve our cash and to offer incentives to employees to
remain with us despite lower cash compensation. Under this program, most of our
salaried employees permanently waived a portion of their salaries in exchange
for options to purchase shares of our common stock, at a ratio of options to
purchase 2.5 shares of our stock for each dollar in salary waived. Social
benefits (such as pension) and contractual bonuses for such employees continued
to be calculated based on their salaries prior to reduction. The
options-for-salary program was ended on December 31, 2002.
During 2002, options were accrued quarterly in advance for the Named
Executive Officers, and annually in advance for other employees.
During 2002, in exchange for waiver of $364,209 in salary, our
employees other than the Named Executive Officers received a total of 910,522
options, which options were granted based on the lowest closing price of our
common stock during the month of December 2002 ($0.61). Named Executive
Officers, in exchange for waiver of $119,774 in salary, received a total of
299,435 options during 2002, which options were granted based on the lowest
closing prices of our common stock during each quarter of 2002, as set forth in
the table below.
87
Following is a table setting forth the number of options that we issued
to each of our Named Executive Officers under the options-for-salary program
during each fiscal quarter in 2002, and the range of trading prices for our
common stock during each such fiscal quarter:
Low Trading Closing
Fiscal Amount of Number of Number of Average Price High Trading Price
Quarter Salary Options Options Exercise During Price During on Last Day
Named Executive Officer Ended Waived Accrued Issued Price Quarter Quarter of Quarter
- ------------------------ -------------------------- -------------------------- -----------------------------------------------------
Robert S. Ehrlich...... 03/31/02 $ 26,250 65,625 65,625 $1.42 $1.35 $2.41 $1.55
06/30/02 $ 26,250 65,625 65,625 $0.73 $0.73 $1.79 $0.91
09/30/02 $ 26,250 65,625 65,625 $0.85 $0.79 $1.70 $1.05
12/31/02 $ 26,250 65,625 65,625 $0.61 $0.61 $1.17 $0.64
Avihai Shen............ 03/31/02 $ 3,262 8,153 8,153 $1.42 $1.35 $2.41 $1.55
06/30/02 $ 3,262 8,153 8,153 $0.73 $0.73 $1.79 $0.91
09/30/02 $ 3,262 12,476 12,476 $0.85 $0.79 $1.70 $1.05
12/31/02 $ 3,262 8,153 8,153 $0.61 $0.61 $1.17 $0.64
Stock Options
The table below sets forth information with respect to stock options
granted to the Named Executive Officers for the fiscal year 2004.
Option Grants in Last Fiscal Year
Name Individual Grants
--------------- ----------------------------
Number of % of Total
Options Potential Realizable Value
Securities granted to Exercise of Assumed Annual Rates
Underlying Employees or Based of Stock Price Appreciation
Options in Fiscal Price Expiration for Option Term(1)
------------------------------
Name Granted Year ($/Sh) Date 5% ($) 10% ($)
--------------- ----------- ------------- ----------- ---------- ------------- -------------
Robert S. Ehrlich..... 50,000 3.3% $1.20 08/09/09 $ 16,577 $ 36,631
Avihai Shen........... 18,750 1.2% $1.20 08/09/09 $ 6,216 $ 13,736
---------------------------------
(1)The potential realizable value illustrates value that might be realized upon
exercise of the options immediately prior to the expiration of their terms,
assuming the specified compounded rates of appreciation of the market price
per share from the date of grant to the end of the option term. Actual
gains, if any, on stock option exercise are dependent upon a number of
factors, including the future performance of the common stock and the timing
of option exercises, as well as the executive officer's continued employment
through the vesting period. The gains shown are net of the option exercise
price, but do not include deductions for taxes and other expenses payable
upon the exercise of the option or for sale of underlying shares of common
stock. The 5% and 10% rates of appreciation are mandated by the rules of the
Securities and Exchange Commission and do not represent our estimate or
projection of future increases in the price of our stock. There can be no
assurance that the amounts reflected in this table will be achieved, and
unless the market price of our common stock appreciates over the option
term, no value will be realized from the option grants made to the executive
officers.
The table below sets forth information for the Named Executive Officers
with respect to aggregated option exercises during fiscal 2004 and fiscal 2004
year-end option values.
88
Aggregated Option Exercises and Fiscal Year-End Option Values
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options
Shares Options at Fiscal Year End at Fiscal-Year-End(1)
Acquired on Value ------------------------------ ----------------------------------
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
--------------------------------- ------------------ -------------- --------------- ---------------- -----------------
Robert S. Ehrlich.... 19,000 $ (665) 2,384,166 500,000 $ 2,062,541 $ 426,000
Steven Esses......... 50,000 $ 128,500 641,808 178,333 $ 457,134 $ 299,282
Avihai Shen.......... - $ - 309,653 310,000 $ 280,438 $ 0
- -----------------------------------
(1) Options that are "in-the-money" are options for which the fair market value
of the underlying securities on December 31, 2004 ($1.62) exceeds the
exercise or base price of the option.
Employment Contracts
Mr. Ehrlich is party to an employment agreement with us effective as of
January 1, 2000. The term of this employment agreement, as extended, expires on
December 31, 2005, and is extended automatically for additional terms of two
years each unless either Mr. Ehrlich or we terminate the agreement sooner.
The employment agreement provides for a base salary of $20,000 per
month, as adjusted annually for Israeli inflation and devaluation of the Israeli
shekel against the U.S. dollar, if any. Additionally, the board may at its
discretion raise Mr. Ehrlich's base salary. In January 2002, the board raised
Mr. Ehrlich's base salary to $23,750 per month effective January 1, 2002; during
2002 and 2003, Mr. Ehrlich elected to waive this increase in his salary and to
receive options instead, under our salary for options program.
The employment agreement provides that if the results we actually
attain in a given year are at least 80% of the amount we budgeted at the
beginning of the year, we will pay a bonus, on a sliding scale, in an amount
equal to a minimum of 35% of Mr. Ehrlich's annual base salary then in effect, up
to a maximum of 90% of his annual base salary then in effect if the results we
actually attain for the year in question are 120% or more of the amount we
budgeted at the beginning of the year.
The employment agreement also contains various benefits customary in
Israel for senior executives (please see "Item 1. Business - Employees," above),
tax and financial planning expenses and an automobile, and contain
confidentiality and non-competition covenants. Pursuant to the employment
agreements, we granted Mr. Ehrlich demand and "piggyback" registration rights
covering shares of our common stock held by him.
We can terminate Mr. Ehrlich's employment agreement in the event of
death or disability or for "Cause" (defined as conviction of certain crimes,
willful failure to carry out directives of our board of directors or gross
negligence or willful misconduct). Mr. Ehrlich has the right to terminate his
employment upon a change in our control or for "Good Reason," which is defined
to include adverse changes in employment status or compensation, our insolvency,
material breaches and certain other events. Additionally, Mr. Ehrlich may retire
(after age 68) or terminate his agreement for any reason upon 150 days' notice.
Upon termination of employment, the employment agreement provides for payment of
all accrued and unpaid compensation, and (unless we have terminated the
agreement for Cause or Mr. Ehrlich has terminated the agreement without Good
Reason and without giving us 150 days' notice of termination) bonuses due for
the year in which employment is terminated and severance pay in the amount of
three years' base salary (or, in the case of termination by Mr. Ehrlich on 150
days' notice, a lump sum payment of $520,000). Furthermore, certain benefits
will continue and all outstanding options will be fully vested.
89
Mr. Esses is not a party to an employment agreement with us. See also
"Item 13. Certain Relationships and Related Transactions - Consulting Agreement
with Sampen Corporation," below.
Mr. Shen has signed our standard employee employment agreement,
described below.
Other employees (including Mr. Shen) have entered into individual
employment agreements with us. These agreements govern the basic terms of the
individual's employment, such as salary, vacation, overtime pay, severance
arrangements and pension plans. Subject to Israeli law, which restricts a
company's right to relocate an employee to a work site farther than sixty
kilometers from his or her regular work site, we have retained the right to
transfer certain employees to other locations and/or positions provided that
such transfers do not result in a decrease in salary or benefits. All of these
agreements also contain provisions governing the confidentiality of information
and ownership of intellectual property learned or created during the course of
the employee's tenure with us. Under the terms of these provisions, employees
must keep confidential all information regarding our operations (other than
information which is already publicly available) received or learned by the
employee during the course of employment. This provision remains in force for
five years after the employee has left our service. Further, intellectual
property created during the course of the employment relationship belongs to us.
A number of the individual employment agreements, but not all, contain
non-competition provisions which restrict the employee's rights to compete
against us or work for an enterprise which competes against us. Such provisions
remain in force for a period of two years after the employee has left our
service.
Under the laws of Israel, an employee of ours who has been dismissed
from service, died in service, retired from service upon attaining retirement
age, or left due to poor health, maternity or certain other reasons, is entitled
to severance pay at the rate of one month's salary for each year of service. We
currently fund this obligation by making monthly payments to approved private
provident funds and by its accrual for severance pay in the consolidated
financial statements. See Note 2.s. of the Notes to the Consolidated Financial
Statements.
Compensation Committee Interlocks and Insider Participation
The Compensation Committee of our board of directors for the 2004
fiscal year consisted of Dr. Jay M. Eastman, Jack E. Rosenfeld and Bert W.
Wasserman. None of the members has served as our officers or employees.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Security Ownership of Certain Beneficial Owners and Management
The following table sets forth information regarding the security
ownership, as of March 10, 2005, of those persons owning of record or known by
us to own beneficially more than 5% of our common stock and of each of our Named
Executive Officers and directors, and the shares of common stock held by all of
our directors and executive officers as a group.
90
Percentage of Total
Name and Address of Beneficial Owner(1) Shares Beneficially Owned(2)(3) Shares Outstanding(3)
--------------------------------------- ------------------------------- ---------------------
Robert S. Ehrlich....................................... 3,219,546(4) 3.9%
Steven Esses............................................ 806,808(5) 1.0%
Avihai Shen............................................. 528,904(6) *
Dr. Jay M. Eastman...................................... 95,001(7) *
Jack E. Rosenfeld....................................... 97,001(8) *
Lawrence M. Miller...................................... 543,580(9) *
Bert W. Wasserman....................................... 20,001(10) *
Edward J. Borey......................................... 36,001(11) *
All of our directors and executive officers as a group
(9 persons)............................................. 5,346,842(12) 6.4%
------------------------------------
*Less than one percent.
(1) The address of each named beneficial owner is in care of Arotech
Corporation, 250 West 57th Street, Suite 310, New York, New York 10107.
(2) Unless otherwise indicated in these footnotes, each of the persons or
entities named in the table has sole voting and sole investment power with
respect to all shares shown as beneficially owned by that person, subject
to applicable community property laws.
(3) Based on 80,103,668 shares of common stock outstanding as of March 10,
2005. For purposes of determining beneficial ownership of our common
stock, owners of options exercisable within sixty days are considered to
be the beneficial owners of the shares of common stock for which such
securities are exercisable. The percentage ownership of the outstanding
common stock reported herein is based on the assumption (expressly
required by the applicable rules of the Securities and Exchange
Commission) that only the person whose ownership is being reported has
converted his options into shares of common stock.
(4) Includes 50,000 shares held by Mr. Ehrlich's wife (in which shares Mr.
Ehrlich disclaims beneficial ownership), 161,381 shares held in Mr.
Ehrlich's pension plan, 3,000 shares held by children sharing the same
household (in which shares Mr. Ehrlich disclaims beneficial ownership),
and 2,387,000 shares issuable upon exercise of options exercisable within
60 days.
(5) Includes 641,808 shares issuable upon exercise of options exercisable
within 60 days.
(6) Includes 488,404 shares issuable upon exercise of options exercisable
within 60 days.
(7) Consists of 95,001 shares issuable upon exercise of options exercisable
within 60 days.
(8) Includes 95,001 shares issuable upon exercise of options exercisable
within 60 days.
(9) Includes 441,665 shares held by Leon S. Gross and Lawrence M. Miller as
co-trustees of the Rose Gross Charitable Foundation, and 90,001 shares
issuable upon exercise of options exercisable within 60 days.
(10) Consists of 20,001 shares issuable upon exercise of options exercisable
within 60 days.
(11) Includes 20,001 shares issuable upon exercise of options exercisable
within 60 days.
(12) Includes 3,837,217 shares issuable upon exercise of options exercisable
within 60 days.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth certain information, as of December 31,
2004, with respect to our 1991, 1993, 1995, 1998 and 2004 stock option plans, as
well as any other stock options and warrants previously issued by us (including
individual compensation arrangements) as compensation for goods and services:
91
Equity Compensation Plan Information
Number of securities
remaining available
for future issuance
Number of securities under equity
to be issued upon Weighted-average compensation plans
exercise of exercise price of (excluding securities
outstanding options, outstanding options, reflected in column
warrants and rights warrants and rights (a))
Plan Category (a) (b) (c)
- ---------------------------- ------------------------ ----------------------- -----------------------
Equity compensation 6,715,343 $1.19 5,523,931
plans approved by
security holders.....
Equity compensation
plans not approved
by security
holders(2)(3)........ 2,399,417 $1.54 291
--------- ----- -------------
Total.................. 9,114,760 $1.28 5,524,222
========= ===== =========
-------------------------------------
(1)In October 1998, the Board of Directors adopted the 1998 Non-Executive
Stock Option and Restricted Stock Purchase Plan, which under Delaware law
did not require shareholder approval since directors and executive
officers were ineligible to participate in it. Participation in the 1998
Plan is limited to those of our employees and consultants who are neither
executive officers nor otherwise subject to Section 16 of the Securities
Exchange Act of 1934, as amended, or Section 162(m) of the Internal
Revenue Code of 1986, as amended. The 1998 Plan is administered by the
Compensation Committee of our Board of Directors, which determined the
conditions of grant. Options issued under the 1998 Plan generally expire
no more than ten years from the date of grant, and incentive options
issued under the 1998 Plan may be granted only at exercise prices equal
to the fair market value of our common stock on the date the option is
granted.
(2)For a description of the material features of grants of options and
warrants other than options granted under our employee stock option
plans, please see Note 14.f. and 14.g. of the Notes to the Consolidated
Financial Statements.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Officer Loans
On December 3, 1999, Robert S. Ehrlich purchased 125,000 shares of our
common stock out of our treasury at the closing price of the common stock on
December 2, 1999. Payment was rendered by Mr. Ehrlich in the form of
non-recourse promissory notes due in 2009 in the amount of $167,975, bearing
simple annual interest at a rate of 2%, secured by the shares of common stock
purchased and other shares of common stock previously held by him. As of
December 31, 2003, the aggregate amount outstanding pursuant to this promissory
note was $201,570.
On February 9, 2000, Mr. Ehrlich exercised 131,665 stock options. Mr.
Ehrlich paid the exercise price of the stock options and certain taxes that we
paid on his behalf by giving us a non-recourse promissory note due in 2025 in
the amount of $789,991, bearing annual interest (i) as to $329,163, at 1% over
the then-current federal funds rate announced from time to time by the Wall
Street Journal, and (ii) as to $460,828, at 4% over the then-current percentage
increase in the Israeli consumer price index between the date of the loan and
92
the date of the annual interest calculation, secured by the shares of our common
stock acquired through the exercise of the options and certain compensation due
to Mr. Ehrlich upon termination. As of December 31, 2003, the aggregate amount
outstanding pursuant to this promissory note was $657,146.
On June 10, 2002, Mr. Ehrlich exercised 50,000 stock options. Mr.
Ehrlich paid the exercise price of the stock options by giving us a non-recourse
promissory note due in 2012 in the amount of $36,500, bearing simple annual
interest at a rate equal to the lesser of (i) 5.75%, and (ii) 1% over the
then-current federal funds rate announced from time to time, secured by the
shares of our common stock acquired through the exercise of the options. As of
December 31, 2003, the aggregate amount outstanding pursuant to this promissory
note was $37,810.
Director Consulting Agreements
Beginning in February 2002, Mr. Steven Esses, who became one of our
directors in July 2002, entered into an oral consulting arrangement with us,
whereby he performed periodic financial and other consulting for us. We paid Mr.
Esses a total of $120,480 in consulting fees in 2002. Beginning in July 2002,
when Mr. Esses became a director, this consulting arrangement ceased.
Beginning in January 2004, Mr. Edward J. Borey, who became one of our
directors in December 2003, entered into a consulting agreement with us pursuant
to which he agreed to aid us in identifying potential acquisition candidates in
exchange for transaction fees in respect of acquisitions in which he plays a
"critical role" (as determined by us in our sole and absolute discretion) in
identifying and/or initiating and/or negotiating the transaction in the amount
of (i) 1.5% of the value of the transaction up to $10,000,000, plus (ii) 1.0% of
the value of the transaction in excess of $10,000,000 and up to $50,000,000,
plus (iii) 0.5% of the value of the transaction in excess of $50,000,000. We
also agreed to issue to Mr. Borey, at par value, a total of 32,000 shares of our
common stock, the value of which is to be deducted from any transaction fees
paid. 16,000 of these shares were earned and issued prior to termination of this
agreement in August 2004.
Consulting Agreement with Sampen Corporation
We have a consulting agreement with Sampen Corporation that we executed
in March 2005, effective as of January 1, 2005. Sampen is a New York corporation
owned by members of Steven Esses's immediate family, and Mr. Esses is an
employee of Sampen. The term of this consulting agreement expires on December
31, 2006, and is extended automatically for additional terms of two years each
unless either Sampen or we terminate the agreement sooner.
Pursuant to the terms of our agreement with Sampen, Sampen provides one
of its employees to us for such employee to serve as our Executive Vice
President and Chief Operating Officer. We pay Sampen $12,800 per month, plus an
annual bonus, on a sliding scale, in an amount equal to a minimum of 25% of
Sampen's annual base compensation then in effect, up to a maximum of 75% of its
annual base compensation then in effect if the results we actually attain for
the year in question are 120% or more of the amount we budgeted at the beginning
of the year. We also pay Sampen, to cover the cost of our use of Sampen's
offices as an ancillary New York office life and the attendant expenses and
insurance costs, an amount equal to 16% of each monthly payment of base
compensation.
93
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
In accordance with the requirements of the Sarbanes-Oxley Act of 2002
and the Audit Committee's charter, all audit and audit-related work and all
non-audit work performed by our independent accountants, Kost, Forer, Gabbay &
Kassierer, is approved in advance by the Audit Committee, including the proposed
fees for such work. The Audit Committee is informed of each service actually
rendered.
>> Audit Fees. Audit fees billed or expected to be billed to us
by Kost, Forer, Gabbay & Kassierer for the audit of the
financial statements included in our Annual Report on Form
10-K, and reviews of the financial statements included in our
Quarterly Reports on Form 10-Q, for the years ended December
31, 2003 and 2004 totaled approximately $177,000 and $594,924,
respectively.
>> Audit-Related Fees. Kost, Forer, Gabbay & Kassierer billed us
$34,500 and $214,659 for the fiscal years ended December 31,
2003 and 2004, respectively, for assurance and related
services that are reasonably related to the performance of the
audit or review of our financial statements and are not
reported under the caption "Audit Fees," above.
