UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
|X| Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 2005
|_| 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 001-14015
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IONATRON, INC.
(Exact Name of Registrant as Specified in Its Charter)
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Delaware 77-0262908
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(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification Number)
3590 East Columbia Street
Tucson, Arizona 85714
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (520) 628-7415
Securities registered pursuant to Section 12(b) of the Exchange Act:
None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, $.001 par value
Series A Preferred Stock, $.001 par value
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(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes |_| No |X|
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes |_| No [X ]
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 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. [X ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large Accelerated Filer |_| Accelerated Filer |X| Non-Accelerated Filer |_|
1
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act. Yes |_| No |X|
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The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant, computed by reference to the last reported
sales price at which the stock was sold on June 30, 2005 (the last day of the
registrant's most recently completed second quarter) was approximately
$209,895,000.
The number of outstanding shares of the registrant's Common Stock, $.001 par
value, as of March 14, 2006 was 72,339,453.
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IONATRON, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
INDEX
PART I. Page No.
Item 1. Business........................................................4
Item 1A. Risk Factors....................................................7
Item 1B. Unresolved Staff Comments......................................14
Item 2. Properties.....................................................14
Item 3. Legal Proceedings..............................................14
Item 4. Submission of Matters to a Vote of Security Holders............14
PART II.
Item 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities....................................................15
Item 6. Selected Financial Data.......................................15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations...........................17
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk..........................................................25
Item 8. Financial Statements and Supplementary Data...................25
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure...........................25
Item 9A. Controls and Procedures........................................25
Item 9B. Other Information..............................................28
PART III.
Item 10. Directors and Executive Officers of the Registrant............29
Item 11. Executive Compensation........................................33
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters....................35
Item 13. Certain Relationships and Related Transactions................38
Item 14. Principal Accountant Fees and Services........................38
PART IV:
Item 15. Exhibits and Financial Statement Schedules....................39
Schedule II - Valuation and Qualifying Accounts ............................39
Signatures: ...............................................................43
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PART I
ITEM 1. BUSINESS:
CAUTIONARY NOTE CONCERNING FORWARD-LOOKING STATEMENTS:
Certain statements in this Form 10-K constitute forward-looking statements for
purposes of the securities laws. Forward-looking statements include all
statements that do not relate solely to the historical or current facts, and can
be identified by the use of forward looking words such as "may", "believe",
"will", "expect", "expected", "project", "anticipate", "anticipated"
"estimates", "plans", "strategy", "target", "prospects" or "continue". These
forward looking statements are based on the current plans and expectations of
our management and are subject to a number of uncertainties and risks that could
significantly affect our current plans and expectations, as well as future
results of operations and financial condition and may cause our actual results,
performances or achievements to be materially different from any future results,
performances or achievements expressed or implied by such forward-looking
statements. This Form 10-K contains important information as to risk factors
above. In making these forward-looking statements, we claim the protection of
the safe-harbor for forward-looking statements contained in the Private
Securities Reform Act of 1995. Although we believe that the expectations
reflected in such forward-looking statements are reasonable, there can be no
assurance that such expectations will prove to have been correct. We do not
assume any obligation to update these forward-looking statements to reflect
actual results, changes in assumptions, or changes in other factors affecting
such forward-looking statements.
AVAILABLE INFORMATION:
Ionatron makes available free of charge on its website at www.ionatron.com its
annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, and amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Exchange Act, as soon as reasonably practical after
electronically filing or furnishing such material to the Securities and Exchange
Commission (SEC).
This report may be read or copied at the SEC's Public Reference Room at 100 F
Street, NE, Room 1580, Washington, DC 20549 or at www.sec.gov. Information on
the operation of the Public Reference Room may be obtained by calling the SEC at
1-800-SEC-0330.
GENERAL:
Ionatron was formed to develop and market Directed Energy Weapon products and
other products incorporating its proprietary LIPC and related technologies. Our
goal is to produce products that incorporate our technology for initial sale to
U.S. Government customers for specific applications and platforms as well as to
produce products for other commercial customers. Ionatron and the U.S.
Government have entered into several contracts for products and services as well
as Cooperative Research and Development Agreements for joint research on Laser
Induced Plasma Channel ("LIPC") based Directed Energy Weapons. We expect to
offer U.S. Government approved versions of our products for other government and
non-government commercial security applications in the future. During 2002 and
2003, we engaged in research and development and business development activities
culminating in our first U.S. Government contract in September of 2003. During
2004 we demonstrated the laser guided man-made lightning Directed Energy
technology in the laboratory; demonstrated the technology effects on a variety
of targets both under U.S. Government contract and using internal research and
development funding; delivered a compact laser source specifically designed to
enable the technology under a U.S. Government contract; and commenced a U.S.
Government contract for the development of a system on a mobile platform for
field demonstration and testing. In 2005, we continued development of laser
sources, advanced high voltage systems, and special-purpose optical systems,
expanded target effects testing under U.S. Government contracts, and furthered
our understanding of the underlying physics and continued to develop additional
intellectual property with internal funding. Additionally in 2005, we developed
a counter IED ("Improved Explosive Device") vehicle for use in Iraq called the
Joint IED Neutralizer ("JIN"). Our JIN units have been tested by the government
and have been determined to have military utility - which the Government
requires before it will consider ordering production units.
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In early April 2005, we took occupancy of our manufacturing facility at the NASA
Stennis Space Center which had recently been upgraded, utilizing $2 million in
U.S. Army funding. We prepared the facility for range testing and manufacturing
throughout 2005 with some level of production anticipated to continue in 2006.
The Stennis manufacturing facility was utilized for the manufacture of our JIN
units; however, the Stennis facility was temporarily closed as a result of
Hurricane Katrina and manufacturing was moved to our facility in Tucson,
Arizona. The facility will be reopened for JIN manufacturing and will also be
utilized for integrated system and component production for both JIN and LIPC
weapon system production. We anticipate that initial production activities will
commence in the event the U.S. Government is satisfied that the technologies are
ready for field use. The Mississippi facility would also be used for extended
range testing and effects testing. It is also anticipated we will use the
facility for any production level contracts from our North Star subsidiary.
The Government's level of interest in our technology has resulted in follow-on
contracts and led to LIPC being funded in the 2006 Department of Defense (or
DoD) budget as a separate line item. The continued move by the DoD towards
Directed Energy solutions for soldiers, versus traditional ballistic
technologies, leads us to believe that DoD spending for Directed Energy
technologies in the coming years will continue to increase.
Overall, we expect to continue our transition from development to commercial
production in 2006. We will continue the long-term development of our LIPC
product line and expect that some LIPC products for high priority, mission
specific applications, will enter into low rate initial production. We also
expect to expand our production capabilities for our JIN units. We anticipate
further growth in our North Star operations and anticipate that some of its
development contracts will mature into production contracts.
Our executive office is located at 3590 East Columbia Street, Tucson, Arizona
85714 and its telephone number is (520) 628-7415.
IONATRON OPERATIONS:
We are a new technology company working under contracts with agencies of the
U.S. Government focused on national security. We have developed and demonstrated
in our laboratory a novel, internally developed Directed Energy Weapon
technology called LIPC. Our LIPC technology controls and directs electrical
energy between two points. Our business strategy is to continue long-term
development of the technology for multiple national security and defense
applications, as well as to develop applications in commercial sectors.
Short-term military applications have been demonstrated to our customers.
We have had meetings and performed demonstrations of the technology for all
branches of the U.S. Military, as well as many other U.S. Government
organizations involved in various defensive, offensive or anti-terrorism
military type operations. We presently have many potential contracts in the
negotiation stage and have U.S. Government customers actively seeking short-term
and long-term funding for our projects. We cannot assure that any such contracts
will become finalized in a timely manner, or at all.
In order to help manage our interface with our Government customers and
Congressional funding counterparts, we maintain an ongoing relationship with a
well-known and qualified Washington, D.C. based Government Relations firm. In
order to evaluate new business opportunities and expand the business development
initiatives at Ionatron, we have added a Vice President, Business
Development/Strategy with established contacts within the military.
Our LIPC technology is designed as a line of sight weapon, which enables the
propagation of various forms and quantities of electrical energy to be aimed and
directed at a target or between two points. Laboratory demonstrations of the
technology have ranged from low voltage disruptive energies up to very high
voltages and currents causing physical damage.
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We intend to take advantage of, and utilize, slightly modified existing and
mature laser targeting and tracking technology for our systems. We are in
negotiations with various vendors to supply, to our specifications, the various
support and auxiliary system requirements. Outsourcing such supply requirements
is intended to free up our technical personnel and other resources to focus on
development of next generation elements of our core technologies. After
subsystems and components are delivered from outside vendors, they are then
assembled and integrated at Ionatron to produce the final integrated LIPC
systems.
These LIPC systems are being designed as all-electric, self-contained, modular
units that can operate off of existing electrical power generation systems found
on typical mobile military platforms. Due to the low average power requirements
of LIPC systems, no additional or exotic power generation systems are required.
We expect future LIPC systems will utilize advanced electrical technologies
developed for other military programs to support smaller, lighter LIPC systems.
This will enable LIPC to be mounted on smaller, autonomous platforms now under
development for other Government programs.
The targets, effects, ranges, voltages and currents delivered, along with many
other aspects of the technology are classified under specific Department of
Defense guidelines and, consequently, cannot be disclosed to the public.
NORTH STAR OPERATIONS:
In September 2004, we completed the acquisition of substantially all the assets
of North Star Research Corporation through our subsidiary, North Star Power
Engineering, Inc. ("North Star"). North Star is engaged in the business of
designing and manufacturing a broad range of high voltage equipment for the
defense, aerospace, semi-conductor and medical industries. North Star has
ongoing contracts for research and development with Government customers such as
the United States Air Force, Sandia National Laboratory and Los Alamos National
Laboratory. Prior to the acquisition, we had been working with North Star to
develop and manufacture the high voltage electrical sources for the LIPC
Directed Energy Weapons.