>> Tax Fees. Kost, Forer, Gabbay & Kassierer billed us an
aggregate of $24,320 and $9,491 for the fiscal years ended
December 31, 2003 and 2004, respectively, for tax services,
principally advice regarding the preparation of income tax
returns.
>> All Other Fees. The Audit Committee of the Board of Directors
has considered whether the provision of the Audit-Related
Fees, Tax Fees and all other fees are compatible with
maintaining the independence of our principal accountant.
Applicable law and regulations provide an exemption that permits
certain services to be provided by our outside auditors even if they are not
pre-approved. We have not relied on this exemption at any time since the
Sarbanes-Oxley Act was enacted.
94
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report:
(1) Financial Statements - See Index to Financial Statements on page
73 above.
(2) Financial Statements Schedules - Schedule II - Valuation and
Qualifying Accounts. All schedules other than those listed above are
omitted because of the absence of conditions under which they are
required or because the required information is presented in the
financial statements or related notes thereto.
(3) Exhibits - The following Exhibits are either filed herewith or have
previously been filed with the Securities and Exchange Commission
and are referred to and incorporated herein by reference to such
filings:
Exhibit No. Description
(8)3.1.........Amended and Restated Certificate of Incorporation
(15)3.1.1.......Amendment to our Amended and Restated Certificate of Incorporation
(24)3.1.2.......Amendment to our Amended and Restated Certificate of Incorporation
**3.1.3.......Amendment to our Amended and Restated Certificate of Incorporation
(2)3.2.........Amended and Restated By-Laws
**4.1.........Specimen Certificate for shares of common stock, $.01 par value
+ (6)10.6........Amended and Restated 1993 Stock Option and
Restricted Stock Purchase Plan dated November 11, 1996
+ (1)10.7.1......Form of Management Employment Agreements
+ * 10.7.2......General Employee Agreements
(1)
* (1)10.8........Office of Chief Scientist documents
(2)10.8.1......Letter from the Office of Chief Scientist to us dated January 4, 1995
+ (3)10.12.......Amended and Restated 1995 Non-Employee Director Stock Option Plan
(4)10.14.......Stock Purchase Agreement between us and Leon S. Gross ("Gross") dated September 30, 1996
(4)10.15.......Registration Rights Agreement between us and Gross dated September 30, 1996
+ (5)10.20.......Amended and Restated Employment Agreement dated as of October 1, 1996 between us, EFL and
Robert S. Ehrlich
+ (15)10.20.1.....Second Amended and Restated Employment Agreement, effective as of January 1, 2000 between us,
EFL and Robert S. Ehrlich
(6)10.26.......Amendment No. 2 to the Registration Rights Agreement between us, Gross, Robert S. Ehrlich and
Yehuda Harats dated December 10, 1997
(7)10.27.......1998 Non-Executive Stock Option and Restricted Stock Purchase Plan
(9)10.31.......Form of Warrant dated December 28, 1999
(10)10.35.1.....Promissory Note dated January 3, 1993, from Robert S. Ehrlich to us
(10)10.35.2.....Amendment dated April 1, 1998, to Promissory Note dated January 3, 1993 between Robert S.
Ehrlich and us
(10)10.37.......Promissory Note dated December 3, 1999, from Robert S. Ehrlich to us
95
Exhibit No. Description
(10)10.39.......Promissory Note dated February 9, 2000, from Robert S. Ehrlich to us
(11)10.48.......Series A Stock Purchase Warrant issued to Capital Ventures International dated November 17, 2000
(11)10.49.......Series B Stock Purchase Warrant issued to Capital Ventures International dated November 17, 2000
(11)10.50.......Stock Purchase Warrant issued to Josephthal & Co., Inc. dated November 17, 2000
(12)10.52.......Promissory Note dated January 12, 2001, from Robert S. Ehrlich to us
(12)10.54.......Agreement of Lease dated December 5, 2000 between us as tenant and Renaissance 632 Broadway LLC
as landlord
(13)10.55.......Series C Stock Purchase Warrant issued to Capital Ventures International dated May 3, 2001
(14)10.56.......Form of Common Stock Purchase Warrant dated May 8, 2001
(15)10.63.......Securities Purchase Agreement dated December 31, 2002 between us and the Investors
(15)10.64.......Form of 9% Secured Convertible Debenture due June 30, 2005
(15)10.65.......Form of Warrant dated December 31, 2002
(15)10.66.......Form of Security Agreement dated December 31, 2002
(15)10.67.......Form of Intellectual Property Security Agreement dated December 31, 2002
+(16)10.68.......Settlement Agreement and Release between us and Yehuda Harats dated December 31, 2002
(16)10.69.1.....Commercial lease agreement between Commerce Square Associates L.L.C. and I.E.S. Electronics
Industries U.S.A., Inc. dated September 24, 1997
(16)10.69.2.....Amendment to Commercial lease agreement between Commerce Square Associates L.L.C. and I.E.S.
Electronics Industries U.S.A., Inc. dated as of May 1, 2000
(16)10.70.......Agreement of Lease dated December 6, 2000 between Janet Nissim et al. and M.D.T. Protection
(2000) Ltd. [English summary of Hebrew original]
(16)10.71.......Agreement of Lease dated August 22, 2001 between Aviod Building and Earthworks Company Ltd. et
al. and M.D.T. Protective Industries Ltd. [English summary of Hebrew original]
(22)10.72.......Promissory Note dated July 1, 2002 from Robert S. Ehrlich to us
(17)10.73.......Securities Purchase Agreement dated September 30, 2003 between us and the Investors named
therein
(17)10.74.......Form of 8% Secured Convertible Debenture due September 30, 2006
(17)10.75.......Form of Warrant dated September 30, 2003
(17)10.76.......Form of Security Agreement dated September 30, 2003
(17)10.77.......Form of Intellectual Property Security Agreement dated September 30, 2003
(18)1010.78.. Form of Amendment and Exercise Agreement dated December 10, 2003
(18)10.79.......Form of Supplemental Warrant dated December 18, 2003
(19)10.80.......Stock Purchase and Sale Agreement dated January 7, 2004 between us and the shareholders of FAAC
Incorporated
96
Exhibit No. Description
(19)10.81.......Securities Purchase Agreement dated January 7, 2004 between us and the Investors named therein
(19)10.82.......Registration Rights Agreement dated January 7, 2004 between us and the Investors named therein
(19)10.83.......Form of Warrant dated January __, 2004
(20)10.84.......Share Purchase Agreement dated January __, 2004 between us and the shareholders of Epsilor
Electronics Industries, Ltd.
(20)10.85.......Management Agreement dated January __, 2004 among us, Office Line Ltd. and Hezy Aspis
*(21)10.86.......Settlement Agreement between us and I.E.S. Electronics Industries, Ltd. dated February 4, 2004
+(22)10.86.......Consulting agreement dated January 1, 2004 between us and Edward J. Borey
(22)10.87.......Lease dated April 8, 1997, between AMR Holdings, L.L.C. and FAAC Incorporated
(22)10.88.......Lease dated as of March 22, 2004 between us and Fisk Building Associates L.L.C.
(23)10.89.......Stock Purchase Agreement dated as of July 15, 2004 between us and Armour of America,
Incorporated and its sole shareholder
(24)10.90.......Securities Purchase Agreement dated as of July 15, 2004, by and among us and various investors
+**10.91.......Consulting Agreement, effective as of January 1, 2005, between us and Sampen Corporation
(22)14.1........Code of Ethics
**21.1........List of Subsidiaries of the Registrant
**23.1........Consent of Kost, Forer, Gabbay & Kassierer, a member of Ernst & Young Global
**23.2........Consent of Stark Winter Schenkein & Co., LLP
**31.1........Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
**31.2........Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
**32.1........Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
**32.2........Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
- -------------------------------------
*English translation or summary from original Hebrew
**Filed herewith
+Includes management contracts and compensation plans and arrangements
(1)Incorporated by reference to our Registration Statement on Form S-1
(Registration No. 33-73256), which became effective on February 23, 1994
(2)Incorporated by reference to our Registration Statement on Form S-1
(Registration No. 33-97944), which became effective on February 5, 1996
(3)Incorporated by reference to our Annual Report on Form 10-K for the year
ended December 31, 1995
(4)Incorporated by reference to our Current Report on Form 8-K dated October 4,
1996
97
(5)Incorporated by reference to our Annual Report on Form 10-K for the year
ended December 31, 1996, as amended
(6)Incorporated by reference to our Annual Report on Form 10-K for the year
ended December 31, 1997, as amended
(7)Incorporated by reference to our Registration Statement on Form S-8
(Registration No. 333- 74197), which became effective on March 10, 1998
(8)Incorporated by reference to our Annual Report on Form 10-K for the year
ended December 31, 1998
(9)Incorporated by reference to our Current Report on Form 8-K filed January 7,
2000
(10)Incorporated by reference to our Annual Report on Form 10-K for the year
ended December 31, 1999
(11)Incorporated by reference to our Current Report on Form 8-K filed November
17, 2000
(12)Incorporated by reference to our Annual Report on Form 10-K for the year
ended December 31, 2000
(13)Incorporated by reference to our Current Report on Form 8-K filed May 7,
2001 (EDGAR Film No. 1623996)
(14)Incorporated by reference to our Current Report on Form 8-K filed May 7,
2001 (EDGAR Film No. 1623989)
(15)Incorporated by reference to our Current Report on Form 8-K filed January 6,
2003
(16)Incorporated by reference to our Annual Report on Form 10-K for the year
ended December 31, 2002
(17)Incorporated by reference to our Current Report on Form 8-K filed October 3,
2003
(18)Incorporated by reference to our Current Report on Form 8-K filed December
23, 2003
(19)Incorporated by reference to our Current Report on Form 8-K filed January 9,
2004
(20)Incorporated by reference to our Current Report on Form 8-K filed February
4, 2004
(21)Incorporated by reference to our Current Report on Form 8-K filed February
5, 2004
(22)Incorporated by reference to our Annual Report on Form 10-K for the year
ended December 31, 2003
(23)Incorporated by reference to our Quarterly Report on Form 10-Q for the
quarter ended June 30, 2004 (24)Incorporated by reference to our Current
Report on Form 8-K filed July 15, 2004
98
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on March 31 , 2005.
AROTECH CORPORATION
By: /s/ Robert S. Ehrlich
----------------------------------------
Name: Robert S. Ehrlich
Title: Chairman, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
Chairman, President, Chief Executive Officer and
/s/ Robert S. Ehrlich Director
- ------------------------
Robert S. Ehrlich (Principal Executive Officer) March 31 , 2005
------
/s/ Avihai Shen Vice President - Finance March 31 , 2005
- ----------------------- ------
Avihai Shen (Principal Financial Officer)
/s/ Danny Waldner Controller March 31 , 2005
- ----------------------- ------
Danny Waldner (Principal Accounting Officer)
/s/ Steven Esses Executive Vice President, Chief Operating Officer March 31 , 2005
- ----------------------- ------
Steven Esses and Director
/s/ Jay M. Eastman Director March 31 , 2005
- ----------------------- ------
Dr. Jay M. Eastman
/s/ Lawrence M. Miller Director March 31 , 2005
- ------------------------- ------
Lawrence M. Miller
/s/ Jack E. Rosenfeld Director March 31 , 2005
- ------------------------ ------
Jack E. Rosenfeld
/s/ Bert W. Wasserman Director March 31 , 2005
- ------------------------ ------
Bert W. Wasserman
/s/ Edward J. Borey Director March 31 , 2005
- ----------------------- ------
Edward J. Borey
99
AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2004
IN U.S. DOLLARS
INDEX
Page
---------------
Reports of Independent Registered Public Accounting Firms 2 - 3
Consolidated Balance Sheets 4 - 5
Consolidated Statements of Operations 6
Statements of Changes in Stockholders' Equity 7 - 9
Consolidated Statements of Cash Flows 10 - 13
Notes to Consolidated Financial Statements 14 - 60
[logo] ERNST & YOUNG
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders of
AROTECH CORPORATION
We have audited the accompanying consolidated balance sheets of Arotech
Corporation (the "Company") and its subsidiaries as of December 31, 2004 and
2003, and the related consolidated statements of operations, changes in
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 2004. Our audits also included the financial statement
schedule listed in Item 15(a)(2) of the Company's 10-K. These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits. We did not audit the financial statements of
"Armor of America," a wholly-owned subsidiary of the Company, financial
statements of which reflect total assets of 4% of the consolidated assets of the
Company as of December 31, 2004, and total revenues of 5% of the consolidated
revenues of the Company for the year then ended. Those statements were audited
by other auditors whose report has been furnished to us, and our opinion,
insofar as it relates to the data included for this subsidiary, is based solely
on the report of the other auditors.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion based on our audits and the other auditors the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of the Company and its
subsidiaries as of December 31, 2004 and 2003, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2004, in conformity with U.S. generally accepted accounting
principles. Additionally, in our opinion the related financial statement
schedule, when considered in relation to the basic financial statements and
schedule taken as a whole, present fairly in all material respects the
information set forth therein.
As discussed in Note 1.b., the Consolidated Financial Statements at
December 31, 2003 and for the year then ended have been restated for the matters
set forth therein.
Tel Aviv, Israel KOST, FORER, GABBAY & KASIERER
March 24, 2005 A Member of Ernst & Young Global
F-2
[logo]
STARK WINTER SCHENKEIN
Report of Independent Registered Public Accounting Firm
To the Shareholder
Armour of America, Inc.
Gardena, California
We have audited the accompanying balance sheets of Armour of America, Inc. as of
December 31, 2004, and the related statements of income, stockholder's equity
and cash flows for the period August 11, 2004 to December 31, 2004. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Armour of America, Inc. as of
December 31, 2004, and the results of its operations, stockholder's equity and
cash flows for the period August 11, 2004 to December 31, 2004, in conformity
with accounting principles generally accepted in the United States of America.
/s/ Stark Winter Schenkein & Co., LLP
Denver, Colorado
January 31, 2005
STARK WINTER SCHENKEIN & CO., LLP Certified Public Accountants
Financial Consultants
- --------------------------------------------------------------------------------
7535 EAST HAMPDEN AVENUE SUITE 109 DENVER, COLORADO 80231
PHONE: 303.694.6700 FAX: 303.694.6761 TOLL FREE: 888.766.3985
WWW.SWSCPAS.COM
F-3
AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
In U.S. dollars
December 31,
-----------------------------------------
2004 2003*
------------------ ------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 6,734,512 $ 13,685,125
Restricted collateral deposits and restricted held-to-maturity
securities 6,962,110 706,180
Available for sale marketable securities 135,568 -
Trade receivables (net of allowance for doubtful accounts in the
amounts of $55,394 and $61,282 as of December 31, 2004 and 2003,
respectively) 8,266,880 4,706,423
Unbilled receivables 2,881,468 -
Other accounts receivable and prepaid expenses 1,339,393 1,187,371
Inventories 7,277,301 1,914,748
Assets of discontinued operations - 66,068
------------------ ------------------
Total current assets 33,597,232 22,265,915
------------------ ------------------
SEVERANCE PAY FUND 1,980,047 1,023,342
RESTRICTED DEPOSITS 4,000,000 -
PROPERTY AND EQUIPMENT, NET 4,600,691 2,292,741
OTHER INTANGIBLE ASSETS, NET 14,368,701 2,375,195
GOODWILL 39,745,516 5,064,555
------------------ ------------------
$ 98,292,187 $ 33,021,748
================== ==================
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
In U.S. dollars
December 31,
------------------------------------------
2004 2003*
------------------- ------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade payables $ 6,177,546 $ 1,967,448
Other accounts payable and accrued expenses 5,818,188 4,030,411 **
Current portion of promissory notes due to purchase of subsidiaries 13,585,325 150,000
Short term bank credit and current portion of long term loans 181,352 40,849
Deferred revenues 618,229 140,936 **
Liabilities of discontinued operations - 380,108
------------------- ------------------
Total current liabilities 26,380,640 6,709,752
------------------- ------------------
LONG TERM LIABILITIES
Accrued severance pay 3,422,951 2,814,492
Convertible debenture 1,754,803 1,450,194
Deferred revenues 163,781 220,143
Long term loan 20,891 -
Long-term portion of promissory note due to purchase of subsidiaries 980,296 150,000
------------------- ------------------
Total long-term liabilities 6,342,722 4,634,829
------------------- ------------------
COMMITMENTS AND CONTINGENT LIABILITIES (Note 12)
MINORITY INTEREST 95,842 51,290
------------------- ------------------
STOCKHOLDERS' EQUITY:
Share capital -
Common stock - $0.01 par value each;
Authorized: 250,000,000 shares and 100,000,000 shares as of December
31, 2004 and 2003, respectively; Issued: 80,576,902 shares and
47,972,407 shares as of December 31, 2004 and 2003, respectively;
Outstanding - 80,021,569 shares and 47,417,074 shares as of
December 31, 2004 and 2003, respectively 805,769 479,726
Preferred shares - $0.01 par value each;
Authorized: 1,000,000 shares as of December 31, 2004 and 2003; No
shares issued and outstanding as of December 31, 2004 and 2003 - -
Additional paid-in capital 189,266,704 135,702,413
Accumulated deficit (118,953,553) (109,911,240)
Deferred stock compensation (1,258,295) (8,464)
Treasury stock, at cost (common stock - 555,333 shares as of December 31,
2004 and 2003) (3,537,106) (3,537,106)
Notes receivable from stockholders (1,222,871) (1,203,881)
Accumulated other comprehensive income 372,335 104,429
------------------- ------------------
Total stockholders' equity 65,472,983 21,625,877
------------------- ------------------
$ 98,292,187 $ 33,021,748
=================== ==================
- ----------------------------
* Restated (see Note 1.b.).
** Reclassified.
F-5
AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
In U.S. dollars
Year ended December 31,
-------------------------------------------------------------
2004 2003* 2002
------------------ ------------------- -------------------
Revenues $ 49,953,846 $ 17,326,641 $ 6,406,739
Cost of revenues 34,011,094 11,087,840 4,421,748
------------------ ------------------- -------------------
Gross profit 15,942,752 6,238,801 1,984,991
------------------ ------------------- -------------------
Operating expenses:
Research and development, net 1,731,379 1,053,408 685,919
Selling and marketing expenses 4,922,217 3,532,636 1,309,669
General and administrative expenses 10,656,866 5,857,876 4,023,103
Amortization of intangible assets and impairment losses 2,814,835 864,910 623,543
In-process research and development write-off - - 26,000
------------------ ------------------- -------------------
Total operating costs and expenses 20,125,297 11,308,830 6,668,234
------------------ ------------------- -------------------
Operating loss (4,182,545) (5,070,029) (4,683,243)
Financial income (expenses), net (4,228,965) (4,038,709) 100,451
------------------ ------------------- -------------------
Loss before minorities interests in loss (earnings) of a
subsidiaries and tax expenses (8,411,510) (9,108,738) (4,582,792)
Income taxes (586,109) (396,193) -
Minorities interests in loss (earnings) of a subsidiaries (44,694) 156,900 (355,360)
------------------ ------------------- -------------------
Loss from continuing operations (9,042,313) (9,348,031) (4,938,152)
Income (loss) from discontinued operations (including
loss on disposal of $4,446,684 during 2002) - 110,410 (13,566,206)
------------------ ------------------- -------------------
Net loss $ (9,042,313) $ (9,237,621) $ (18,504,358)
Deemed dividend to certain stockholders $ (3,328,952) $ (350,000) $ -
------------------ ------------------- -------------------
Net loss attributable to common stockholders $ (12,371,265) $ (9,587,621) $ (18,504,358)
================== =================== ===================
Basic and diluted net loss per share from continuing
operations $ (0.13) $ (0.24) $ (0.15)
================== =================== ===================
Basic and diluted net loss per share from discontinued $ 0.00 $ 0.00 $ (0.42)
operations
================== =================== ===================
Basic and diluted net loss per share $ (0.18) $ (0.25) $ (0.57)
================== =================== ===================
Weighted average number of shares used in computing basic
and diluted net loss per share 69,933,057 38,890,174 32,381,502
================== =================== ===================
- ----------------------------------
* Restated (see Note 1.b.).