In January 2005, we doubled the space at North Star's facility in anticipation
of continued growth in its product line. Through North Star, we are involved in
the design and manufacture of a broad range of high voltage equipment for the
defense, aerospace, semi-conductor, and medical industries. We intend for North
Star to grow its base of business in both the defense sector and commercial
industry.
PATENTS/PROPRIETARY INFORMATION:
We have 3 patents and numerous patent applications in various stages of
preparation and prosecution, which we believe possess novel intellectual
property. These applications might be able to secure patents that will protect
our proprietary technical information and capabilities and will give us a
competitive advantage in continuing to be the leader in LIPC technology. Some of
these patent applications will be evaluated by the Government to determine if
the technology protected is classified in nature. These applications will not be
published as specified under section 181 of the U.S. Patent Act. We also have
proprietary information in the form of trade secrets and technology specific
know-how that should give us additional competitive advantages.
CUSTOMER DEPENDENCY AND ELECTION OF GOVERNMENT:
Our revenue is derived from contracts with the U.S. Government or contractors to
the U.S. Government which represents approximately 100%, 99% and 96% of total
revenue for 2003, 2004 and 2005, respectively. The loss of any of these
customers would have a material adverse effect on Ionatron. All contracts are
subject to renegotiation of profits or termination at the election of the
Government.
RESEARCH AND DEVELOPMENT:
We funded our original research and development through capital investment by
our founders and we retain the ownership of all the original intellectual
property. We believe the core intellectual property we have developed is that
which is necessary to use and control the LIPC technology. We also outsource
certain research tasks to experienced individuals or companies for some
activities that require sophisticated laboratory equipment or optical modeling
programs we do not have at our disposal. We have over ten relationships of this
kind, which provide that any intellectual property developed under these
agreements is the sole property of Ionatron. Our research and development
expense for 2003, 2004 and 2005 was $1,151,350, $808,242 and $1,266,382,
respectively.
Our short-term research and development goals are to complement the existing
system design by developing more efficient and compact laser sources, high
voltage electrical sources, and lower cost, more efficient optical systems. We
are developing prototype products that incorporate our key technologies for
government and non-government commercial markets that will be commercialized
pending outcomes of technical and commercial developments. Our Government
customers fund some of this development work. Most of our research related work
is funded internally in order to capture any intellectual property rights from
novel processes and inventions that may arise.
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Our long-term research goal is to identify and extend the long-range physical
limits of the technology. This work relates to understanding the long-range
capabilities of LIPC from alternative and potentially technically superior
optical sources and new potential wavelengths that it may be advantageous to
exploit. This work includes efforts to achieve a more complete understanding of
the entire physical laws we work within regarding atmospheric physics, plasma
physics, and the future capabilities of new solid-state laser materials and
laser processes that may enable the technology to be more fully exploited.
We also intend to explore other uses of the technology in the existing
application area as well as completely novel applications in commercial sectors
outside the defense and national security application areas.
EMPLOYEES:
As of March 14, 2006, we had 104 employees, compared to 67 on December 31, 2004
and 12 on December 31, 2003, 40 of which are in management and general
administrative, 7 are in human resources, 31 are in technical and engineering
and 26 are in manufacturing. The increase in employees was driven by the need to
increase staff to meet the demands of our contract commitments as well as the
acquisition of North Star. We expect to significantly increase the number of our
personnel during 2006, primarily in manufacturing.
ITEM 1A. RISKS FACTORS:
Future results of operations of Ionatron involve a number of known and unknown
risks and uncertainties. Factors that could affect future operating results and
cash flows and cause actual results to vary materially from historical results
include, but are not limited to those risks set forth below:
Risk Related to Our Business
We have a history of losses and may not be able to achieve and maintain
profitable operations.
We have incurred net losses since our formation in June 2002, including net
losses of $3,242,109, $3,261,005, and $3,624,603 for the years ended December
31, 2003, 2004 and 2005, respectively. Additionally, losses are continuing to
date. Our ability to achieve profitable operations is dependent upon, among
other things, our ability to obtain sufficient government contracts and to
complete the development of products based on our technologies. We cannot
assure you that we will be able to significantly increase our revenue or
achieve and maintain profitability.
We expect that we will be dependent upon sales of our JIN products for a
substantial portion of our revenue over the near term and the timing and
magnitude of such sales cannot be predicted.
We expect that we will be dependent upon sales of our JIN products for a
substantial portion of our revenue over the near term and until such time as
our LIPC technology advances enable our Government customers to provide
additional funding to advance our LIPC technology from early system
integration stage to fully integrated prototypes and fieldable systems, and
develop additional products based on our proprietary technology. Because
Government agencies are the intended customers for our JIN products, it is
uncertain whether we will enter into such production orders and, if we do,
what the timing or magnitude of such orders will be. In the event these
orders do not develop as anticipated, especially following hiring of
additional employees and further expenditures in anticipation of such sales,
our losses may increase and we may experience cash flow shortages. There can
be no assurance that we will receive production orders for our JIN products
in accordance with our anticipated time table, or at all.
If our LIPC technology does not meet certain testing milestones, it is
possible that additional government funding may be reduced or eliminated.
Congressional funding for LIPC is subject to our technology meeting certain
Government established milestones. If our LIPC technology does not meet
government established milestones, additional government funding may be
reduced or eliminated. If additional government funding for LIPC is reduced
or is not forthcoming, in the absence of additional funding, our LIPC
technology development efforts will be adversely affected.
Our future success will depend on our ability to develop new technologies
and applications that address the needs of our markets.
Both our defense and commercial markets are characterized by rapidly changing
technologies and evolving industry standards. Accordingly, our future
performance depends on a number of factors, including our ability to:
o identify emerging technological trends in our target markets;
o develop and maintain competitive products;
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o enhance our products by improving performance and adding innovative
features that differentiate our products from those of our
competitors;
o develop and manufacture and bring products to market quickly at
cost-effective prices; and
o meet scheduled timetables for the development, certification and
delivery of new products.
We believe that, in order to remain competitive in the future, we will need
to continue to develop new products, which will require the investment of
significant financial and engineering resources. The need to make these
expenditures could divert our attention and resources from other projects,
and we cannot be sure that these expenditures will ultimately lead to the
timely development of new technology. Due to the design complexity of our
products, we may in the future experience delays in completing development
and introduction of new products. Any delays could result in increased costs
of development, deflect resources from other projects or loss of contracts.
In addition, there can be no assurance that the market for our products will
develop or continue to expand as we currently anticipate. The failure of our
technology to gain market acceptance could significantly reduce our revenue
and harm our business. Furthermore, we cannot be sure that our competitors
will not develop competing technologies which gain market acceptance in
advance of our products. The possibility that our competitors might develop
new technology or products might cause our existing technology and products
to become obsolete or create significant price competition. If we fail in our
new product development efforts or our products fail to achieve market
acceptance more rapidly than our competitors, our revenue will decline and
our business, financial condition and results of operations will be
negatively affected.
We depend on the U.S. Government for substantially all of our revenue, and
a reduction in the quality of this relationship or a shift in Government
funding could have severe consequences on our prospects and financial
condition.
Approximately 100%, 99% and 96% of our net revenue for the years ended
December 31, 2003, 2004 and, 2005, respectively, were to the U.S. Government
and U.S. Government contractors. Therefore, any significant disruption or
deterioration of our relationship with the U.S. Government would
significantly reduce our revenue. Our U.S. Government programs must compete
with programs managed by other defense contractors for a limited number of
programs and for uncertain levels of funding. The development of our business
will depend upon the continued willingness of the U.S. government agencies to
fund existing and new defense programs and, in particular, to continue to
purchase our products and services. Although defense spending in the United
States has recently increased, further increases may not continue and any
proposed budget or supplemental budget request may not be approved. In
addition, the U.S. Department of Defense may not continue to focus its
spending on technologies that we incorporate in our products.
Our competitors continuously engage in efforts to expand their business
relationships with the U.S. Government which may be to our disadvantage and
are likely to continue these efforts in the future. The U.S. Government may
choose to use other defense contractors for its limited number of defense
programs. In addition, the funding of defense programs also competes with
non-defense spending of the U.S. Government. Budget decisions made by the
U.S. Government are outside of our control and have long-term consequences
for the size and structure of Ionatron. A shift in Government defense
spending to other programs in which we are not involved or a reduction in
U.S. Government defense spending generally could have severe consequences for
our results of operations.
The U.S. Government may terminate or modify our existing contracts, which
would adversely affect our revenue.
There are inherent risks in contracting with the U.S. Government, including
risks peculiar to the defense industry, which could have a material adverse
effect on our business, financial condition or results of operations. Laws
and regulations permit the U.S. Government to:
o terminate contracts for its convenience;
o reduce or modify contracts if its requirements or budgetary
constraints change;
o cancel multi-year contracts and related orders if funds for contract
performance for any subsequent year become unavailable;
o shift its spending practices; and
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o adjust contract costs and fees on the basis of audits done by its
agencies.
If the U.S. Government terminates our contracts for convenience, we may only
recover our costs incurred or committed for settlement expenses and profit on
work completed before the termination. Additionally, most of our backlog
could be adversely affected by any modification or termination of contracts
with the U.S. Government or contracts the prime contractors have with the
U.S. Government. The U.S. Government regularly reviews our costs and
performance on its contracts, as well as our accounting and general business
practices. The U.S. Government may reduce the reimbursement for our fees and
contract-related costs as a result of an audit. We can give no assurance that
one or more of our Government contracts will not be terminated under these
circumstances. Also, we can give no assurance that we would be able to
procure new Government contracts to offset the revenue lost as a result of
any termination of our contracts. As our revenue is dependent on our
procurement, performance and payment under our contracts, the loss of one or
more critical contracts could have a negative impact on our financial
condition.
Our business is subject to various restrictive laws and regulations
because we are a contractor and subcontractor to the U.S. Government.