F-6
AROTECH CORPORATION AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
In U.S. dollars
Common stock Additional Deferred
--------------------------- paid-in Accumulated stock Treasury
Shares Amount capital deficit compensation stock
------------- ------------- ------------- -------------- -------------- -------------
Balance as of January 1, 2002 29,059,469 $290,596 $105,686,909 $(82,169,261) $(18,000) $(3,537,106)
Adjustment of notes from
stockholders
Repayment of notes from
employees
Issuance of shares to investors 2,041,176 20,412 3,209,588
Issuance of shares to service
providers 368,468 3,685 539,068
Issuance of shares to lender
in respect of prepaid
interest expenses 387,301 3,873 232,377
Exercise of options by
employees 191,542 1,915 184,435
Amortization of deferred stock
compensation 6,000
Stock compensation related to
options issued to employees 13,000 130 12,870
Issuance of shares in respect
of acquisition 3,640,638 36,406 4,056,600
Accrued interest on notes
receivable 160,737
Other comprehensive loss
Foreign currency translation
adjustment
Net loss (18,504,358)
------------- ------------- ------------- -------------- -------------- -------------
Total comprehensive loss
Balance as of December 31, 2002 35,701,594 $ 357,017 $114,082,584 $(100,673,619) $ (12,000) $(3,537,106)
============= ============= ============= ============== ============== =============
Notes Accumulated
Total receivable other Total
comprehensive from comprehensive stockholders'
loss stockholders loss equity
---------- ------------- -------------- --------------
Balance as of January 1, 2002 $(845,081) $ - $19,408,057
Adjustment of notes from
stockholders (178,579) (178,579)
Repayment of notes from
employees 43,308 43,308
Issuance of shares to investors 3,230,000
Issuance of shares to service
providers 542,753
Issuance of shares to lender
in respect of prepaid
interest expenses 236,250
Exercise of options by
employees (36,500) 149,850
Amortization of deferred stock
compensation 6,000
Stock compensation related to
options issued to employees 13,000
Issuance of shares in respect
of acquisition 4,093,006
Accrued interest on notes
receivable (160,737) -
Other comprehensive loss
Foreign currency translation
adjustment $ (1,786) (1,786) (1,786)
Net loss (18,504,358) (18,504,358)
--------------- ------------- -------------- --------------
Total comprehensive loss $ (18,506,144)
===============
Balance as of December 31, 2002 $(1,177,589) $ (1,786) $ 9,037,501
============= ============== ==============
F-7
AROTECH CORPORATION AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
In U.S. dollars
Common stock Additional Deferred
--------------------------- paid-in Accumulated stock Treasury
Shares Amount capital deficit compensation stock
------------- ------------- ------------- -------------- -------------- -------------
Balance as of January 1, 2003* 35,701,594 $ 357,017 $114,082,584 $(100,673,619) $ (12,000) $(3,537,106)
Compensation related to
warrants issued to the
holders of convertible
debentures 5,157,500
Compensation related to
beneficial conversion
feature of convertible
debentures 5,695,543
Issuance of shares on
conversion of convertible
debentures 6,969,605 69,696 6,064,981
Issuance of shares on exercise
of warrants 3,682,997 36,831 3,259,422
Issuance of shares to
consultants 223,600 2,236 159,711
Compensation related to grant
and reprcing of warrants and
options issued to
consultants 229,259
Compensation related to
non-recourse loan granted to
shareholder 38,500
Deferred stock compensation 4,750 (4,750)
Amortization of deferred stock
compensation 8,286
Exercise of options by
employees 689,640 6,896 426,668
Exercise of options by
consultants 15,000 150 7,200
Conversion of convertible
promissory note 563,971 5,640 438,720
Increase in investment in
subsidiary against common
stock issuance 126,000 1,260 120,960
Accrued interest on notes
receivable from stockholders 16,615
Other comprehensive income -
foreign currency translation
adjustment
Net loss (9,237,621)
------------- ------------- ------------- -------------- -------------- -------------
Balance as of December 31, 2003 47,972,407 $ 479,726 $135,702,413 $(109,911,240) $ (8,464) $(3,537,106)
============= ============= ============= ============== ============== =============
Notes Accumulated
Total receivable other Total
comprehensive from comprehensive stockholders'
loss stockholders loss equity
--------------- ------------- -------------- --------------
Balance as of January 1, 2003* $(1,177,589) $ (1,786) $ 9,037,501
Compensation related to
warrants issued to the
holders of convertible
debentures 5,157,500
Compensation related to
beneficial conversion
feature of convertible
debentures 5,695,543
Issuance of shares on
conversion of convertible
debentures (9,677) 6,125,000
Issuance of shares on exercise
of warrants 3,296,253
Issuance of shares to
consultants 161,947
Compensation related to grant
and reprcing of warrants and
options issued to
consultants 229,259
Compensation related to
non-recourse loan granted to
shareholder 38,500
Deferred stock compensation -
Amortization of deferred stock
compensation 8,286
Exercise of options by
employees 433,564
Exercise of options by
consultants 7,350
Conversion of convertible
promissory note 444,360
Increase in investment in
subsidiary against common
stock issuance 122,220
Accrued interest on notes
receivable from stockholders (16,615) -
Other comprehensive income -
foreign currency translation
adjustment 106,215 $ 106,215 106,215
Net loss (9,237,621) (9,237,621)
------------ -------------- ---------------- --------------
$ (9,131,406)
================
Balance as of December 31, 2003 $(1,203,881) $ 104,429 $ 21,625,877
============ ============== ==============
- -----------------------
* Restated (see Note 1.b.).
F-8
AROTECH CORPORATION AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
In U.S. dollars
Common stock Additional Deferred
--------------------------- paid-in Accumulated stock Treasury
Shares Amount capital deficit compensation stock
------------- ------------- ------------- -------------- -------------- -------------
Balance as of January 1, 2004 47,972,407 $ 479,726 $135,702,413 $(109,911,240) $ (8,464) $(3,537,106)
Issuance of shares, net 14,138,491 141,384 24,252,939
Issuance of shares and
warrants due to settlement
of litigation 450,000 4,500 1,244,328
Issuance of shares to employees 40,000 400 92,800
Conversion of convertible
debentures 3,843,728 38,437 3,754,279
Exercise of warrants by
investors and others 11,363,342 113,633 19,119,638
Issuance of shares to
consultants 90,215 902 198,489
Reclassification to liability
in connection with warrants
granted (10,841,020)
Reclassification of liability
to equity related to the
fair value of warrants 10,514,181
Compensation related to
non-recourse loan granted to
shareholder (10,000)
Deferred stock compensation
related to options and
restricted stock 740,000 7,400 2,074,057 (2,081,457)
Amortization of deferred stock
compensation 831,626
Exercise of options by
employees 897,248 8,972 1,101,172
Exercise of options by
consultants 37,615 376 50,799
Issuance of shares in respect
of FAAC acquisition 1,003,856 10,039 1,993,639
Accrued interest on notes
receivable from stockholders 18,990
Other comprehensive income -
foreign currency translation
adjustment
Other comprehensive income -
realized gain on available
for sale marketable
securities
Net loss (9,042,313)
------------- ------------- ------------- -------------- -------------- -------------
Balance as of December 31, 2004 80,576,902 $805,769 $189,266,704 $(118,953,553) $(1,258,295) $(3,537,106)
============= ============= ============= ============== ============== =============
Notes Accumulated
Total receivable other Total
comprehensive from comprehensive stockholders'
loss stockholders loss equity
--------------- ------------- -------------- --------------
Balance as of January 1, 2004 $(1,203,881) $ 104,429 $ 21,625,877
Issuance of shares, net 24,394,323
Issuance of shares and
warrants due to settlement
of litigation 1,248,828
Issuance of shares to employees 93,200
Conversion of convertible
debentures 3,792,716
Exercise of warrants by
investors and others 19,233,271
Issuance of shares to
consultants 199,391
Reclassification to liability
in connection with warrants
granted (10,841,020)
Reclassification of liability
to equity related to the
fair value of warrants 10,514,181
Compensation related to
non-recourse loan granted to
shareholder (10,000)
Deferred stock compensation
related to options and
restricted stock -
Amortization of deferred stock
compensation 831,626
Exercise of options by
employees 1,110,144
Exercise of options by
consultants 51,175
Issuance of shares in respect
of FAAC acquisition 2,003,678
Accrued interest on notes
receivable from stockholders (18,990) -
Other comprehensive income -
foreign currency translation
adjustment 263,404 $ 263,404 263,404
Other comprehensive income -
realized gain on available
for sale marketable
securities 4,502 4,502 4,502
Net loss (9,042,313) (9,042,313)
------------ -------------- ---------------- --------------
$(8,774,407)
================
Balance as of December 31, 2004 $(1,222,871) $372,335 $65,472,983
============ ============== ==============
F-9
AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
In U.S. dollars
Year ended December 31,
-----------------------------------------------------------
2004 2003* 2002
------------------ ------------------ -----------------
Cash flows from operating activities:
Net loss $ (9,042,313) $ (9,237,621) $ (18,504,358)
Less loss (profit) for the period from discontinued
operations - (110,410) 13,566,206
Adjustments required to reconcile net loss to net cash used
in operating activities:
Minorities interests in earnings (loss) of subsidiary 44,694 (156,900) 355,360
Depreciation 1,199,465 730,159 473,739
Amortization of intangible assets, capitalized software
costs and impairment of intangible assets 2,888,226 879,311 623,543
Remeasurement of liability in connection to warrants
granted (326,839) - -
In-process research and development write-off - - 26,000
Accrued severance pay, net (441,610) 3,693 (357,808)
Amortization of deferred stock compensation and
compensation related to shares issued to employees 884,826 8,286 19,000
(Mark up) write-off of loans to stockholders (32,397) (12,519) 542,317
Write-off of inventories 121,322 96,350 116,008
Impairment of property and equipment - 68,945 -
Amortization of compensation related to warrants issued
to the holders of convertible debentures and beneficial
conversion feature 4,142,109 3,928,237 -
Amortization of deferred charges related to convertible
debentures issuance 222,732 483,713 -
Amortization of prepaid financial expenses - 236,250 -
Stock-based compensation related to grant of new warrants
and repricing of warrants granted to consultants - 229,259 -
Stock-based compensation related to shares issued and to
be issued to consultants and shares granted as a
donation 89,078 161,947 -
Stock-based compensation related to non-recourse note
granted to stockholder (10,000) 38,500 -
Interest accrued on promissory notes due to acquisition 39,311 (66,793) 29,829
Interest accrued on restricted collateral deposits (267,179) - (3,213)
Capital gain from sale of marketable securities (4,247) - -
Amortization of premium related to restricted held to
maturity securities 202,467 - -
Capital gain from sale of property and equipment (16,479) (11,504) (4,444)
Decrease (increase) in trade receivables 732,828 (820,137) 389,516
(Increase) decrease in other accounts receivable and
prepaid expenses (49,513) 40,520 257,218
Decrease in deferred tax assets (89,823) - -
Increase in inventories (2,040,854) (193,222) (520,408)
Increase in unbilled revenues (1,581,080) - -
Decrease in deferred revenues (91,271) - -
Decrease in trade payables 2,913,623 (986,022) (62,536)
Increase (decrease) in other accounts payable and accrued
expenses (125,231) 1,677,668 (423,664)
------------------ ------------------ -----------------
Net cash used in operating activities from continuing (638,155) (3,012,290) (3,477,695)
operations (reconciled from continuing operations)
Net cash used in operating activities from discontinued
operations (reconciled from discontinued operations) (214,041) (313,454) (5,456,912)
------------------ ------------------ -----------------
Net cash used in operating activities $ (852,196) $ (3,325,744) $ (8,934,607)
------------------ ------------------ -----------------
- ---------------------------------
* Restated. (see Note 1.b.)
F-10
AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
In U.S. dollars
Year ended December 31,
---------------------------------------------------------
2004 2003* 2002
----------------- ----------------- -----------------
Cash flows from investing activities:
Purchase of property and equipment (1,659,688) (580,949) (314,876)
Increase in capitalized software costs (365,350) (209,616) -
Loans granted to stockholders (1,036) (13,737) (4,529)
Repayment of loans granted to stockholders 32,397 9,280 -
Proceeds from sale of property and equipment 114,275 16,753 8,199
Proceeds from sale of marketable securities 90,016 - -
Investment in marketable securities (89,204) - -
Acquisition of IES (1) - - (2,958,083)
Acquisition of MDT (2) - - (1,201,843)
Acquisition of Epsilor (3) (7,190,777) - -
Acquisition of FAAC (4) (12,129,103) - -
Acquisition of AoA (5) (17,339,522) - -
Repayment of promissory notes related to acquisition of
subsidiaries (2,000,000) (750,000) -
Purchase of certain tangible and intangible assets (150,000) (196,331) -
Increase in restricted cash and held to maturity securities (9,809,091) (72,840) (595,341)
Net cash used in discontinued operations (purchase of
property and equipment) - - (290,650)
-------------- -------------- --------------
Net cash used in investing activities (50,497,083) (1,797,440) (5,357,123)
-------------- -------------- --------------
Cash flows from financing activities:
Proceeds from issuance of shares, net 24,361,750 (6,900) 3,230,000
Proceeds from exercise of options to employees and
consultants 1,148,819 440,914 113,350
Proceeds from exercise of warrants 19,233,271 3,296,254 -
Proceeds from issuance of convertible debentures, net - 13,708,662 -
Payment of interest and principal on notes receivable from
stockholders - - 43,308
Profit distribution to minority - - (412,231)
Long term loan received 69,638 - -
Repayment of long term loan (65,674) - -
Increase (decrease) in short term bank credit (376,783) (74,158) 108,659
Payment on capital lease obligation (4,145) (4,427) (5,584)
-------------- -------------- --------------
Net cash provided by financing activities 44,366,876 17,360,345 3,077,502
-------------- -------------- --------------
Increase (decrease) in cash and cash equivalents (6,982,403) 12,237,161 (11,214,228)
Cash erosion due to exchange rate differences 31,790 (9,562) -
Cash and cash equivalents at the beginning of the year 13,685,125 1,457,526 12,671,754
-------------- -------------- --------------
Cash and cash equivalents at the end of the year $ 6,734,512 $ 13,685,125 $ 1,457,526
============== ============== ==============
Supplementary information on non-cash transactions:
Issuance of shares and warrants against accrued expenses and
restricted deposit $ 1,310,394 $ - $ -
============== ============== ==============
Issuance of shares to consultants in respect of prepaid
interest expenses $ - $ - $ 236,250
============== ============== ==============
Exercise of options against notes receivable $ - $ - $ 36,500
============== ============== ==============
Purchase of intangible assets against note receivable $ - $ 300,000 $ -
============== ============== ==============
Increase of investment in subsidiary against issuance of
shares of common stock $ - $ 123,480 $ -
============== ============== ==============
Conversion of promissory note to shares of common stock $ - $ 450,000 $ -
============== ============== ==============
Conversion of convertible debenture to shares of common stock $ 3,837,500 $ 6,125,000 $ -
============== ============== ==============
Benefit due to convertible debentures and warrants $ - $ 10,853,043 $ -
============== ============== ==============
Accrual for earn out in regard to subsidiary acquisition $ 13,435,325 $ - $ -
============== ============== ==============
Interest $ 532,750 $ 39,412 $ 10,640
============== ============== ==============
Taxes on income $ 969,009 $ 527,053 $ 114,901
============== ============== ==============
- ---------------------------------
* Restated (see Note 1.b.).
F-11
AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
In U.S. dollars
(1) In July 2002, the Company acquired substantially all of the assets of
I.E.S. Electronics Industries U.S.A., Inc. ("IES"). 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 $ 1,233,000
cash equivalents
Property and equipment, net 396,776
Capital lease obligation (15,526)
Technology 1,515,000
Existing contracts 46,000
Covenants not to compete 99,000
In process research and development 26,000
Customer list 527,000
Trademarks 439,000
Goodwill 4,032,726
-----------
-----------
8,298,976
Issuance of shares (3,653,929)
Issuance of promissory note (1,686,964)
-----------
-----------
$ 2,958,083
===========
(2) In July 2002, the Company acquired 51% of the outstanding ordinary shares
of MDT Protective Industries Ltd. ("MDT"). The fair value of the assets
acquired and liabilities assumed, at the date of acquisition, was as
follows:
Working capital, excluding cash and $ 350,085
cash and cash equivalents
Property, and equipment, net 139,623
Minority rights (300,043)
Technology 280,000
Customer base 285,000
Goodwill 886,255
-----------
-----------
1,640,920
Issuance of shares (439,077)
-----------
$ 1,201,843
===========
(3) 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 $ (849,992)
Property and equipment 709,847
Intangible assets and goodwill 10,284,407
------------
------------
10,144,262
Issuance of shares in respect to transaction costs (12,500)
Issuance of promissory note *) (2,940,985)
------------
------------
$ 7,190,777
============
*) During the year 2004 amount of $2,000,000 was repaid to the former
shareholders of Epsilor.
F-12
AROTECH CORPORATION AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Cont.)
- --------------------------------------------------------------------------------
In U.S. dollars
(4) In January 2004, the Company acquired all of the outstanding common stock
of FAAC Incorporated ("FAAC"). 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 $ 1,796,791
Property and equipment 263,669
Intangible assets and goodwill 25,507,646
------------
27,568,106
Accrual of earn out payment (13,435,325)
Issuance of shares, net (2,003,678)
------------
$ 12,129,103
============
(5) 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 and the liabilities assumed at the date of acquisition was as
follows:
Working capital, excluding cash and cash equivalents.. $ 3,219,728
Property and equipment 997,148
Intangible assets and goodwill 13,122,646
-----------
$17,339,522
===========
F-13
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
NOTE 1:- GENERAL
a. Arotech Corporation, f/k/a Electric Fuel Corporation ("Arotech" or the
"Company") and its subsidiaries are engaged in the development, manufacture and
marketing of defense and security products, including advanced hi-tech
multimedia and interactive digital solutions for training of military, law
enforcement and security personnel and sophisticated lightweight materials and
advanced engineering processes to armor vehicles, and in the design, development
and commercialization of its proprietary zinc-air battery technology for
electric vehicles and defense applications. The Company is primarily operating
through IES Interactive Training, Inc. ("IES"), a wholly-owned subsidiary based
in Littleton, Colorado; FAAC Corporation, a wholly-owned subsidiary based in Ann
Arbor, Michigan, and FAAC's 80%-owned United Kingdom subsidiary FAAC Limited;
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; MDT Protective Industries, Ltd. ("MDT"), 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.
Revenues derived from the Company's largest customers in 2004, 2003 and 2002 are
described in Note 18.
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 of 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 reclassified 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. These restatements do not affect the balance sheet, the stockholders'
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
the valuation of warrants granted in a litigation settlement.
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 associated with the convertible debentures. As a result of
this review, the Company found errors which increased its financial expenses in
the amount of $568,000 for the year ended December 31, 2003. The errors were
related to the amortization of debt discount attributable to the warrants and
their related convertible debentures, whereby the Company understated the amount
of amortization for the year ended December 31, 2003 attributable to certain of
the convertible debentures. See Note 13.
F-14
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
Similar errors were also noted in the Company's interim financial statements in
the three-month period ended June 30, 2003, the nine-month period ended
September 30, 2003, and the three and six-month periods ended March 31 and June
30, 2004.
The impacts of these restatements with respect to the year ended December 31,
2003 are summarized below:
Statement of Operations Data:
For the Year ended December 31, 2003
-----------------------------------------------------------
Previously Adjustment As Restated
Reported
----------------- ----------------- -----------------
General and administrative expenses.............. $ 6,196,779 $ (338,903) $ 5,857,876
Operating loss................................... 5,408,932 (338,903) 5,070,029
Financial expenses, net.......................... 3,470,459 568,250 4,038,709
Loss from continuing operations.................. 9,118,684 229,347 9,348,031
----------------- ----------------- -----------------
Net loss......................................... 9,008,274 229,347 9,237,621
Deemed dividend to certain stockholders of
common stock................................. - 350,000 350,000
----------------- ----------------- -----------------
Net loss attributable to common stockholders..... $ 9,008,274 $ 579,347 $ 9,587,621
================= ================= =================
Basic and diluted net loss per share from
continuing operations.......................... $ 0.23 $ 0.01 $ 0.24
================= ================= =================
Basic and diluted net loss per share............. $ 0.23 $ 0.02 $ 0.25
================= ================= =================
Balance sheet data:
As of December 31, 2003
-----------------------------------------------------------------------
Previously Reported Adjustment As Restated
--------------------- --------------------- ---------------------
Other accounts payable and accrued $ 4,180,411 $ (150,000) $ 4,030,411
expenses..........................
Total current liabilities............ 6,859,752 (150,000) 6,709,752
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 stockholders' equity........... 22,044,127 (418,250) 21,625,877
Cash flow data:
F-15
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
For the Year ended December 31, 2003
-----------------------------------------------------------
Previously Adjustment As Restated
Reported
----------------- ----------------- -----------------
Net loss......................................... $ 9,008,274 $ 229,347 $ 9,237,621
Stock based compensation related to repricing of
warrants granted to investors and the grant of
new warrants................................... 388,403 (188,903) 199,500
Increase in other accounts payable and accrued
expenses....................................... 1,827,668 (150,000) 1,677,668
Amortization of compensation related to warrants
issued to the holders of convertible
debentures and beneficial conversion feature... 3,359,987 568,250 3,928,237
c. 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
acquisition. The total consideration of $10,144,262 (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:
Tangible assets acquired 2,239,848
Intangible assets
Customer list 5,092,395
Goodwill 5,192,012
Liabilities assumed (2,379,993)
------------
Total consideration $ 10,144,262
============
Customer list in the amount of $5,092,395 has a useful life of approximately ten
years.
F-16
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
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 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 $5,092,395.
See Note 1.h. for pro forma financial information.
d. Acquisition of FAAC:
In January of 2004, the Company entered into a stock purchase agreement with the
stockholders of FAAC Incorporated ("FAAC"), pursuant to the terms of which it
acquired all of the issued and outstanding common stock of FAAC, a provider of
driving simulators, systems engineering and software products to the United
States military, government and private industry.
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 income, with an
additional earn-out on the 2005 pretax income from certain specific and limited
programs. Based on FAAC's 2004 net pretax income, the Company estimates its
earn-out obligation at $13.4 million, of which $6.0 million was pre-paid into
escrow in the form of restricted cash (See Note 3). In March 2005, the Company
and the former stockholders of FAAC signed an agreement pursuant to which the
Company will transfer the restricted cash to the former stockholders of FAAC by
March 31, 2005, and will issue to the former stockholders of FAAC $10.0 million
in Arotech stock by April 30, 2005, with such stock to be registered and sold on
behalf of the former stockholders of FAAC by March 31, 2006 until the earn-out
shall have been paid in full (with any remaining shares of Arotech stock after
proceeds of the sales reach $7.4 million to be returned to the Company) ; should
the proceeds of the sales be less than $7.4 million, the Company will pay any
shortfall in cash). The total consideration of $27.6 million (including the
earn-out as well as $135,131 of transaction costs) was determined based upon
arm's-length negotiations between the Company and FAAC's stockholders.
F-17
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
Based upon a valuation of tangible and intangible assets acquired, Arotech has
allocated the total cost of the acquisition to FAAC's assets and liabilities as
follows:
Tangible assets acquired $ 4,833,553
Intangible assets
Technology 4,610,000
Backlog 636,000
Customer list 1,125,000
Trademarks 374,000
Goodwill 18,762,646
Liabilities assumed (2,770,843)
------------
Total consideration $ 27,570,356
============
Intangible assets which are subject to amortization, excluding trademarks, which
are not subject to amortization, in the amount of $6,371,000 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 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.
F-18
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
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 $374,000.
See Note 1.h. for pro forma financial information.
e. 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, if any, will be
recorded as additional purchase price. The purchase price also included $121,192
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 valuation of tangible and intangible assets acquired, Arotech has
allocated the total cost of the acquisition to AoA's assets and liabilities as
follows :
Tangible assets acquired 6,346,316
Intangible assets
Certifications 246,969
Backlog 1,512,000
Customer relationships 490,000
Tradename /Trademark 70,000
Covenants not to compete 260,000
Goodwill 10,543,677
Liabilities assumed (347,770)
------------
Total consideration $ 19,121,192
============
Intangible assets, excluding trademarks, which are not subject to amortization,
in the amount of $2,508,969 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.
F-19
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
See Note 1.h. for pro forma financial information.
f. Acquisition of IES:
In August 2, 2002, the Company entered into an asset purchase agreement among
I.E.S. Electronics Industries U.S.A., Inc. ("IES"), its direct and certain of
its indirect shareholders, and its wholly-owned Israeli subsidiary, EFL,
pursuant to the terms of which it acquired substantially all the assets, subject
to substantially all the liabilities, of IES, a developer, manufacturer and
marketer of advanced hi-tech multimedia and interactive digital solutions for
training of military, law enforcement and security personnel. The Company
intends to continue to use the assets purchased in the conduct of the business
formerly conducted by IES (the "Business"). The acquisition has been accounted
under the purchase method of accounting. Accordingly, all assets and liabilities
were acquired as at the values on such date, and the Company consolidated IES's
results with its own commencing at such date.
The assets purchased consisted of the current assets, property and equipment,
and other intangible assets used by IES in the conduct of the Business. The
consideration for the assets and liabilities purchased consisted of (i) cash and
promissory notes in an aggregate amount of $4,800,000 ($3,000,000 in cash and
$1,800,000 in promissory notes, which was recorded at its fair value in the
amount of $1,686,964) (see Note 10), and (ii) the issuance, with registration
rights, of a total of 3,250,000 shares of our common stock, $.01 par value per
share, having a value of approximately $3,653,929, which shares are the subject
of a voting agreement on the part of IES and certain of its affiliated
companies. The value of 3,250,000 shares issued was determined based on the
average market price of Arotech's Common stock over the period including two
days before and after the terms of the acquisition were agreed to and announced.
The total consideration of $8,354,893 (including $14,000 of transaction costs)
was determined based upon arm's-length negotiations between the Company and IES
and IES's shareholders.
F-20
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
Based upon a valuation of tangible and intangible assets acquired, Arotech has
allocated the total cost of the acquisition to IES's assets as follows:
Tangible assets acquired $ 2,856,951
Intangible assets
Technology 1,515,000
Existing contracts 46,000
Covenants not to compete 99,000
In process research and development 26,000
Customer 527,000
Trademarks 439,000
Goodwill 4,032,726
Liabilities assumed (1,186,784)
-----------
Total consideration $ 8,354,893
===========
In September 2003, the Company's IES subsidiary purchased selected assets of
Bristlecone Corporation. The assets purchased consisted of inventories, customer
lists, and certain other assets (including intangible assets such as
intellectual property and customer lists), including the name "Bristlecone
Training Products" and the patents for the Heads Up Display (HUD) and a remote
trigger device, used by Bristlecone in connection with its designing and
manufacturing firearms training devices, for a total consideration of $183,688
in cash and $300,000 in promissory notes, payable in four equal semi-annual
payments of $75,000 each, to become due and payable on March 1, 2004, August 31,
2004, February 28, 2005 and August 31, 2005. The acquired patents are used in
the IES's Range FDU (firearm diagnostics unit).
The purchase consideration was estimated as follows:
Cash consideration 183,688
Present value of promissory notes 289,333
Transaction expenses 12,643
--------
Total consideration $485,664
========
Based upon a valuation of tangible and intangible assets acquired, the Company
has allocated the total cost of the acquisition of Bristlecone's assets as
follows:
Tangible assets acquired $ 33,668
Intangible assets
Technology and patents 436,746
Customer list 15,250
--------
--------
Total consideration $485,664
========
The Company believes that the acquisition of Bristlecone is not material to its
business.
F-21
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
g. Acquisition of MDT:
On July 1, 2002, the Company entered into a stock purchase agreement with all of
the shareholders of M.D.T. Protective Industries Ltd. ("MDT"), pursuant to the
terms of which the Company purchased 51% of the issued and outstanding shares of
MDT, a privately-held Israeli company that specializes in using sophisticated
lightweight materials and advanced engineering processes to armor vehicles. The
Company also entered into certain other ancillary agreements with MDT and its
shareholders and other affiliated companies. The Acquisition was accounted under
the purchase method accounting and results of MDT's operations have been
included in the consolidated financial statements since that date. The total
consideration of $1,767,877 for the shares purchased consisted of (i) cash in
the aggregate amount of 5,814,000 New Israeli Shekels ($1,231,780), and (ii) the
issuance, with registration rights, of an aggregate of 390,638 shares of our
common stock, $0.01 par value per share, having a value of approximately
$439,077. The value of 390,638 shares issued was determined based on the average
market price of Arotech's Common stock over the period including two days before
and after the terms of the acquisition were agreed to and announced.
Based upon a valuation of tangible and intangible assets acquired, Arotech has
allocated the total cost of the acquisition to MDT's assets as follows:
Tangible assets acquired $ 1,337,048
Intangible assets
Technology 280,000
Customer base 285,000
Goodwill 886,255
Liabilities assumed (1,020,426)
-----------
Total consideration $ 1,767,877
===========
In September 2003, the Company increased its holdings in both of its vehicle
armoring subsidiaries. The Company now holds 88% of MDT Armor Corporation
(compared to 76% before this transaction) and 75.5% of MDT Protective Industries
Ltd. (compared to 51% before this transaction). The Company acquired the
additional stake in MDT from AGA Means of Protection and Commerce Ltd. in
exchange for the issuance to AGA of 126,000 shares of its common stock, valued
at $0.98 per share based on the closing price of the Company's common stock on
the closing date of September 4, 2003, or a total of $123,480. Of this amount, a
total of $75,941 was allocated to intangible assets. The Company did not obtain
a valuation due to the immaterial nature of this acquisition.
h. Pro forma results:
In January 2004, the Company acquired FAAC and Epsilor, as more fully described
in "Note 1.c. - Acquisition of Epsilor" and "Note 1.d. - Acquisition of FAAC,"
above, in August 2004, the Company acquired AoA, as more fully described in
"Note 1.e. - Acquisition of AoA," above (the "Acquisitions") and in the year
2002 the Company acquired IES and MDT as more fully described in Note 1.f and
Note 1.g (the "2002 Acquisitions"). The following summary pro forma information
includes the effects of the Acquisitions on the operating results of the
Company. The following unaudited pro forma data for 2004 and 2003 are presented
as if the Acquisitions had been completed on January 1, 2004 and 2003,
respectively. The unaudited pro forma data for 2002 are presented as if 2002
Acquisitions had been completed on January 1, 2002.
F-22
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
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.
Year Ended December 31,
--------------------------------------------
2004 2003* 2002
------------ ------------ ------------
(Unaudited)
Total revenues $ 61,086,697 $ 39,680,394 $ 12,997,289
============ ============ ============
Gross profit 22,528,254 17,214,249 4,424,952
============ ============ ============
Net loss (5,810,114) (6,959,174) (6,103,771)
============ ============ ============
Deemed dividend of common stock
attributable to certain stockholders (3,328,952) (350,000) --
============ ============ ============
Net loss attributable to stockholders of
common stock $ (9,139,066) $ (7,309,174) $ (6,103,771)
============ ============ ============
Basic and diluted net loss per share $ (0.13) $ (0.14) $ (0.18)
============ ============ ============
Weighted average number of shares used in 69,933,057 52,966,330 34,495,185
computing basic net loss per share
============ ============ ============
- ----------
*Restated.
i. Discontinued operations:
In September 2002, the Company committed to a plan to discontinue the operations
of its retail sales of consumer battery products. The Company ceased the
operation and disposed of all assets related to this segment by an abandonment.
The operations and cash flows of consumer battery business have been eliminated
from the operations of the Company as a result of the disposal transactions. The
Company has no intent of continuing its activity in the consumer battery
business. The Company's plan of discontinuance involved (i) termination of all
employees whose time was substantially devoted to the consumer battery line and
who could not be used elsewhere in the Company's operations, including payment
of all statutory and contractual severance sums, by the end of the fourth
quarter of 2002, and (ii) disposal of the raw materials, equipment and inventory
used exclusively in the consumer battery business, since the Company has no
reasonable expectation of being able to sell such raw materials, equipment or
inventory for any sum substantially greater than the cost of disposal or
shipping, by the end of the first quarter of 2003. The Company had previously
reported its consumer battery business as a separate segment (Consumer
Batteries) as called for by Statement of Financial Standards No. 131,
"Disclosures About Segments of an Enterprise and Related Information" ("SFAS No.
131").
The results of operations including revenue, operating expenses, other income
and expense of the retail sales of consumer battery products business unit for
2003 and 2002 have been reclassified in the accompanying statements of
operations as a discontinued operation. The Company's balance sheets at December
31, 2003 reflect the net liabilities of the retail sales of consumer battery
products business as net liabilities and net assets of discontinued operation
within current liabilities and current assets.
F-23
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
At December 31, 2002, the estimated net losses associated with the disposition
of the retail sales of consumer battery products business were $13,566,206 for
2002. These losses included approximately $6,508,522 in losses from operations
for the period from January 1, 2002 through the measurement date of December 31,
2002 and $7,057,684, reflecting a write-down of inventory and net property and
equipment of the retail sales of consumer battery products business, as follows:
December 31, 2002
----------
Write-off of inventories $2,611,000
Impairment of property and equipment 4,446,684
----------
$7,057,684
==========
As a result of the discontinuance of consumer battery segment, the Company
ceased to use property and equipment related to this segment. In accordance with
Statement of Financial Accounting Standard No. 144 "Accounting for the
Impairment or Disposal of Long- Lived Assets" ("SFAS No. 144") such assets was
considered to be impaired. The impairment to be recognized was measured by the
amount by which the carrying amount of the assets exceeds the fair value of the
assets.
Obligations to employees for severance and other benefits resulting from the
discontinuation have been reflected in the financial statements on an accrual
basis.
Summary operating results from the discontinued operation for the years ended
December 31, 2004, 2003 and 2002 are as follows:
Year Ended December 31,
-------------------------------------------------------------
2004 2003 2002
----------------- ---------------- -----------------
Revenues $ - $ 117,267 $ 1,100,442
Cost of sales (1) - - (5,293,120)
----------------- ---------------- -----------------
Gross profit (loss) - 117,267 (4,192,678)
Operating expenses, net - 6,857 4,926,844
Impairment of fixed assets - - 4,446,684
----------------- ---------------- -----------------
Operating profit (loss) $ - $ 110,410 $ (13,566,206)
================= ================ =================
- ----------
(1) Including write-off of inventory in the amount of $0, $0 and $2,611,000 for
the years ended December 31, 2004, 2003 and 2002.
F-24
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles in the United States ("U.S. GAAP").
a. Use of estimates:
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
b. Financial statements in U.S. dollars:
A majority of the revenues of the Company and most of its subsidiaries is
generated in U.S. dollars. In addition, a substantial portion of the Company's
and most of its subsidiaries costs are incurred in U.S. dollars ("dollar").
Management believes that the dollar is the primary currency of the economic
environment in which the Company and most of its subsidiaries operate. Thus, the
functional and reporting currency of the Company and most of its subsidiaries is
the dollar. Accordingly, monetary accounts maintained in currencies other than
the U.S. dollar are remeasured into U.S. dollars in accordance with Statement of
Financial Accounting Standards No. 52 "Foreign Currency Translation" ("SFAS No.
52"). All transaction, gains and losses from the remeasured monetary balance
sheet items are reflected in the consolidated statements of operations as
financial income or expenses, as appropriate.
The majority of transactions of MDT and Epsilor are in New Israel Shekel ("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 has been translated using the weighted average exchange rate for the
period. The resulting translation adjustments are reported as a component of
accumulated other comprehensive loss in stockholders' equity
c. Principles of consolidation:
The consolidated financial statements include the accounts of the Company and
its wholly and majority owned subsidiaries. Intercompany balances and
transactions have been eliminated upon consolidation.
d. Cash equivalents:
Cash equivalents are short-term highly liquid investments that are readily
convertible to cash with maturities of three months or less when acquired.
F-25
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
e. Restricted collateral deposits
Restricted cash is primarily invested in highly liquid deposits,
held-to-maturity marketable securities and long-term deposits, which are used as
a security for the Company's guarantee performance and its liability to former
shareholders of its acquired subsidiaries.
f. 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.
At December 31, 2004 the Company and its subsidiaries classified its investment
in marketable securities as held-to-maturity and available-for-sale.
Debt securities are classified as held-to-maturity, when the Company has the
positive intent and ability to hold the securities to maturity, and are stated
at amortized cost. The cost of held-to-maturity securities is adjusted for
amortization of premiums and accretion of discounts to maturity. Such
amortization, accretion and interest are included in financial income, net.