As a contractor and subcontractor to the U.S. Government, we are subject to
various laws and regulations that are more restrictive than those applicable
to non-government contractors. We are required to obtain and maintain
material governmental authorizations and approvals to run our business as it
is currently conducted. New or more stringent laws or government regulations
concerning government contracts, if adopted and enacted, could have a
material adverse effect on our business.
Generally, government contracts are subject to oversight audits by government
representatives. Responding to governmental audits, inquiries or
investigations may involve significant expense and divert management
attention from regular operations. Our government business is also subject to
specific procurement regulations and a variety of socio-economic and other
requirements. These requirements, although customary in government contracts,
increase our performance and compliance costs. These costs might increase in
the future, reducing our margins, which could have a negative effect on our
financial condition. Failure to comply with these regulations and
requirements could lead to suspension or debarment, for cause, from
government contracting or subcontracting for a period of time. Among the
causes for debarment are violations of various statutes, including those
related to:
o procurement integrity;
o export control;
o government security regulations;
o employment practices;
o protection of the environment;
o accuracy of records and the recording of costs; and
o foreign corruption.
Any of these factors, which are largely beyond our control, could also
negatively impact our financial condition. We also may experience problems
associated with advanced designs required by the government, which may result
in unforeseen technological difficulties and cost overruns. Failure to
overcome these technological difficulties and the occurrence of cost overruns
would have a negative impact on our results.
At North Star, if we fail to win competitively awarded contracts in the
future, we may experience a reduction in our revenue, which could
negatively affect our profitability.
North Star obtains many of its U.S. Government, U.S. Government subcontractor
and commercial contracts through a competitive bidding process. We cannot
assure you that we will continue to win competitively awarded contracts or
that awarded contracts will generate revenue sufficient to result in our
profitability. We are also subject to risks associated with the following:
o the frequent need to bid on programs in advance of the completion of
their design (which may result in unforeseen technological
difficulties and cost overruns);
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o the substantial time and effort, including the relatively
unproductive design and development required to prepare bids and
proposals, spent for competitively awarded contracts that may not be
awarded to us;
o design complexity and rapid technological obsolescence; and
o the constant need for design improvement.
Our government contracts may be subject to protest or challenge by
unsuccessful bidders or to termination, reduction or modification in the
event of changes in government requirements, reductions in federal spending
or other factors.
Competition within our markets may reduce our procurement of future
contracts and our revenue.
The defense and commercial industries in which we operate are highly
competitive. Our future competitors may range from highly resourceful small
concerns, which engineer and produce specialized items, to large, diversified
firms and defense contractors. Many of our potential competitors have more
extensive or more specialized engineering, manufacturing and marketing
capabilities and greater financial resources than we do. Consequently, these
competitors may be better suited to take advantage of economics of scale and
devote greater resources to develop new technologies. There can be no
assurance that we can continue to compete effectively with these firms. In
addition, some of our suppliers and customers could develop the capability to
manufacture products similar to products that we are developing. This would
result in them competing directly which could significantly reduce our
revenue and seriously harm our business.
There can be no assurance that we will be able to compete successfully
against our current or future competitors or that the competitive pressures
we face will not result in reduced revenue and market share or seriously harm
our business.
We derive a substantial portion of our revenue from a limited number of
contracts. Therefore, our revenue will be adversely affected if we fail to
receive renewal or follow-on contracts.
Renewal and follow-on contracts are important because our contracts are
typically for fixed terms. These terms vary from shorter than one year to
multi-year, particularly for contracts with options. The typical term of our
contracts with the U.S. government is between one and two years. The loss of
revenue from our possible failure to obtain renewal or follow-on contracts
may be significant because our U.S. Government contracts account for a
substantial portion of our revenue.
Our products may fail to perform satisfactorily in field tests at various
stages of development and even if our products perform satisfactorily,
there may be unanticipated delays in obtaining contracts.
Our government customers typically field test our products at various stages
of development. Although we believe our technologies will perform their
ultimately intended applications, many of our products have not been
completed to date. Our success will ultimately depend upon our products
meeting performance criteria established by our customers. Failure of a
product to perform satisfactorily in a field test could result in delay of
product development, cost overruns or even termination of the contract, any
of which could materially affect the development of such product and our
prospects, revenue and final condition.
We have in the past experienced delays in obtaining government contracts
despite what we have been advised by prospective government customers after
our products have been satisfactorily field tested. These delays are inherent
in doing business with government contracting agencies. Nevertheless, these
delays make it difficult for us to predict and prepare for production and can
adversely affect anticipated operating results.
We depend on component availability, subcontractor performance and our key
suppliers to manufacture and deliver our products and services.
Our manufacturing operations are highly dependent upon the delivery of
materials by outside suppliers in a timely manner. In addition, we depend in
part upon subcontractors to assemble major components and subsystems used in
our products in a timely and satisfactory manner. If these contract
manufacturers are not willing to contract with us on competitive terms or
devote adequate resources to fulfill their obligations to us, or we do not
properly manage these relationships, our existing customer relationships may
suffer. In addition, by undertaking these activities, we run the risks that:
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o the reputation and competitiveness of our products and services may
deteriorate as a result of the reduction of our control and quality
and delivery schedules and the consequent risk that we will
experience supply interruptions and be subject to escalating costs;
and
o our competitiveness may be harmed by the failure of our contract
manufacturers to develop, implement or maintain manufacturing
methods appropriate for our products and customers.