Investment in trust funds are classified as available-for-sale and stated at
fair value, with unrealized gains and losses reported in accumulated other
comprehensive income (loss), a separate component of stockholders' equity, net
of taxes. Realized gains and losses on sales of investments, as determined on a
specific identification basis, are included in the consolidated statements of
income.
g. Inventories:
Inventories are stated at the lower of cost or market value. Inventory
write-offs and write-down provisions are provided to cover risks arising from
slow-moving items or technological obsolescence and for market prices lower than
cost. The Company periodically evaluates the quantities on hand relative to
current and historical selling prices and historical and projected sales volume.
Based on this evaluation, provisions are made to write inventory down to its
market value. In 2002, 2003 and 2004, the Company wrote off $116,008, $96,350
and $121,322 of obsolete inventory respectively, which has been included in the
cost of revenues.
Cost is determined as follows:
Raw and packaging materials - by the average cost method.
Work in progress - represents the cost of manufacturing with additions of
allocable indirect manufacturing cost.
Finished products - on the basis of direct manufacturing costs with additions of
allocable indirect manufacturing costs.
F-26
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
h. Property and equipment:
Property and equipment are stated at cost net of accumulated depreciation and
investment grants (no investment grants were received during 2004, 2003 and
2002).
Depreciation is calculated by the straight-line method over the estimated useful
lives of the assets, at the following annual rates:
%
---------------------------
Computers and related equipment 33
Motor vehicles 15
Office furniture and equipment 6 - 10
Machinery and equipment 10 - 25 (mainly 10)
Leasehold improvements By the shorter of the term
of the lease and the life
of the asset
i. Goodwill:
Goodwill represents the excess of cost over the fair value of the net assets of
businesses acquired. Under Statement of Financial Accounting Standard No. 142,
"Goodwill and Other Intangible Assets" ("SFAS No, 142") goodwill acquired in a
business combination on or after July 1, 2001, is not amortized after January 1,
2002.
SFAS No. 142 requires goodwill to be tested for impairment on adoption of the
Statement and at least annually thereafter or between annual tests in certain
circumstances, and written down when impaired, rather than being amortized as
previous accounting standards required. Goodwill is tested for impairment by
comparing the fair value of the Company's reportable units with their carrying
value. Fair value is determined using discounted cash flows. Significant
estimates used in the methodologies include estimates of future cash flows,
future short-term and long-term growth rates, weighted average cost of capital
and estimates of market multiples for the reportable units.
The Company performed the required annual impairment test of goodwill. Based on
the management projections and using expected future discounted operating cash
flows, no indication of goodwill impairment was identified.
j. Long-lived assets:
Intangible assets acquired in a business combination that are subject to
amortization are amortized over their useful life using a method of amortization
that reflects the pattern in which the economic benefits of the intangible
assets are consumed or otherwise used up, in accordance with SFAS No. 142.
The acquired trademarks and tradenames are deemed to have an indefinite useful
life because they are expected to contribute to cash flows indefinitely.
Therefore, the trademarks will not be amortized until their useful life is no
longer indefinite. The trademarks and tradenames are tested annually for
impairment in accordance FAS 142.
F-27
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
The Company and its subsidiaries' long-lived assets and certain identifiable
intangibles are reviewed for impairment in accordance with Statement of
Financial Accounting Standard No. 144 "Accounting for the Impairment or Disposal
of Long-Lived Assets" ("SFAS No. 144") whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of the carrying amount of assets to be held and used
is measured by a comparison of the carrying amount of the assets to the future
undiscounted cash flows expected to be generated by the assets. If such assets
are considered to be impaired, the impairment to be recognized is measured by
the amount by which the carrying amount of the assets exceeds the fair value of
the assets. As of December 31, 2004 the Company identified an impairment of the
technology previously purchased from Bristlecone and as a result has recorded an
impairment loss in the amount of $320,000.
k. Revenue recognition:
The Company is a defense and security products and services company, engaged in
three business areas: interactive simulation for military, law enforcement and
commercial markets; batteries and charging systems for the military; and
high-level armoring for military, paramilitary and commercial vehicles. During
2004, the Company and its subsidiaries recognized revenues as follows: (i) from
the sale and customization of interactive training systems and from the
maintenance services in connection with such systems (Interactive Training
Division); (ii) from revenues under armor contracts and for service and repair
of armored vehicles (Armoring Division); (iii) from the sale of batteries,
chargers and adapters to the military, and under certain development contracts
with the U.S. Army (Battery Division); and (iv) from the sale of lifejacket
lights (Battery Division.
Revenues from the Battery division products and Armoring division are recognized
in accordance with SEC Staff Accounting Bulletin No. 104, "Revenue Recognition"
when persuasive evidence of an agreement exists, delivery has occurred, the fee
is fixed or determinable, collectability is probably, and no further obligation
remains.
Revenues from products not delivered upon customers' request due to lack of
storage space at the customers' facilities during the integration are recognized
when the criteria of Staff Accounting Bulletin No. 104 ("SAB No. 104") for
bill-and-hold transactions are met.
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
December 31, 2004 no such estimated losses were identified.
F-28
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
The Company believes that the use of the percentage of completion method is
appropriate as the Company has 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 the terms of settlement, including in cases of terminations for convenience.
In all cases the Company expects to perform its contractual obligations and its
customers are expected to satisfy their obligations under the contract.
Revenues from simulators, which do not require significant customization, are
recognized in accordance with Statement of Position 97-2, "Software Revenue
Recognition," ("SOP 97-2"). SOP 97-2 generally requires revenue earned on
software arrangements involving multiple elements to be allocated to each
element based on the relative fair value of the elements. The Company has
adopted Statement of Position 98-9, "Modification of SOP 97-2, Software Revenue
Recognition with Respect to Certain Transactions" ("SOP 98-9"). According to SOP
No. 98-9, revenues are allocated to the different elements in the arrangement
under the "residual method" when Vendor Specific Objective Evidence ("VSOE") of
fair value exists for all undelivered elements and no VSOE exists for the
delivered elements. Under the residual method, at the outset of the arrangement
with the customer, the Company defers revenue for the fair value of its
undelivered elements (maintenance and support) and recognizes revenue for the
remainder of the arrangement fee attributable to the elements initially
delivered in the arrangement (software product) when all other criteria in SOP
97-2 have been met.
Revenue from such simulators is recognized when persuasive evidence of an
agreement exists, delivery has occurred, no significant obligations with regard
to implementation remain, the fee is fixed or determinable and collectibility is
probable.
Maintenance and support revenue included in multiple element arrangements is
deferred and recognized on a straight-line basis over the term of the
maintenance and support services. Revenues from training are recognized when its
performed. The VSOE of fair value of the maintenance, training and support
services is determined based on the price charged when sold separately or when
renewed.
Unbilled receivables include cost and gross profit earned in excess of billing.
Deferred revenues include unearned amounts received under maintenance and
support services and billing in excess of costs and estimated earnings on
uncompleted contracts.
F-29
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
l. 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.
m. Research and development cost:
Research and development costs, net of grants received, are charged to the
statements of operations as incurred.
Software development costs incurred by the Company's subsidiaries between
completion of the working model and the point at which the product is ready for
general release, are capitalized.
Capitalized software costs are amortized by using the straight-line method over
the estimated useful life of the product (three to five years). The Company
assesses the recoverability of this intangible asset on a regular basis by
determining whether the amortization of the asset over its remaining life can be
recovered through future gross revenues from the specific software product sold.
Based on its most recent analyses, management identified an impairment of
software development costs previously capitalized and as a result has recorded
an impairment loss in the amount of $26,000.
n. Income taxes:
The Company and its subsidiaries account for income taxes in accordance with
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes" ("SFAS No. 109"). This Statement prescribes the use of the liability
method, whereby deferred tax assets and liability account balances are
determined based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse. The Company
and its subsidiaries provide a valuation allowance, if necessary, to reduce
deferred tax assets to it's estimated realizable value.
o. Concentrations of credit risk:
Financial instruments that potentially subject the Company and its subsidiaries
to concentrations of credit risk consist principally of cash and cash
equivalents, restricted collateral deposit and restricted held-to-maturity
securities, trade receivables and available for sale marketable securities. Cash
and cash equivalents are invested mainly in U.S. dollar deposits with major
Israeli and U.S. banks. Such deposits in the U.S. may be in excess of insured
limits and are not insured in other jurisdictions. Management believes that the
financial institutions that hold the Company's investments are financially sound
and, accordingly, minimal credit risk exists with respect to these investments.
The trade receivables of the Company and its subsidiaries are mainly derived
from sales to customers located primarily in the United States, Europe and
Israel. Management believes that credit risks are moderated by the diversity of
its end customers and geographical sales areas. The Company performs ongoing
credit evaluations of its customers' financial condition. An allowance for
doubtful accounts is determined with respect to those accounts that the Company
has determined to be doubtful of collection.
F-30
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
The Company's available for sale marketable securities and held-to-maturity
securities include investments in debentures of U.S. and Israeli corporations
and state and local governments. Management believes that those corporations and
states are institutions that are financially sound, that the portfolio is well
diversified, and accordingly, that minimal credit risk exists with respect to
these marketable securities.
The Company and its subsidiaries had no off-balance-sheet concentration of
credit risk such as foreign exchange contracts, option contracts or other
foreign hedging arrangements.
p. Basic and diluted net loss per share:
Basic net loss per share is computed based on the weighted average number of
shares of common stock outstanding during each year. Diluted net loss per share
is computed based on the weighted average number of shares of common stock
outstanding during each year, plus dilutive potential shares of common stock
considered outstanding during the year, in accordance with Statement of
Financial Standards No. 128, "Earnings Per Share."
All outstanding stock options and warrants have been excluded from the
calculation of the diluted net loss per common share because all such securities
are anti-dilutive for all periods presented. The total weighted average number
of shares related to the outstanding options and warrants excluded from the
calculations of diluted net loss per share was 31,502,158, 22,194,211 and
4,394,803 for the years ended December 31, 2004, 2003 and 2002, respectively.
q. 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 Interpretation No.
44 "Accounting for Certain Transactions Involving Stock Compensation" in
accounting for its employee stock option plans. Under APB No. 25, when the
exercise price of the Company's share options is less than the market price of
the underlying shares on the date of grant, compensation expense is recognized.
Under Statement of Financial Accounting Standard No. 123, "Accounting for
Stock-Based Compensation" ("SFAS No. 123"), pro-forma information regarding net
income and net income 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 Company applies SFAS No. 123 and Emerging Issue Task Force No. 96-18
"Accounting for Equity Instruments that are Issued to Other than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services" ("EITF 96-18")
with respect to options issued to non-employees. SFAS No. 123 requires use of an
option valuation model to measure the fair value of the options at the grant
date.
The fair value for the options to employees was estimated at the date of grant,
using the Black-Scholes Option Valuation Model, with the following
weighted-average assumptions: risk-free interest rates of 3.63%, 2.54% and 3.5%
for 2004, 2003 and 2002, respectively; a dividend yield of 0.0% for each of
those years; a volatility factor of the expected market price of the common
stock of 0.81 for 2004, 0.67 for 2003 and 0.64 for 2002; and a weighted-average
expected life of the option of 5 years for 2004, 2003 and 2002.
F-31
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
The following table illustrates the effect on net income and earnings
per share, assuming that the Company had applied the fair value recognition
provision of SFAS No. 123 on its stock-based employee compensation:
Year ended December 31,
2004 2003* 2002
Net loss as reported $ (9,042,313) $ (9,237,621) $(18,504,358)
Add: Stock-based compensation expenses included in
reported net loss 831,626 8,286 6,000
Deduct: Stock-based compensation expenses
determined under fair value method for all awards (2,741,463) (1,237,558) (2,072,903)
$(10,952,150) $(10,466,893) $(20,571,261)
Loss per share:
Basic and diluted, as reported $ (0.18) $ (0.25) $ (0.57)
Diluted, pro forma $ (0.16) $ (0.27) $ (0.64)
- -----------------------
* Restated (see Note 1.b.).
r. Fair value of financial instruments:
The following methods and assumptions were used by the Company and its
subsidiaries in estimating their fair value disclosures for financial
instruments:
The carrying amounts of cash and cash equivalents, restricted collateral deposit
and restricted held-to-maturity securities, trade receivables, short-term bank
credit, and trade payables approximate their fair value due to the short-term
maturity of such instruments.
The fair value of available for sale marketable securities is based on the
quoted market price.
Long-terms promissory notes are estimated by discounting the future cash flows
using current interest rates for loans or similar terms and maturities. The
carrying amount of the long-term liabilities approximates their fair value.
s. Severance pay:
The Company's liability for severance pay is calculated pursuant to Israeli
severance pay law based on the most recent salary of the employees multiplied by
the number of years of employment as of the balance sheet date. Israeli
employees are entitled to one month's salary for each year of employment, or a
portion thereof. The Company's liability for all of its employees is fully
provided by monthly deposits with severance pay funds, insurance policies and by
an accrual. The value of these policies is recorded as an asset in the Company's
balance sheet.
In addition and according to certain employment agreements, the Company is
obligated to provide for a special severance pay in addition to amounts due to
certain employees pursuant to Israeli severance pay law. The Company has made a
provision for this special severance pay in accordance with Statement of
Financial Accounting Standard No. 106, "Employer's Accounting for Post
Retirement Benefits Other than Pensions." As of December 31, 2004 and 2003, the
accumulated severance pay in that regard amounted to $1,642,801 and $1,699,260,
respectively.
F-32
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
The deposited funds include profits accumulated up to the balance sheet date.
The deposited funds may be withdrawn only upon the fulfillment of the obligation
pursuant to Israeli severance pay law or labor agreements. The value of the
deposited funds is based on the cash surrendered value of these policies and
includes immaterial profits.
Severance expenses for the years ended December 31, 2004, 2003 and 2002 amounted
to $460,178, $219,857 and ($338,574) respectively.
t. Advertising costs:
The Company and its subsidiaries expense advertising costs as incurred.
Advertising expense for the years ended December 31, 2004, 2003 and 2002 was
approximately $13,271, $34,732 and $294,599, respectively.
u. New accounting pronouncements:
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued
FASB Statement No. 123 (revised 2004), "Share-Based Payment," which is a
revision of FASB Statement No. 123, "Accounting for Stock-Based Compensation."
Statement 123(R) supersedes APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and amends FASB Statement No. 95, "Statement of Cash Flows."
Generally, the approach in Statement 123(R) is similar to the approach described
in Statement 123. However, Statement 123(R) requires all share-based payments to
employees, including grants of employee stock options, to be recognized in the
income statement based on their fair values. Pro forma disclosure is no longer
an alternative.
Statement 123(R) must be adopted no later than July 1, 2005. Early adoption will
be permitted in periods in which financial statements have not yet been issued.
The Company expects to adopt Statement 123(R) on the first interim period
beginning after July 1, 2005.
Statement 123(R) permits public companies to adopt its requirements using one of
two methods:
1. A "modified prospective" method in which compensation cost is recognized
beginning with the effective date (a) based on the requirements of Statement
123(R) for all share-based payments granted after the effective date and (b)
based on the requirements of Statement 123 for all awards granted to employees
prior to the effective date of Statement 123(R) that remain unvested on the
effective date.
2. A "modified retrospective" method which includes the requirements of the
modified prospective method described above, but also permits entities to
restate based on the amounts previously recognized under Statement 123 for
purposes of pro forma disclosures either (a) all prior periods presented or (b)
prior interim periods of the year of adoption.
The Company is still in the process of evaluating the method it will use.
F-33
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
As permitted by Statement 123, the Company currently accounts for share-based
payments to employees using Opinion 25's intrinsic value method and, as such,
generally recognizes no compensation cost for employee stock options.
Accordingly, the adoption of Statement 123(R)'s fair value method will have a
significant impact on our result of operations, although it will have no impact
on our overall financial position. The impact of adoption of Statement 123(R)
cannot be predicted at this time because it will depend on levels of share-based
payments granted in the future. However, had the Company adopted Statement
123(R) in prior periods, the impact of that standard would have approximated the
impact of Statement 123 as described in the disclosure of pro forma net income
and earnings per share in Note 2r above to the Company's consolidated financial
statements. Statement 123(R) also requires the benefits of tax deductions in
excess of recognized compensation cost to be reported as a financing cash flow,
rather than as an operating cash flow as required under current literature.
In November 2004, the FASB issued Statement of Financial Accounting Standard No.
151, "Inventory Costs, an Amendment of ARB No. 43, Chapter 4.." SFAS 151 amends
Accounting Research Bulletin ("ARB") No. 43, Chapter 4, to clarify that abnormal
amounts of idle facility expense, freight handling costs and wasted materials
(spoilage) should be recognized as current-period charges. In addition, SFAS 151
requires that allocation of fixed production overheads to the costs of
conversion be based on normal capacity of the production facilities. SAFS 151 is
effective for inventory costs incurred during fiscal years beginning after June
15, 2005. The Company is still in the process of the evaluating the impact of
the adoption of SFAS 151 on its financial position or results of operations.
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
NOTE 3:- RESTRICTED COLLATERAL DEPOSIT AND OTHER RESTRICTED CASH (Cont.)
December 31,
-------------------------
2004 2003
----------- -----------
Short-term:
Restricted, held to maturity, bonds
in connection with FAAC earn out
(Note 1.d.)(1) $ 5,969,413 $ --
IES deposit in connection to the
Company's litigation with IES
Electronics Industries Ltd. -- 450,000
Deposits in connection with FAAC
projects 650,989 --
Forward Deal -- 205,489
Property lease -- 41,412
Other 341,708 9,279
----------- -----------
Total short-term 6,962,110 706,810
----------- -----------
Long-term:
Restricted cash in connection with
AoA earn out (Note 1.e.) 3,000,000 --
Restricted deposit in connection with
Epsilor acquisition (Note 1.c.) 1,000,000 --
----------- -----------
Total long-term 4,000,000 --
----------- -----------
$10,962,110 $ 706,180
=========== ===========
F-34
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
(1) The following is a summary of held-to-maturity securities at December 31,
2004 and 2003:
Amortized cost Unrealized losses Estimated fair value
---------- ---------- ---------- ---------- ---------- ----------
2004 2003 2004 2003 2004 2003
---------- ---------- ---------- ---------- ---------- ----------
Obligations of States $1,012,787 $ -- $ (1,870) $ -- $1,010,917 $ --
and political
subdivisions
Corporate obligations 4,956,626 -- (11,966) -- 4,944,660 --
---------- ---------- ---------- ---------- ---------- ----------
$5,969,413 $ -- $ (13,836) $ -- $5,955,577 $ --
========== ========== ========== ========== ========== ==========
The amortized cost of held-to-maturity debt securities at December 31, 2004, by
contractual maturities, is shown below:
Amortized Unrealized Estimated
cost losses fair value
------------- -------------- -------------
Due in one year or less $5,969,413 $ (13,836) $ 5,955,577
============= ============== =============
The unrealized losses in the Company's investments were caused by interest rate
increases. It is expected that the securities would not be settled at a price
less than the amortized cost of the Company's investment. Based on the
immaterial severity of the impairments and the obligation of the Company to hold
these investments until maturity, the bonds were not considered to be other than
temporarily impaired at December 31, 2004.
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
NOTE 4: - AVAILABLE FOR SALE MARKETABLE SECURITIES
The following is a summary of investments in marketable securities as of
December 31, 2004 and 2003:
Cost Unrealized gains Estimated fair value
-------------------------- --------------------------- --------------------------
2004 2003 2004 2003 2004 2003
------------ ------------ ------------- ------------- ------------ ------------
Available for sale
marketable securities $ 130,061 $ - $ 5,507 $ - $ 135,568 $ -
NOTE 5:- OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES
December 31,
-----------------------------
2004 2003
---------- ----------
Government authorities $ 433,427 $ 65,402
Employees 217,948 246,004
Prepaid expenses 490,357 551,010
Deferred taxes 135,482 --
Other 62,179 324,955
---------- ----------
$1,339,393 $1,187,371
========== ==========
F-35
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
NOTE 6:- INVENTORIES
December 31,
--------------------------------------
2004 2003
----------------- -----------------
Raw and packaging materials $ 3,969,400 $ 657,677
Work in progress 1,996,139 634,221
Finished products 1,311,762 622,850
----------------- -----------------
$ 7,277,301 $ 1,914,748
================= =================
NOTE 7:- PROPERTY AND EQUIPMENT, NET
a. Composition of property and equipment is as follows:
December 31,
-------------------------------------
2004 2003
----------------- -----------------
Cost:
Computers and related equipment $ 3,374,695 $ 1,015,836
Motor vehicles 653,255 288,852
Office furniture and equipment 872,804 402,726
Machinery, equipment and installations 7,464,470 4,866,904
Leasehold improvements 1,321,025 882,047
Demo inventory 141,961 150,996
---------------- ----------------
13,828,210 7,607,361
---------------- ----------------
Accumulated depreciation:
Computers and related equipment 2,581,689 753,593
Motor vehicles 197,071 95,434
Office furniture and equipment 494,181 173,301
Machinery, equipment and installations 5,143,186 3,637,111
Leasehold improvements 811,392 655,181
---------------- ----------------
9,227,519 5,314,620
---------------- ----------------
Depreciated cost $ 4,600,691 $ 2,292,741
================ ================
b. Depreciation expense amounted to $1,199,465, $730,159 and $473,739, for the
years ended December 31, 2004, 2003 and 2002, respectively.
As for liens, see Note 12.d.
F-36
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
NOTE 8:- OTHER INTANGIBLE ASSETS, NET
a.
Year ended December 31,
--------------------------------
2004 2003
------------ ------------
Cost:
Technology $ 6,841,746 $ 2,231,746
Capitalized software costs 574,967 209,615
Backlog 2,194,000 46,000
Covenants not to compete 359,000 99,000
Customer list 7,548,645 827,250
Certification 246,969 --
------------ ------------
17,765,327 3,413,611
Exchange differences 125,455 25,438
Less - accumulated amortization (4,391,081) (1,502,854)
------------ ------------
Amortized cost 13,499,701 1,936,195
Trademarks 869,000 439,000
------------ ------------
$ 14,368,701 $ 2,375,195
============ ============
b. Amortization expenses amounted to $2,888,226, $879,311 and $623,543 for
the years ended December 31, 2004, 2003 and 2002.
c. Estimated amortization expenses, except capitalized software costs, for
the years ended
Year ended December 31,
- --------------------------------------
2005 $ 3,280,815
2006 2,073,209
2007 1,381,883
2008 1,276,075
2009 and forward 5,000,546
-----------------
$13,012,528
=================
NOTE 9:- SHORT-TERM BANK CREDIT AND LOANS
The Company has a $ 3.2 million authorized credit line from certain banks, of
which $ 209,000 is denominated in NIS and carries an interest rate of
approximately prime + 2.5% and $ 3.0 million of which is denominated in dollars
and carries an interest rate of prime + 0.25%. As of December 31, 2004, $ 2.1
million was utilized, out of which $2.0 million is related to letter of credit
issued to one of the customers of one of the Company's subsidiaries.
This line of credit is secured by the accounts receivable, inventory and
marketable securities of the relevant subsidiary of the Company.
In addition the Company has two automobile purchase loans, of which the later
one will be repaid in June 2006. Those loans are denominated in NIS and carry an
interest rate of 5.2%-6.2%. Each loan is secured by the automobile purchased
with the proceeds of the loan.
F-37
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
NOTE 10:- PROMISSORY NOTES
In connection with the acquisition of IES, the Company issued promissory notes
in the face amount of an aggregate of $1,800,000, one of which was a note for
$400,000 that was convertible into an aggregate of 200,000 shares of the
Company's common stock. The Company has accounted for these notes in accordance
with Accounting Principles Board Opinion No. 21, "Interest on Receivables and
Payables," and recorded the notes at their present value in the amount of
$1,686,964. In December 2002, the terms of these promissory notes were amended
to (i) extinguish the $1,000,000 note due at the end of June 2003 in exchange
for prepayment of $750,000, (ii) amend the $400,000 note due at the end of
December 2003 to be a $450,000 note, and (iii) amend the convertible $400,000
note due at the end of June 2004 to be a $450,000 note convertible at $0.75 as
to $150,000, at $0.80 as to $150,000, and at $0.85 as to $150,000. In accordance
with EITF 96-19, "Debtor's Accounting for a Modification or Exchange of Debt
Instruments," the terms of promissory notes were not treated as changed or
modified as the cash flow effect on a present value basis was less than 10%. The
$450,000 note due at the end of June 2004 was converted into an aggregate of
563,971 shares of common stock in August 2003. With reference to the $450,000
note due at the end of December 2003, see Note 14.f.6.
NOTE 11:- OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES
December 31,
------------------------------------
2004 2003*
--------------- -----------------
Employees and payroll accruals $ 1,534,295 $ 1,232,608
Accrued vacation pay 469,527 216,768
Accrued expenses 1,770,348 842,760
Minority balance 243,116 149,441
Government authorities 1,036,669 357,095
Litigation settlement accrual(1) - 1,163,642
Advances from customers 746,819 -
Other 17,414 68,097
--------------- -----------------
$ 5,818,188 $ $4,174,030,411
=============== =================
* Restated (see Note 1.b.).
(1) See Note 14.f.6.
F-38
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
NOTE 12:- COMMITMENTS AND CONTINGENT LIABILITIES
a. Royalty commitments:
1. Under EFL's research and development agreements with the Office of the Chief
Scientist ("OCS"), and pursuant to applicable laws, EFL is required to pay
royalties at the rate of 3%-3.5% of net sales of products developed with funds
provided by the OCS, up to an amount equal to 100% of research and development
grants received from the OCS (linked to the U.S. dollars. Amounts due in respect
of projects approved after year 1999 also bear interest at the Libor rate). EFL
is obligated to pay royalties only on sales of products in respect of which OCS
participated in their development. Should the project fail, EFL will not be
obligated to pay any royalties.
Royalties paid or accrued for the years ended December 31, 2004, 2003 and 2002,
to the OCS amounted to $17,406, $435 and $32,801, respectively.
As of December 31, 2004, the total contingent liability to the OCS was
approximately $10,158,000. The Company regards the probability of this
contingency coming to pass in any material amount to be low.
2. EFL, in cooperation with a U.S. participant, has received approval from the
Israel-U.S. Bi-national Industrial Research and Development Foundation
("BIRD-F") for 50% funding of a project for the development of a hybrid
propulsion system for transit buses. The maximum approved cost of the project is
approximately $1.8 million, and the EFL's share in the project costs is
anticipated to amount to approximately $1.1 million, which will be reimbursed by
BIRD-F at the aforementioned rate of 50%. Royalties at rates of 2.5%-5% of sales
are payable up to a maximum of 150% of the grant received, linked to the U.S.
Consumer Price Index. Accelerated royalties are due under certain circumstances.
EFL is obligated to pay royalties only on sales of products in respect of which
BIRD-F participated in their development. Should the project fail, EFL will not
be obligated to pay any royalties.
No royalties were paid or accrued to the BIRD-F in each of the three years in
the period ended December 31, 2004.
As of December 31, 2004, the total contingent liability to pay BIRD-F (150%) was
approximately $772,000. The Company regards the probability of this contingency
coming to pass in any material amount to be low.
b. Lease commitments:
The Company and its subsidiaries rent their facilities under various operating
lease agreements, which expire on various dates, the latest of which is in 2009.
The minimum rental payments under non-cancelable operating leases are as
follows:
Year ended December 31
----------------------
2005 $ 762,636
2006 $ 305,109
2007 $ 269,220
2008 $ 66,688
2009 $ 24,312
Total rent expenses for the years ended December 31, 2004, 2003 and 2002 were
approximately $868,900, $484,361 and $629,101, respectively.
F-39
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
c. Guarantees:
The Company obtained bank guarantees in the amount of $1,199,096 in connection
with (i) the purchase agreement of one of the Company's subsidiaries (ii)
obligations of two of the Company's subsidiaries to the Israeli customs
authorities and (iii) obligation of one of the Company's subsidiaries to secure
inventory received from one of its customers. In addition, the Company issued
letters of credit in amounts of $143,895 and $2,000,000 to one of its
subsidiary's suppliers and to one of its subsidiary's customers respectively.
d. Liens:
As security for compliance with the terms related to the investment grants from
the state of Israel, EFL and Epsilor have registered floating liens on all of
its assets, in favor of the State of Israel.
The Company has granted to the holders of its 8% secured convertible debentures
a first position security interest in (i) the shares of MDT Armor Corporation,
(ii) the assets of its IES Interactive Training, Inc. subsidiary, (iii) the
shares of all of its subsidiaries, and (iv) any shares that the Company acquires
in future Acquisitions (as defined in the securities purchase agreement).
EFL has granted to its former CEO a security interest in certain of its property
located in Beit Shemesh, Israel, to secure sums due to him pursuant to the terms
of the settlement agreement with him.
FAAC has a $3 million line of credit secured by all of its accounts receivable,
unbilled revenues and inventory.
Epsilor has recorded a lien on all of its assets in favor of its banks to secure
lines of credit and loans received. In addition the company has a specific
pledge on assets in respect of which government guaranteed loan were given.
See also Note 9 regarding automobiles purchased in EFL and Epsilor.
e. Litigation and other claims:
As of December 31, 2004, there were no pending legal proceedings to which the
Company was a party, other than ordinary routine litigation incidental to its
business, except as follows:
a. In December 2004, AoA filed an action against a U.S. government defense
agency, seeking approximately $2.2 million in damages for alleged improper
termination of a contract. In its answer, the government agency counterclaimed,
seeking approximately $2.1 million in reprocurement expenses. AoA is preparing
its answer to the counterclaim. At this stage in the proceedings, the Company
and its legal advisors cannot determine with any certainty whether AoA will have
any liability and, if so, the extent of that liability.
b. In the beginning of 2005 a competitor of FAAC brought an action against FAAC
and a municipal transport agency, alleging, inter alia, that the municipal
transport agency and FAAC have conspired to violate federal and state antitrust
laws and have engaged in unfair competition with respect to this competitor. The
competitor seeks unspecified monetary damages from FAAC and the municipal
transport agency and injunctive relief. FAAC has not yet filed its answer in
this case. At this stage in the proceedings, the Company and its legal advisors
cannot determine with any certainty whether FAAC will have any liability and, if
so, the extent of that liability.
c. There is an action against EFL brought in the matter of the bankruptcy of an
intellectual property law firm, seeking payment of approximately $150,000, plus
interest, fees and costs, in respect of unpaid legal fees and expenses. EFL has
not yet filed its answer in this case. The Company and its legal advisors does
not believe EFL's liability in this matter will exceed $100,000.The Company has
recorded an appropriate provision in respect of this amount.
d. In 2000 and 2001, the Company sold consumer cellphone batteries and chargers
to a major department store chain. Subsequent to these sales, in late 2001, one
of the Company's employees signed an agreement with the department store chain
to price-protect the goods previously sold, with such price protection "to be
debited from current open invoices." The department store chain has recently
claimed to the Company that the Company owes them approximately $517,000,
primarily in respect of this price protection. The Company contends that
employee who signed the price protection had no authority, actual or apparent,
to do so, and that in any event the clear meaning of the language in the price
protection is that the department store chain may deduct the price protection
from sums they owe the Company, not that the Company is obligated to return sums
previously paid. Settlement discussions are currently taking place. At this
early stage, the Company and its legal advisors cannot determine with any
certainty whether it will have any liability and, if so, the extent of that
liability.
F-40
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
NOTE 13:- CONVERTIBLE DEBENTURES
a. 9% Secured Convertible Debentures due June 30, 2005
Pursuant to the terms of a Securities Purchase Agreement dated December 31,
2002, the Company issued and sold to a group of institutional investors an
aggregate principal amount of 9% secured convertible debentures in the amount of
$3.5 million due June 30, 2005. These debentures are convertible at any time
prior to June 30, 2005 at a conversion price of $0.75 per share, or a maximum
aggregate of 4,666,667 shares of common stock. 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 were not treated as changed or
modified when the cash flow effect on a present value basis was less than 10%.
As part of the securities purchase agreement on 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.
This transaction was accounted according to APB No. 14 "Accounting for
Convertible debt and Debt Issued with Stock Purchase Warrants" ("APB No. 14")
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.
F-41
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
In connection with these convertible debentures, the Company recorded a deferred
debt discount of $1,890,000 with respect to the beneficial conversion feature
and the discount arising from fair value allocation of the warrants according to
APB No. 14, which is being amortized from the date of issuance to the stated
redemption date - June 30, 2005 - or to the actual conversion date, if earlier,
as financial expenses.
During 2003, an aggregate principal amount of $2,350,000 in 9% secured
convertible debentures was converted into an aggregate of 3,671,875 shares of
common stock and an aggregate of 1,500,042 shares were issued pursuant to
exercises of the warrants.
During 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.
During 2003 and 2004, the Company recorded expenses of $1,517,400 and $372,600,
respectively, of which $548,100 and $0, respectively, was attributable to
amortization of the beneficial conversion feature of the convertible debenture
over its term and $969,300 and $372,600, respectively, was attributable to
amortization due to conversion of the convertible debenture into shares.
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 issued and sold to a group of institutional investors an
aggregate principal amount of 8% secured convertible debentures in the amount of
$5.0 million due September 30, 2006. These debentures are convertible at any
time prior to September 30, 2006 at a conversion price of $1.15 per share, or a
maximum aggregate of 4,347,826 shares of common stock.
As part of the securities purchase agreement on 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.
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." 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 recorded a deferred
debt discount of $2,963,043 with respect to the beneficial conversion feature
and the discount arising from fair value allocation of the warrants according to
APB No. 14, which is being amortized from the date of issuance to the stated
redemption date - September 30, 2006 - or to the actual conversion date, if
earlier, as financial expenses.
F-42
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
During 2003, an aggregate principal amount of $3,775,000 in 8% secured
convertible debentures was converted into an aggregate of 3,282,608 shares of
common stock and an aggregate of 437,500 shares were issued pursuant to
exercises of the warrants.
During 2004, an aggregate of principal amount $1,075,000 in 8% secured
convertible debentures was converted into an aggregate of 934,784 shares. As of
December 31, 2004, principal amount of $150,000 remained outstanding under these
debentures.
During 2003 and 2004, the Company recorded expenses of $2,298,034 and $613,263,
respectively, of which $205,858 and $191,895, respectively, was attributable to
amortization of the beneficial conversion feature of the convertible debenture
over its term and $2,092,176 and $421,368, respectively, was attributable to
amortization due to conversion of the convertible debenture into shares.
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 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, or a
maximum aggregate of 4,137,931 shares of common stock.
As a further part of the securities purchase agreement on 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 1,500,000 shares of
common stock at any time prior to December 18, 2006 at a price of $1.8125 per
share. Additionally, the Company issued to the investors supplemental warrants
to purchase an aggregate of 1,038,000 shares of common stock at any time prior
to December 31, 2006 at a price of $2.20 per share.
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." The fair value of these warrants was determined using
Black-Scholes pricing model, assuming a risk-free interest rate of 2.45%, a
volatility factor 98%, dividend yields of 0% and a contractual life of three
years.
In connection with these convertible debentures, the Company recorded a deferred
debt discount of $6,000,000 with respect to the beneficial conversion feature
and the discount arising from fair value allocation to warrants according to APB
No. 14, which is being amortized from the date of issuance to the stated
redemption date - September 30, 2006 - or to the actual conversion date, if
earlier, as financial expenses.
During 2003 the Company recorded an expense of $132,803, which represents the
amortization of the beneficial conversion feature of the convertible debenture
over its term.
F-43
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
During 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. See also Note 14.f.4.
During 2004 the Company recorded expenses of $3,156,246 of which $1,782,561 was
attributable to amortization of the beneficial conversion feature of the
convertible debenture over its term and $1,373,685 was attributable to
amortization due to conversion of the convertible debenture into shares.
d. The Company's debt agreements contain customary affirmative and negative
operations covenants that limit the discretion of its management with respect to
certain business matters and place restrictions on it, including obligations on
the Company's part to preserve and maintain assets and restrictions on its
ability to incur or guarantee debt, to merge with or sell its assets to another
company, and to make significant capital expenditures without the consent of the
debenture holders, as well as granting to the Company's investors a right of
first refusal on any future financings, except for underwritten public offerings
in excess of $30 million. Management does not believe that this right of first
refusal will materially limit the Company's ability to undertake future
financings.
NOTE 14:- STOCKHOLDERS' EQUITY
a. Stockholders' rights:
The Company's shares confer upon the holders the right to receive notice to
participate and vote in the general meetings of the Company and right to receive
dividends, if and when declared.
b. Issuance of common stock to investors:
1. On January 18, 2002, the Company issued a total of 441,176 shares of its
common stock at a purchase price of $1.70 per share, or a total purchase price
of $750,000, to an investor (see also Note 14.f.2.).
2. On January 24, 2002, the Company issued a total of 1,600,000 shares of its
common stock at a purchase price of $1.55 per share, or a total purchase price
of $2,480,000, to a group of investors.
3. In September 2003, the company acquired an additional 12% interest in MDT
Armor Corporation and an additional 24.5% interest in MDT Protective Industries,
Ltd. in exchange for the issuance to AGA Means of Protection and Commerce, Ltd.
of 126,000 shares of its common stock.
4. In January 2004, the Company issued an aggregate of 9,840,426 shares of
common stock at a price of $1.88 per share, or a total purchase price of
$18,500,000, to a group of investors (see also Note 14.f.3.). Finance expenses
in connection with this issuance totaled $692,500.
F-44
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
5. In July 2004, pursuant to a Securities Purchase Agreement dated July 15,
2004, the Company issued 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, to a group of
investors (see also Note 14.f.4.).
c. Issuance of common stock to service providers and employees, in settlement of
litigation, and as donations to charities:
1. On February 15, 2002 and September 10, 2002, the Company issued 318,468 and
50,000 shares, respectively, of common stock at par consideration to a
consultant for providing business development and marketing services in the
United Kingdom. At the issuance date, the fair value of these shares was
determined both by the value of the shares issued as reflected by their market
price at the issuance date and by the value of the services provided which
amounted to $394,698 and $63,000, respectively, in accordance with EITF 96-18.