Moreover, because most of our contracts are with Governmental agencies, we
may be limited in the third parties we can engage as component manufacturers.
We are dependent for some purposes on sole-source suppliers. If any of these
sole-source suppliers fails to meet our needs, we may not have readily
available alternatives. Our inability to fill our supply needs would
jeopardize our ability to satisfactorily and timely complete our obligations
under government and other contracts. This might result in reduced revenue,
termination of one or more of these contracts and damage to our reputation
and relationships with our customers. We cannot be sure that materials,
components, and subsystems will be available in the quantities we require, if
at all.
Because the manufacturing process of our products is highly complex,
errors, changes or uncertainties could disrupt production.
The manufacture of our products involves highly complex and precise
processes, requiring production in a highly controlled and clean environment.
Inadvertent or slight changes or uncertainties in our manufacturing
processes, errors or use of defective or contaminated materials could impact
our ability to achieve, disrupt and/or delay production and affect product
reliability.
Our business could be adversely affected by a negative audit by the U.S.
Government.
U.S. Government agencies such as the Defense Contract Audit Agency ("DCAA")
routinely audit and investigate government contractors. These agencies review
a contractor's performance under its contracts, cost structure and compliance
with applicable laws, regulations and standards. The DCAA also reviews the
adequacy of, and a contractor's compliance with, its internal control systems
and policies, including the contractor's purchasing, property, estimating,
compensation and management information systems. Any costs found to be
improperly allocated to a specific contract will not be reimbursed, while
such costs already reimbursed must be refunded. If an audit uncovers improper
or illegal activities, we may be subject to civil and criminal penalties and
administrative sanctions, including termination of contracts, forfeiture of
profits, suspension of payments, fines and suspension or prohibition from
doing business with the U.S. Government. In addition, we could suffer serious
reputational harm if allegations of impropriety were made against us.
Our backlog is subject to reduction and cancellation.
Backlog represents products or services that our customers have committed by
contract to purchase from us, our total funded backlog as of December 31,
2005 was approximately $8.6 million. Backlog is subject to fluctuations and
is not necessarily indicative of future revenue. Moreover, cancellations of
purchase orders or reductions of product quantities in existing contracts
could substantially and materially reduce backlog and, consequently, future
revenue. Our failure to replace cancelled or reduced backlog could result in
lower revenue.
We depend on the recruitment and retention of qualified personnel, and our
failure to attract and retain such personnel could seriously harm our
business.
Due to the specialized nature of our businesses, our future performance is
highly dependent upon the continued services of our key engineering personnel
and executive officers. Our prospects depend upon our ability to attract and
retain qualified engineering, manufacturing, marketing, sales and management
personnel for our operations. Competition for personnel is intense, and we
may not be successful in attracting or retaining qualified personnel. Our
failure to compete for these personnel could seriously harm our business,
results of operations and financial condition. Additionally, since the
majority of our business involves technologies that are classified due to
national security reasons, we must hire U.S. Citizens who have the ability to
obtain a security clearance. This further reduces our potential labor pool.
11
Because many of our contracts and projects are classified for national
security reasons, we may not be able to provide important information to
the public.
To date, substantially all of our revenue has been derived from contracts
which are classified by the U.S. Government for national security reasons.
Therefore, we are prohibited from filing these contracts as exhibits to our
SEC reports, registration statements and filings or provide more than the
summary information that we provide in our reports, registration statements
and other filings with the SEC and in our press releases. Accordingly,
investors may not have important information concerning our businesses and
operations with which to make an informed investment decision.
The U.S. government's royalty-free right to use technology developed by us
limits our intellectual property rights.
We seek to protect the competitive benefits we derive from our patents,
proprietary information and other intellectual property. However, we do not
have the right to prohibit the U.S. government from using certain
technologies developed or acquired by us or to prohibit third party
companies, including our competitors, from using those technologies in
providing products and services to the U.S. government. The U.S. government
has the right to royalty-free use of technologies that we have developed
under U.S. Government contracts. We are free to commercially exploit those
government-funded technologies and may assert our intellectual property
rights to seek to block other non-government users thereof, but we cannot
assure you we could successfully do so.
We are subject to government regulation which may require us to obtain
additional licenses and could limit our ability to sell our products outside
the United States.
We may be unable to adequately protect our intellectual property rights,
which could affect our ability to compete.
Protecting our intellectual property rights is critical to our ability to
compete and succeed as a company. We hold a number of United States patents
and patent applications, as well as trademark, and registrations which are
necessary and contribute significantly to the preservation of our competitive
position in the market. There can be no assurance that any of these patents
or future patent applications and other intellectual property will not be
challenged, invalidated or circumvented by third parties. In some instances,
we have augmented our technology base by licensing the proprietary
intellectual property of others. In the future, we may not be able to obtain
necessary licenses on commercially reasonable terms. We enter into
confidentiality and invention assignment agreements with our employees, and
enter into nondisclosure agreements with our suppliers and appropriate
customers so as to limit access to and disclosure of our proprietary
information. These measures may not suffice to deter misappropriation or
independent third party development of similar technologies. Moreover, the
protection provided to our intellectual property by the laws and courts of
foreign nations may not be as advantageous to us as the remedies available
under United States law.