In accordance with EITF 96-18, the Company recorded this compensation expense of
$394,698 and $63,000, respectively, during the year 2002 and included this
amount in marketing expenses.
2. On September 10, 2002, the Company issued an aggregate of 13,000 shares of
common stock at par consideration to two of its employees as stock bonuses. At
the issuance date, the fair value of these shares was determined by the fair
market value of the shares issued as reflected by their market price at the
issuance date in accordance with APB No. 25. In accordance with APB No. 25, the
Company recorded this compensation expense of $13,000 during the year 2002 and
included this amount in general and administrative expenses.
3. In July 2003, the Company issued 215,294 shares of common stock to a
consultant as commissions on battery orders. At the issuance date, the fair
value of these shares was determined both by the value of the shares issued as
reflected by the market price at the issuance date and by the value of the
services provided and amounted to $154,331 in accordance with EITF 96-18. In
accordance with EITF 96-18, the Company recorded this compensation expense of
$154,331 during the year 2003 and included this amount in marketing expenses.
4. In November 2003, the Company issued 8,306 shares of common stock to a
consultant as commissions on battery orders. At the issuance date, the fair
value of these shares was determined by the fair market value of the shares
issued as reflected by their market price at the issuance date and by the value
of the services provided and amounted to $7,616 in accordance with EITF 96-18.
In accordance with EITF 96-18, the Company recorded this compensation expense of
$7,616 during the year 2003 and included this amount in marketing expenses.
5. In February 2004, the Company issued 74,215 shares of common stock to a
consultant as commissions on battery orders. At the issuance date, the fair
value of these shares was determined both by the value of the shares issued as
reflected by their market price at the issuance date and by the value of the
services provided and amounted to $171,680 in accordance with EITF 96-18. In
accordance with EITF 96-18, the Company accrued this compensation expense of
$171,680 during the year 2003 and included this amount in selling and marketing
expenses.
6. Beginning in January 2004, the Company entered into a consulting agreement
with one of its directors pursuant to which the director agreed to aid the
Company in identifying potential acquisition candidates, in exchange for a
commission. The Company also agreed to issue to this director, at par value, a
total of 32,000 shares of its common stock, the value of which was to be
deducted from any transaction fees paid. 16,000 of these shares were earned and
issued prior to termination of this agreement in August 2004. At the issuance
date, the fair value of these shares was determined both by the value of the
shares issued as reflected by their market price at the issuance date and by the
value of the services provided and amounted to $28,160 in accordance with EITF
96-18. In accordance with EITF 96-18, the Company recorded this compensation
expense of $28,160 during the year 2004 and included this amount in general and
administrative expenses
F-45
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
7. In June 2004 the Company sold 40,000 shares of the Company's common stock at
a price of $1.00 per share to one of its employees. At the issuance date, the
fair value of these shares was determined by the fair market value of the shares
issued as reflected by their market price at the issuance date in accordance
with APB No. 25. In accordance with APB No. 25, the Company recorded this
compensation expense of $53,200 during the year 2004 and included this amount in
general and administrative expenses
8. In December 2004, the Company donated 40,000 shares of its common stock to a
charitable organization recognized by the Internal Revenue Service as tax-exempt
under Section 501(c)(3) of the Internal Revenue Code of 1986, as amended. At the
issuance date, the fair value of these shares was determined by the value of the
shares issued as reflected by their market price at the issuance date and
amounted to $69,200 in accordance with EITF 96-18. This compensation expense
will be amortized over the course of one year due to legal restrictions on
selling these shares for that period of time. In accordance with EITF 96-18, the
Company recorded compensation expense of $4,361 during the year 2004 and
included this amount in general and administrative expenses
9. See Note 14.f.6.
d. Issuance of shares to lenders
As part of the securities purchase agreement on December 31, 2002 (see Note
13.a.), the Company issued 387,301 shares at par as consideration to lenders for
the first nine months of interest expenses. At the issuance date, the fair value
of these shares was determined both by the value of the shares issued as
reflected by their market price at the issuance date and by the value of the
interest and amounted to $236,250 in accordance with APB 14. During 2003 the
Company recorded this amount as financial expenses.
e. Issuance of promissory note:
As part of its purchase of the assets of IES Interactive Training, Inc., the
Company issued a $450,000 convertible promissory note (see Note 10). This note
was converted into an aggregate of 563,971 shares of common stock in August
2003.
f. Warrants:
1. As part of an investment agreement in May 2001, the Company issued to the
investors a total of 2,696,971 warrants (the "May 2001 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.
F-46
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
In June and July 2003, the Company adjusted the purchase price of 1,357,577 of
the May 2001 Warrants to $0.82 per share in exchange for immediate exercise of
these warrants, and issued to the holders of these exercised warrants new
warrants to purchase a total of 905,052 shares of common stock at a purchase
price of $1.45 per share (the "June 2003 Warrants"). The June 2003 Warrants were
originally exercisable at any time from and after December 31, 2003 to June 30,
2008; however, in September 2003, the exercise period of 638,385 of these June
2003 Warrants was adjusted to make them exercisable at any time from and after
December 31, 2004 to June 30, 2009. As a result the company recorded during 2003
a deemed dividend in the amount of $267,026. See also Note 1.b.
In addition, with respect to an additional 387,879 May 2001 Warrants, in
December 2003 the Company adjusted the purchase price to $1.60 per share in
exchange for immediate exercise of these warrants, and issued to the holders of
these exercised warrants new warrants to purchase a total of 193,940 shares of
common stock at a purchase price of $2.25 per share. As a result the company
recorded during 2003 a deemed dividend in the amount of $82,974. See also Note
1.b.
Additionally, in October 2003 the Company granted to three of these investors
additional new warrants to purchase a total of 150,000 shares of common stock at
a purchase price of $1.20 per share. As a result the company recorded during
2003 an expense of $199,500 and included this amount in general and
administrative expenses. During 2004, 64,557 warrants were exercised.
On July 14, 2004, the Company repriced the exercise price of 242,424 warrants
granted previously in May 2001 to $1.88 in order to induce their holders to
exercise them 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
of 79%, dividend yields of 0% and a contractual life of five years. For
accounting treatment, please see also Notes 14.b.4. and 14.f.4.
2. As part of the investment agreement in January 2002 (see Note 14.b.1), the
Company, in January 2002, issued to a financial consultant that provided
investment banking services concurrently with this transaction a warrants to
acquire (i) 150,000 shares of common stock at an exercise price of $1.68 per
share, and (ii) 119,000 shares of common stock at an exercise price of $2.25 per
share; these warrants are exercisable by the holder at any time and will expire
on January 4, 2007.
3. In connection with the Securities Purchase Agreement referred to in Note
14.b.4 above, 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.
F-47
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
In July 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
of 79%, dividend yields of 0% and a contractual life of five years. See also
Note 14.f.4.
4. 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 Notes 14.f.1., 14.f.3. and 13.c.). 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
13.c above and 7,446,811 shares were issued upon exercise of warrants issued in
the transaction referred to in the Note 14.f.4. 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 14.f.1 above. 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
As a result of the transactions described in Notes 14 f.1, 14.f.3 and 13.c.,
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 dividend increased the loss applicable to common
stockholders in the calculation of basic and diluted net loss per share for the
year ended December 31, 2004, without any effect on total shareholder's equity.
As all warrants in the July 14, 2004, securities purchase agreement were subject
to shareholders approval, in accordance with Emerging Issues Task Force
No.00-19, "Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock" their fair value was recorded as
a liability at the closing date. Such fair value was remeasured at each
subsequent cut-off date. Upon obtaining stockholders approval on December 14,
2004, the warrants were remeasured and reclassified to equity. The fair value of
these warrants was determined using the 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 approximately five years. The change in the fair value
of the warrants between the date of grant and December 14, 2004 has been
recorded as finance income in the amount of $326,839.
5. 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 in March 2004 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 2004.
F-48
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
6. 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. subsidiary from IES Electronics in August 2002. The litigation
had sought monetary damages in the amount of approximately $3 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 them 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. The parties also agreed to exchange
mutual releases. In consideration of the foregoing, the Company issued to IES
Electronics (i) 450,000 shares of common stock, and (ii) five-year warrants to
purchase up to an additional 450,000 shares of 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. The fair value of warrants was calculated as $483,828 and fair value of
shares as $765,000.
In respect of the above settlement, the Company recorded in 2003 an expense of
$688,642, representing the fair value of the warrants and shares over the
remaining balance of the Company's debt to IES Electronics as carried in the
Company books at December 31, 2003, less the $112,000 certificate of deposit
that was transferred to the Company's name as noted above. During the year 2004,
200,000 warrants were exercised.
7. As of December 31, 2004, the Company outstanding warrants totaled 16,961,463.
g. Stock option and restricted stock purchase plans:
1. Options and restricted shares to employees and others (except consultants)
a. The Company has adopted the following stock option plans, whereby options and
restricted shares may be granted for purchase of shares of the Company's common
stock. Under the terms of the employee plans, the Board of Directors or the
designated committee grants options and determines the vesting period and the
exercise terms.
1) 1998 Employee Option Plan - as amended, 4,750,000 shares reserved for
issuance, of which no shares were available for future grants to employees and
consultants as of December 31, 2004.
2) 1995 Non-Employee Director Plan - 1,000,000 shares reserved for issuance, of
which 355,000 were available for future grants to directors as of December 31,
2004.
3) 2004 Employee Option Plan - 7,500,000 shares reserved for issuance, of which
5,168,400 were available for future grants to employees and consultants as of
December 31, 2004.
F-49
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
b. Under these plans, options generally expire no later than 5-10 years from the
date of grant. Each option can be exercised to purchase one share, conferring
the same rights as the other common shares. Options that are cancelled or
forfeited before expiration become available for future grants. The options
generally vest over a three-year period (33.3% per annum) and restricted shares
vest after two years; in the event that employment is terminated for cause
within that period, restricted shares revert back to the Company.
c. A summary of the status of the Company's plans and other share options and
restricted shares (except for options granted to consultants) granted as of
December 31, 2004, 2003 and 2002, and changes during the years ended on those
dates, is presented below:
2004 2003 2002
-------------------------- -------------------------- -------------------------
Amount Weighted Amount Weighted Amount Weighted
average average average
exercise exercise exercise
price price price
------------ ------------ -------------
------------ ------------ ----------
$ $ $
------------ ------------ ----------
Options outstanding at beginning 9,018,311 $ 1.37 5,260,366 $ 2.26 4,240,228 $ 2.74
of year
Changes during year:
Granted (1) (2) 2,248,490 $ 1.06 5,264,260 $ 0.71 1,634,567 $ 0.87
Exercised (3) (191,542)
(897,248) $ 1.24 (689,640) $ 0.64 (191,542) $ 1.29
Forfeited (514,793) $ 3.77 (816,675) $ 3.51 (422,887) $ 1.92
---------- ---------- ---------- ---------- ---------- ----------
Options outstanding at end of year 9,854,760 $ 1.19 9,018,311 $ 1.37 5,260,366 $ 2.26
========== ========== ========== ========== ========== ==========
Options exercisable at end of year 6,465,316 $ 1.32 5,826,539 $ 1.70 4,675,443 $ 2.26
========== ========== ========== ========== ========== ==========
(1) Includes 936,250, 2,035,000 and 481,435 options and restricted shares
granted to related parties in 2004, 2003 and 2002, respectively.
(2) The Company recorded deferred stock compensation for options and
restricted shares issued with an exercise price below the fair value of the
common stock in the amount of $2,081,457, $4,750 and $0 as of December 31,
2004, 2003 and 2002, respectively. Deferred stock compensation is amortized
and recorded as compensation expenses ratably over the vesting period of
the option or the restriction period of the restricted shares. The stock
compensation expense that has been charged in the consolidated statements
of operations in respect of options and restricted shares to employees and
directors in 2004, 2003 and 2002, was $831,626, $8,286 and $6,000,
respectively.
(3) In June 2002, the employees exercised 100,000 options for which the
exercise price was not paid at the exercise date. The Company recorded the
owed amount of $73,000 as "Note receivable from stockholders" in the
Statement of Changes in Stockholders' Equity. In accordance with EITF
95-16, since the original option grant did not permit the exercise of the
options through loans, and due to the Company's history of granting
non-recourse loans, this postponement in payments of the exercise price
resulted in a variable plan accounting. However, the Company did not record
any compensation due to the decrease in the market value of the Company's
shares during 2002. During 2002 the note in the amount of $36,500 was
forgiven and appropriate compensation was recorded. During 2003 and 2004,
the Company recorded compensation expenses and (income) in amounts of
$38,500 and ($10,000), respectively, due to increase and decrease in the
market value of the Company's shares.
F-50
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In U.S. dollars
d. The options and restricted shares outstanding as of December 31, 2004 have
been separated into ranges of exercise price, as follows:
Total options outstanding Exercisable options outstanding
--------------------------------------------------- ----------------------------------
Range of Amount Weighted Weighted Amount Weighted
average
outstanding at remaining exercisable at
exercise December 31, contractual average December 31, average
prices 2004 life exercise price 2004 exercise price
---------------- ----------------
- ------------ ---------------- ---------------- ----------------
$ Years $ $
- ------------ ---------------- ---------------- ----------------
0.01-2.00 8,944,827 6.44 0.87 5,730,382 0.88
2.01-4.00 270,933 3.79 2.46 95,934 2.56
4.01-6.00 594,000 1.97 4.80 594,000 4.80
6.01-8.00 35,000 1.05 7.73 35,000 7.73
8.01 10,000 2.75 9.06 10,000 9.06
---------------- ---------------- ---------------- ---------------- ----------------
9,854,760 6.07 1.19 6,465,316 1.32
================ ================ ================ ================ ================
Weighted-average fair values and exercise prices of options and restricted
shares on dates of grant are as follows:
Equals market price Less than market price
----------------------------- ------------------------------
Year ended December 31, Year ended December 31,
----------------------------- ------------------------------
2004 2003 2002 2004 2003 2002
-------- -------- -------- ------- -------- ---------
Weighted average $1.494 $ 0.950 $ 1.265 $1.672 $ - $ 0.755
exercise prices
Weighted average fair
value on grant date $1.002 $ 0.730 $ 0.560 $1.729 $ - $ 0.250
2. Options issued to consultants:
a. The Company's outstanding options to consultants as of December 31, 2004,
are as follows:
2004 2003 2002
--------------------------- --------------------------- ---------------------------
Amount Weighted Amount Weighted Amount Weighted
average average average
exercise exercise exercise
price price price
------------ ------------ -------------
------------- ------------- -------------
$ $ $
------------- ------------- -------------
Options outstanding at 313,901 $ 4.59 245,786 $ 5.55 245,786 $ 5.55
beginning of year
Changes during year:
Granted 10,000 $ - 83,115 $ 0.99 - $ -
Exercised (37,615) $ 1.03 (15,000) $ 0.49 - $ -
Forfeited or cancelled (120,000) $ 6.40 - $ - - $ -
------------ ------------ -------------
Options outstanding at
end of year 166,286 $ 3.80 313,901 $ 4.59 245,786 $ 5.55
============ ============= ============ ============= ============= =============
Options exercisable at
end of year 166,286 $ 3.80 193,901 $ 3.46 125,786 $ 6.42
============ ============= ============ ============= ============= =============
b. The Company accounted for its options to consultants under the fair value
method of SFAS No. 123 and EITF 96-18. The fair value for these options was
estimated using a Black-Scholes option-pricing model with the following
weighted-average assumptions:
F-51
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
2004 2003 2002
---------------- --------------- --------------
Dividend yield 0% 0% -
Expected volatility 81% 78% -
Risk-free interest 3.4% 2.3% -
Contractual life of up to 5 years 10 years -
c. In connection with the grant of stock options to consultants, the Company
recorded stock compensation expenses totaling $0, $29,759 and $0 for the years
ended December 31, 2004, 2003 and 2002, respectively, and included these amounts
in marketing and general and administrative expenses.
3. Dividends:
In the event that cash dividends are declared in the future, such dividends will
be paid in U.S. dollars. The Company does not intend to pay cash dividends in
the foreseeable future.
4. Treasury Stock:
Treasury stock is the Company's common stock that has been issued and
subsequently reacquired. The acquisition of common stock is accounted for under
the cost method, and presented as reduction of stockholders' equity.
NOTE 15:- INCOME TAXES
a. Taxation of U.S. parent company (Arotech) and other U.S. subsidiaries:
As of December 31, 2004, Arotech has operating loss carryforwards for U.S.
federal income tax purposes of approximately $23 million, which are available to
offset future taxable income, if any, expiring in 2009 through 2024. Utilization
of U.S net operating losses may be subject to substantial annual limitations due
to the "change in ownership" provisions of the Internal Revenue Code of 1986 and
similar state provisions. The annual limitation may result in the expiration of
net operating loses before utilization.
The Company files consolidated tax returns with its US subsidiaries.
b. Israeli subsidiary (Epsilor):
Tax benefits under the Law for the Encouragement of Capital Investments, 1959
(the "Investments Law"):
Currently, Epsilor is operating under three programs as follows:
1. Program one:
Epsilor's expansion program of its existing enterprise in Dimona was granted the
status of an "approved enterprise" under the Investments Law and was entitled to
investments grants from the state of Israel in the amount of 24% on property and
equipment located at its Dimona plant.
The approved expansion program was in the amount of approximately $350,000.
Epsilor effectively operated the program during 1999 and is entitled to the tax
benefits available under the Investments Law.
F-52
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Taxable income derived from the approved enterprise is subject to a reduced tax
rate during seven years beginning from the year in which taxable income is first
earned (tax exemption for the first two-year period and 25% tax rate for the
five remaining years).
Those benefits are limited to 12 years from the year that the enterprise began
operations, or 14 years from the year in which the approval was granted,
whichever is earlier. Hence, this approved program will expire in 2005.
2. Program two:
Epsilor's expansion program of its existing enterprise in Dimona was granted the
status of an "approved enterprise" under the Investments Law and was entitled to
investments grants from the State of Israel in the amount of 24% on property and
equipment located at its Dimona plant.
The approved expansion program is in the amount of approximately $600,000.
Epsilor effectively operated the program during 2002, and is entitled to the tax
benefits available under the Investments Law (commencing from 2003).
Taxable income derived from the approved enterprise is subject to a reduced tax
rate during seven years beginning from the year in which taxable income is first
earned (tax exemption for the first two-year period and 25% tax rate for the
five remaining years).
Those benefits are limited to 12 years from the year that the enterprise began
operations, or 14 years from the year in which the approval was granted,
whichever is earlier. Hence, this approved program will expire in 2009.
3. Program three:
Epsilor's expansion program of its existing enterprise in Dimona was granted the
status of an "approved enterprise" under the Investments Law, and is entitled to
investments grants from the State of Israel in the amount of 32% on property and
equipment located at its Dimona plant.
The approved expansion program is in the amount of approximately $945,000. This
program has not yet received final approval.
Taxable income derived from the approved enterprise is subject to a reduced tax
rate during seven years beginning from the year in which taxable income is first
earned (tax exemption for the first two-year period and 25% tax rate for the
five remaining years).