We may face claims of infringement of proprietary rights.
There is a risk that a third party may claim our products infringe on their
proprietary rights. Whether or not our products infringe on proprietary
rights of third parties, infringement or invalidity claims may be asserted or
prosecuted against us and we could incur significant expense in defending
them. If any claims or actions are asserted against us, we may be required to
modify our products or obtain licenses on commercially reasonable terms, in a
timely manner or at all. Our failure to do so could adversely affect our
business.
Our operations expose us to the risk of material environmental
liabilities.
We are also subject to increasingly stringent laws and regulations that
impose strict requirements for the proper management, treatment, storage and
disposal of hazardous substances and wastes, restrict air and water emissions
from our testing and manufacturing operations, and require maintenance of a
safe workplace, These laws and regulations can impose substantial fines and
criminal sanctions for violations, and require the installation of costly
pollution control equipment or operational changes to limit pollution
emissions and/or decrease the likelihood of accidental hazardous substance
releases. We incur, and expect to continue to incur, substantial capital and
operating costs to comply with these laws and regulations. In addition, new
laws and regulations, stricter enforcement of existing laws and regulations,
the discovery of previously unknown contamination or the imposition of new
clean-up requirements could require us to incur costs in the future that
would have a negative effect on our financial condition or results of
operations.
12
The unpredictability of our results may harm the trading price of our
securities, or contribute to volatility.
Our operating results may vary significantly over time for a variety of
reasons, many of which are outside of our control, and any of which may harm
our business. The value of our securities may fluctuate as a result of
considerations that are difficult to forecast, such as:
o the size and timing of contract receipt and funding;
o changes in U.S. Government policies and government budgetary
policies;
o termination or expiration of a key government contract;
o our ability and the ability of our key suppliers to respond to
changes in customer orders;
o timing of our new product introductions and the new product
introductions of our competitors;
o adoption of new technologies and industry standards;
o competitive factors, including pricing, availability and demand for
competing products fluctuations in foreign currency exchange rates;
o conditions in the capital markets and the availability of project
financing;
o regulatory developments;
o general economic conditions;
o changes in the mix of our products;
o cost and availability of components and subsystems; and
o price erosion.
Our management holds a majority of our outstanding voting stock and has
control over stockholder matters.
As of December 31, 2005, our management owned approximately 60% of our
outstanding common stock. Accordingly, they can exert significant influence
over matters, which require stockholder vote, including the election of
directors, amendments to our Certificate of Incorporation or approval of the
dissolution, merger, or sale of Ionatron, our subsidiaries or substantially
all of our assets. This concentration of ownership and control by management
could delay or prevent a change in our control or other action, even when a
change in control or other action might be in the best interests of other
stockholders.
A large number of shares of our common stock could be sold in the market
in the near future, which could depress our stock price.
As of March 14, 2006, we had outstanding approximately 72 million shares of
common stock. A substantial portion of our shares are currently freely
trading without restriction under the Securities Act of 1933, having been
held by their holders for over two years and are eligible for sale under Rule
144(k). The Series A Preferred Stock is convertible into an aggregate of
1,500,000 shares of common stock. There are also currently outstanding
options and warrants to purchase approximately 3 million shares of our common
stock, most of which have exercise prices substantially below our current
market price. To the extent any of our options or warrants are exercised or
the Series A Preferred Stock are converted, your percentage ownership will be
diluted and our stock price could be further adversely affected. The shares
of common stock underlying the Series A Preferred Stock and outstanding
options and warrants have been registered for resale by the holders thereof.
As the underlying shares are sold, the market price could drop significantly
if the holders of these restricted shares sell them or if the market
perceives that the holders intend to sell these shares.
Provisions of our corporate charter documents could delay or prevent
change of control.
13
Our Certificate of Incorporation authorizes our board of directors to issue
up to 1,000,000 shares of "blank check" preferred stock without stockholder
approval, in one or more series and to fix the dividend rights, terms,
conversion rights, voting rights, redemption rights and terms, liquidation
preferences, and any other rights, preferences, privileges, and restrictions
applicable to each new series of preferred stock. In addition, our
Certificate of Incorporation divides our board of directors into three
classes, serving staggered three-year terms. At least two annual meetings,
instead of one, will be required to effect a change in a majority of our
board of directors We also have a rights agreement, commonly known as a
"poison pill" in place which provides that in the event an individual or
entity becomes a beneficial holder of 12% or more of the shares of our
capital stock, without the approval of the board of directors, our other
stockholders shall have the right to purchase shares of our (or in some cases
the acquirer's) common stock from us at 50% of its then market value. The
designation of preferred stock in the future, the classification of our board
of directors, its three classes and the rights agreement could make it
difficult for third parties to gain control of our company, prevent or
substantially delay a change in control, discourage bids for our common stock
at a premium, or otherwise adversely affect the market price of our common
stock.