Those benefits are limited to 12 years from the year that the enterprise began
operations, or 14 years from the year in which the approval was granted,
whichever is earlier.
The main tax benefits available to Epsilor are:
a) Reduced tax rates:
As stated above for each specific program
b) Accelerated depreciation:
Epsilor is entitled to claim accelerated depreciation in respect of machinery
and equipment used by the "Approved Enterprise" for the first five years of
operation of these assets.
F-53
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Income from sources other than the "Approved Enterprise" during the benefit
period will be subject to tax at the regular corporate tax rate of 35%.
.. If retained tax-exempt profits attributable to the "approved enterprise" are
distributed, they would be taxed at the corporate tax rate applicable to such
profits as if Epsilor had not elected the alternative system of benefits,
currently 25% for an "approved enterprise."
Dividends paid from the profits of an approved enterprise are subject to tax at
the rate of 15% in the hands of their recipient.
As of December 31, 2004 approximately $370,000 were derived from tax exempt
profits earned by Epsilor's "approved enterprises"; by Israeli law, the Company
can distribute only $197,000 of this amount. The Company has determined that
such tax exempt income in the amount of $180,000 will not be distributed as
dividends.
Tax liability on what can be distributed as dividends from these tax exempt
profits and other Epsilor profits in 2004 in the hand of the recipient and on
the company level as stated in previous section is $51,000 and accordingly
deferred tax liability was recorded as of December 31, 2004.
c. Israeli subsidiary (EFL):
1. Tax benefits under the Investments Law:
A small part of EFL's manufacturing facility has been granted "Approved
Enterprise" status under the Investments Law, and was entitled to investment
grants from the State of Israel of 38% on property and equipment located in
Jerusalem, and 10% on property and equipment located in its plant in Beit
Shemesh, and to reduced tax rates on income arising from the "Approved
Enterprise," as detailed below.
The period of tax benefits granted by "Approved enterprise" is subject to limits
of 12 years from the commencement of production, or 14 years from the approval
date, whichever is earlier. The approved program expired in 2004. The benefits
were not utilized since the Company had no taxable income, since its
incorporation.
d. Other tax information about the Israeli subsidiaries:
1. Measurement of results for tax purposes under the Income Tax Law
(Inflationary Adjustments), 1985
Results for tax purposes are measured in real terms of earnings in NIS after
certain adjustments for increases in the Consumer Price Index. As explained in
Note 2.b., the financial statements are presented in U.S. dollars. The
difference between the annual change in the Israeli consumer price index and in
the NIS/dollar exchange rate causes a difference between taxable income and the
income before taxes shown in the financial statements. In accordance with
paragraph 9(f) of SFAS No. 109, EFL, Epsilor and MDT have not provided deferred
income taxes on this difference between the reporting currency and the tax bases
of assets and liabilities.
F-54
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
2. Tax benefits under the Law for the Encouragement of Industry (Taxation),
1969:
EFL and Epsilor are "industrial companies," as defined by this law and, as such,
are entitled to certain tax benefits, mainly accelerated depreciation, as
prescribed by regulations published under the inflationary adjustments law, the
right to claim amortization of know-how, patents and certain other intangible
property rights as deductions for tax purposes.
3. Tax rates applicable to income from other sources:
Income from sources other than the "Approved Enterprise," is taxed at the
regular rate of 35%. See also Note 15.e
4. Tax loss carryforwards:
As of December 31, 2004, EFL has operating and capital loss carryforwards for
Israeli tax purposes of approximately $87.0 million, which are available,
indefinitely, to offset future taxable income.
e. Reduction in corporate tax rate
In June 2004, the Israeli Parliament approved an amendment to the Income Tax
Ordinance (No. 140 and Temporary Provision) (the "Amendment"), which
progressively reduces the corporate tax rate from 36% to 35% in 2004 and to a
rate of 30% in 2007. The amendment was signed and published in July 2004 and is,
therefore, considered enacted in July 2004. As the Company currently has no
taxable income, and no deferred taxes were recorded, the amendment does not have
an impact on the Company's results of operation or financial position.
f. Deferred income taxes:
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and amounts used for income tax purposes. Significant components of the
Company's deferred tax assets resulting from tax loss carryforward are as
follows:
December 31,
------------ ------------
2004 2003
------------ ------------
Operating loss carryforward $ 32,532,998 $ 33,958,434
Reserve and allowance 1,328,479 843,453
------------ ------------
Net deferred tax asset before valuation allowance 33,861,477 34,801,887
Valuation allowance (33,725,995) (34,801,887)
------------ ------------
Total deferred tax asset $ 135,482 $ --
============ ============
Deferred tax liability $ 51,366 $ --
============ ============
The Company and its subsidiaries provided valuation allowances in respect of
deferred tax assets resulting from tax loss carryforwards and other temporary
differences. Management currently believes that it is more likely than not that
the deferred tax assets related to the loss carryforwards and other temporary
differences will not be realized. The change in the valuation allowance as of
December 31, 2004 was $1,075,892
F-55
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
g. Loss from continuing operations before taxes on income and minorities
interests in loss (earnings) of a subsidiary:
Year ended December 31
---------------------------------------------------------------
2004 2003* 2002**
------------------- ------------------- -------------------
Domestic $ 8,006,205 $ 7,411,121 $ 5,250,633
Foreign 405,305 1,697,617 13,253,725
------------------- ------------------- -------------------
$ 8,411,510 $ 9,108,738 $ 18,504,358
=================== =================== ===================
- -------------------------
* Restated (see Note 1.b.).
** Includes loss from discontinued operations and minority interest
in loss (earnings) of a subsidiary
h. Taxes on income were comprised of the following:
Year ended December 31
----------------------------------------------------
2004 2003 2002
--------------- --------------- ---------------
Current state and local
taxes $ 539,674 $ 44,102 $ --
Deferred taxes (37,857) -- --
Taxes in respect of prior
years 84,292 352,091 --
--------------- --------------- ---------------
$ 586,109 $ 396,193 $ --
=============== =============== ===============
Domestic $ 163,087 $ 33,020 $ --
Foreign 423,022 363,173 --
--------------- --------------- ---------------
$ 586,109 $ 396,193 $ --
=============== =============== ===============
i. The cumulative amount of undistributed earnings of foreign subsidiaries,
which is intended to be permanently reinvested and for which U.S. income taxes
have not been provided, totaled approximately $180,000 and $0 on December 31,
2004 and 2003 respectively.
j. A reconciliation between the theoretical tax expense, assuming all income is
taxed at the statutory tax rate applicable to income of the Company and the
actual tax expense as reported in the Statement of Operations is as follows:
F-56
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Year ended December 31,
-------------------------------------------
2004 2003* 2002
----------- ----------- -----------
Loss from continuing operations before taxes, as $(8,411,510) $(9,108,738) $(4,582,792)
reported in the consolidated statements of income
=========== =========== ===========
Statutory tax rate 34% 34% 34%
=========== =========== ===========
Theoretical income tax on the above amount at the $(2,859,914) $(3,096,971) $(1,558,149)
U.S. statutory tax rate
Deferred taxes on losses for which valuation
allowance was provided 556,692 1,146,754 1,558,149
Non-deductible expenses 1,629,874 1,873,129 --
State taxes 168,081 33,020 --
Accrual for deferred taxes on undistributed earnings 49,416 -- --
Foreign income in tax rates other then U.S rate
919,895 86,954 --
Taxes in respect of prior years 84,292 352,091 --
Others 37,773 1,216 --
----------- ----------- -----------
Actual tax expense $ 586,109 $ 396,193 $ --
=========== =========== ===========
- -----------------------
* Restated (see Note 1.b.).
NOTE 16:- SELECTED STATEMENTS OF OPERATIONS DATA
Financial income (expenses), net:
Year ended December 31,
------------------------------------------
2004 2003* 2002
----------- ----------- -----------
Financial expenses:
Interest, bank charges and fees $ (622,638) $ (355,111) $ (89,271)
Amortization of compensation related to warrants
issued to the holders of convertible debentures and
beneficial conversion feature (4,142,109) (3,928,237) --
Bonds premium amortization (202,467) -- --
Foreign currency translation differences (71,891) 115,538 15,202
----------- ----------- -----------
(5,039,105) (4,167,810) (74,069)
----------- ----------- -----------
Financial income:
Interest 443,182 129,101 174,520
Realized gain from marketable securities sale 40,119 -- --
Financial income in connection with warrants
granted (note 14.f.4) 326,839 -- --
----------- ----------- -----------
Total $(4,228,965) $(4,038,709) $ 100,451
=========== =========== ===========
- ----------
* Restated (see Note 1.b.).
F-57
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 17:- RELATED PARTY DISCLOSURES
Year ended December 31,
----------------------------------------------------------
2004 2003 2002
----------------- ----------------- -----------------
Transactions:
Reimbursement of general and administrative expenses - - $ 36,000
================= ================= =================
Financial income (expenses), net from notes receivable
and loan holders $ 18,251 - $ (7,309)
================= ================= =================
NOTE 18:- SEGMENT INFORMATION
a. General:
The Company and its subsidiaries operate primarily in three business segments
(see Note 1.a. for a brief description of the Company's business) 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 and AoA in August of 2004, the Company reorganized into three segments:
Simulation and Security; Armor; and Battery and Power Systems. As a result the
Company restated information previously reported in order to comply with new
segment reporting.
The Company's reportable operating segments have been determined in accordance
with the Company's internal management structure, which is organized based on
operating activities. The accounting policies of the operating segments are the
same as those described in the summary of significant accounting policies. 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 gains, losses and assets:
Simulation Armor Battery and All Others(4) Total
and Security Power Systems
------------- --------------- --------------- --------------- -------------
2004
Revenues from outside customers $21,464,406 $ 17,988,687 $ 10,500,753 $ - $49,953,846
Depreciation expenses and amortization (1) (1,983,822) (1,755,847) (1,132,953) (135,613) (5,008,235)
Direct expenses (2) (17,910,967) (16,444,476) (9,974,544) (5,431,627) (49,761,614)
------------- --------------- --------------- --------------- -------------
Segment net income (loss) $ 1,569,617 $ (211,636) $ (606,744) $ (5,567,240) (4,816,003)
============= =============== =============== ===============
Financial expenses (after deduction of
minority interest) (4,226,310)
Net loss from continuing operations $(9,042,313)
=============
Segment assets (3) $ 1,872,943 $ 5,819,266 $ 3,455,188 $ 730,595 $11,877,992
============= =============== =============== =============== =============
F-58
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Simulation Armor Battery and All Others(4) Total
and Security Power Systems
------------- --------------- --------------- --------------- -------------
2004
2003*
Revenues from outside customers $ 8,022,026 $ 3,435,716 $ 5,868,899 $ - $17,326,641
Depreciation expenses and amortization (757,997) (169,668) (527,775) (139,630) (1,595,070)
Direct expenses (2) (7,308,649) (3,584,284) (5,945,948) (4,200,770) (21,039,651)
------------- --------------- --------------- --------------- -------------
Segment net income (loss) $ (44,620) $ (318,236) $ (604,824) $ (4,340,400) (5,308,080)
============= =============== =============== ===============
Financial expenses (after deduction of (4,039,951)
minority interest)
-------------
Net loss from continuing operations $(9,348,031)
=============
Segment assets (3) $ 898,271 $ 730,291 $ 2,128,062 $ 450,864 $ 4,207,488
============= =============== =============== =============== =============
2002
Revenues from outside customers $ 1,980,061 $ 2,744,382 $ 1,682,296 $ - $ 6,406,739
Depreciation expenses and amortization (1) (569,832) (106,921) (252,514) (194,014) (1,123,281)
Direct expenses (1) (2,037,775) (2,315,995) (3,062,548) (2,905,743) (10,322,061)
------------- --------------- --------------- --------------- -------------
Segment net income (loss) $ (627,546) $ 321,466 $ (1,632,766) $ (3,099,757) (5,038,603)
============= =============== =============== ===============
Financial income (after deduction of 100,451
minority interest)
-------------
Net income from continuing operations $(4,938,152)
=============
Segment assets (3) $ 655,143 $ 1,028,682 $ 2,007,291 $ 575,612 $ 4,266,728
============= =============== =============== =============== =============
- -----------------------------
* Restated (see Note 1.b.).
(1) Including property and equipment depreciation, intangible assets
amortization and amortization of adjustment of one of the Company's
subsidiaries' inventory to market values as of the purchase date. (2) Including
sales and marketing, general and administrative expenses.
(3) Including property and equipment and inventory. (4) Including unallocated
costs.
c. Summary information about geographic areas:
The following presents total revenues according to end customers location for
the years ended December 31, 2004, 2003 and 2002, and long-lived assets as of
December 31, 2004, 2003 and 2002:
2004 2003 2002
------------------------------ ------------------------------ ------------------------------
Total Long-lived Total Long-lived Total Long-lived
revenues assets revenues assets revenues assets
-------------- -------------- -------------- -------------- -------------- ---------------
U.S. dollars
----------------------------------------------------------------------------------------------
U.S.A. $40,656,729 $ 45,154,086 $10,099,652 $ 6,778,050 $ 2,787,250 $ 6,710,367
Germany 319,110 - 2,836,725 - 38,160 -
England 344,261 - 29,095 - 47,696 -
Thailand - - 95,434 - 291,200 -
India 3,061,705 - - - - -
Israel 4,212,408 13,560,822 3,576,139 2,954,441 2,799,365 3,367,320
Other 1,359,633 - 689,596 - 443,068 -
-------------- -------------- -------------- -------------- -------------- ---------------
$49,953,846 $ 58,714,908 $17,326,641 $ 9,732,491 $ 6,406,739 $ 10,077,687
============== ============== ============== ============== ============== ===============
F-59
AROTECH CORPORATION AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
d. Revenues from major customers:
Year ended December 31,
----------------------------------------------------
2004 2003 2002
%
-------------- --- -------------- --- --------------
Batteries and power systems:
Customer A 8% 27% 8%
Armor:
Customer B 4% 17% 43%
Customer C 24% - -
Simulation and security:
Customer D 13% - -
Customer E 1% 16% -
e. Revenues from major products:
Year ended December 31,
----------------------------------------------------
2004 2003 2002
-------------- -------------- --------------
Electric - vehicle $ 232,394 $ 408,161 $ 460,562
Water activated batteries 921,533 703,084 647,896
Military batteries 9,324,247 4,757,116 573,839
Car armoring 17,988,686 3,435,715 2,744,382
Simulators 21,414,968 7,961,302 1,980,060
Other 72,018 61,263 -
-------------- -------------- --------------
Total $49,953,846 $ 17,326,641 $ 6,406,739
============== ============== ==============
F-60
SUPPLEMENTARY FINANCIAL DATA
Quarterly Financial Data (unaudited) for the two years ended December 31, 2004
Quarter Ended*
--------------------------------------------------------------------
2004 March 31 June 30 September 30 December 31
------------------------------ --------------------------------------------------------------------
Net revenue................................. $ 7,182,254 $ 9,928,248 $ 16,272,521 $ 16,570,823
Gross profit................................ $ 2,625,034 $ 3,353,501 $ 4,723,573 $ 5,240,644
Net profit (loss) from continuing operations $ (2,517,889) $ (4,396,123) $ 1,126,845 $ (3,255,146)
Net loss from discontinued operations....... $ - $ - $ - $ -
Net profit (loss) for the period............ $ (2,517,889) $ (4,396,123) $ 1,126,845 $ (3,255,146)
Deemed dividend to certain stockholders of
common stock $ (1,163,000) $ - $ (2,165,952) $ -
Net loss attributable to common stockholders $ (3,680,889) $ (4,396,123) $ (1,039,107) $ (3,255,146)
Net profit (loss) per share - basic and
diluted..................................... $ (0.06) $ (0.07) $ (0.01) $ (0.04)
Shares used in per share calculation........ 59,406,466 64,499,090 76,744,251 79,075,181
Quarter Ended
--------------------------------------------------------------------
2003* March 31 June 30 September 30 December 31
------------------------------ --------------------------------------------------------------------
Net revenue................................. $ 4,033,453 $ 3,493,135 $ 5,705,898 $ 4,094,155
Gross profit................................ $ 1,399,734 $ 1,013,965 $ 2,453,575 $ 1,371,527
Net loss from continuing operations......... $ (1,291,122) $ (2,788,348) $ 218,606 $ (5,487,167)
Net income (loss) from discontinued
operations.................................. $ (95,962) $ 179,127 $ (2,285) $ 29,529
Net income (loss) for the period............ $ (1,387,083) $ (2,609,221) $ 216,321 $ (5,457,638)
Deemed dividend to certain stockholders of
common stock................................ $ - $ (172,350) $ (94,676) $ (82,974)
Net income (loss) attributable to common
stockholders................................ $ (1,387,083) $ (2,781,571) $ 121,645 $ (5,540,612)
Net loss per share - basic and diluted...... $ (0.04) $ (0.08) $ 0.00 $ (0.13)
Shares used in per share calculation........ 34,758,960 36,209,872 40,371,940 43,604,830
- -----------------------
* Restated (see Note 1.b. of Notes to Consolidated Financial Statements).
F-61
FINANCIAL STATEMENT SCHEDULE
Arotech Corporation and Subsidiaries
Schedule II - Valuation and Qualifying Accounts
For the Years Ended December 31, 2004, 2003 and 2002
Additions
Balance at charged to Balance at
beginning costs and end of
Description of period expenses period
- --------------------------------------------- --------------- --------------- ----------------
Year ended December 31, 2004
Allowance for doubtful accounts........... $ 61,282 $ (5,888) $ 55,394
Allowance for slow moving inventory 96,350 121,322 217,672
Valuation allowance for deferred taxes.... 34,801,887 (1,075,892) 33,725,995
--------------- --------------- ----------------
Totals.................................... $ 34,959,519 $ (960,458) $ 33,999,061
=============== =============== ================
Year ended December 31, 2003
Allowance for doubtful accounts........... $ 40,636 $ 20,646 $ 61,282
Allowance for slow moving inventory - 96,350 96,350
Valuation allowance for deferred taxes.... 29,560,322 5,241,565 34,801,887
--------------- --------------- ----------------
Totals.................................... $ 29,600,958 $ 5,358,561 $ 34,959,519
=============== =============== ================
Year ended December 31, 2002
Allowance for doubtful accounts........... $ 39,153 $ 1,483 $ 40,636
Valuation allowance for deferred taxes.... 12,640,103 16,920,219 29,560,322
--------------- --------------- ----------------
Totals.................................... $ 12,679,256 $ 16,921,702 $ 29,600,958
=============== =============== ================
EXHIBIT INDEX
Exhibit
Number Description
------ -----------
4.1......Specimen certificate for shares of common stock, $.01 par value
10.91....Consulting Agreement, effective as of January 1, 2005, between us and Sampen Corporation
21.1.....List of Subsidiaries of the Registrant
23.1.....Consent of Kost, Forer, Gabbay & Kassierer, a member of Ernst & Young Global
23.2.....Consent of Stark Winter Schenkein & Co., LLP
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.....Written Statement of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
32.2.....Written Statement of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
100