ITEM 1B. UNRESOLVED STAFF COMMENTS:
None.
ITEM 2. PROPERTIES:
Our executive office currently is located at 3590 East Columbia Street, Tucson,
Arizona, where we lease approximately 25,000 square feet of space. The lease
commitment on this property expires November 2012, and the lease contains
renewal options and an escalation provision at the end of five years that
increases our annual rent by $49,500. We account for the escalation provision by
straight-lining the rent expense. This is primarily a research and development
and prototyping facility. North Star leases a 12,000 square foot office,
manufacturing and storage space at 4421 McCleod Street NE, Albuquerque, New
Mexico with assembly areas to build custom ordered high voltage power supplies
as well as offices for general and administrative.
On April 1, 2005 we took possession of approximately 50,000 square feet of
office, manufacturing and warehouse facilities at the Stennis Space Center in
Mississippi. The lease is for a five-year term and may be renewed three times in
five-year increments.
In September 2005, we entered into a lease for approximately 7,000 square feet
of additional office and manufacturing space for our Tucson facility. This
non-cancellable operating lease expires in September 2006.
To accommodate our expanding research and development requirements and to
consolidate office support operations, in January 2006, we entered into an
11-month lease effective March 1, 2006 for approximately 12,000 square feet of
office space proximate to our current facilities in Tucson. We did not have
access to or control over the facility prior to occupation on March 1, 2006 and
incurred no financial obligations until the improvements were completed and the
property turned over to us. We are not subject to incentives or allowances for
leasehold improvements from the landlord. We expect to fully occupy this
property by April 15, 2006. The lease may be extended one time for three years.
Rent expense was approximately $355,000, $411,000 and $733,000 for 2003, 2004
and 2005, respectively.
See Note 12 to the Consolidated Financial Statements of our 2005 Financial
Statements, which is incorporated herein by reference for information with
respect to our lease commitments at December 31, 2005.
ITEM 3. LEGAL PROCEEDINGS:
We may from time to time be involved in legal proceedings arising from the
normal course of business. As of the date of this report, we were not involved
in any legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS:
Not Applicable
14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASE OF EQUITY SECURITIES:
Market price per share
Our common stock is currently listed on the NASDAQ National Market, trading
under the symbol "IOTN." Prior to listing on NASDAQ in December 2004, our common
stock was traded on the Over-The-Counter electronic bulletin board (the "OTC
BB") maintained by NASD under the symbol "IOTN". The following table sets forth
information as to the price range of our common stock for the period January 1,
2004 through December 31, 2004 and for the period January 1, 2005 through
December 31, 2005. No dividends on common stock were declared for these periods.
The table reflects the range of high and low sales prices per share as reported
on the OTC BB for the periods in 2004 and reflects the range of high and low
sales prices per share as reported on the NASDAQ National Market for periods in
2005.
Quarterly Periods High Low
2004 --------- ---------
First $ 4.98 $ 0.48
Second 8.40 3.00
Third 9.60 4.55
Fourth 11.60 5.90
2005
First 11.81 6.70
Second 9.68 6.26
Third 10.24 6.50
Fourth 11.30 8.31
Holders of Record
As of March, 14, 2006, there were approximately 313 holders of record of
Ionatron's common stock.
Dividends
We have not paid cash dividends on our common stock and do not expect to do so
in the foreseeable future. Instead, we intend to retain any earnings to support
our operations and the growth of our business.
Equity Compensation Plan Information
See Item 12.
ITEM 6. SELECTED FINANCIAL DATA:
The following selected financial data should be read in conjunction with the
consolidated financial statements and the notes thereto contained herein in Item
8. "Financial Statements and Supplementary Data," and the information contained
herein in Item 7. "Management's Discussion and Analysis of Financial Condition
and Results of Operations." Historical results are not necessarily indicative of
future results.
Following is a summary of Ionatron's selected financial data for the period June
3 to December 31, 2002 and for the years ended and as of December 31, 2003, 2004
and 2005. The financial data for 2004 includes the effect of the acquisition of
substantially all the assets and some of the liabilities of North Star Research
Corporation on September 30, 2004 by our subsidiary North Star Power
Engineering, Inc. ("North Star"). The financial results include the results of
operations of North Star from October 1, 2004 to December 31, 2004 and for the
year ended December 31, 2005.
15
Consolidated Statements of Operations Data:
For the Period
June 3 to Years Ended December 31,
December 31, ------------------------------------------
2002 2003 2004 2005
------------ ------------ ------------ ------------
Revenue $ -- $ 383,273 $ 10,930,522 $ 18,875,928
Cost of revenue -- 356,822 10,094,379 17,757,305
Operating expenses:
General and administrative 429,352 1,681,174 2,565,778 3,613,151
Selling and marketing 53,524 239,847 544,564 525,067
Research and development 264,799 1,151,350 808,242 1,266,382
Other expense (income) - net -- 196,189 168,987 (699,788)
------------ ------------ ------------ ------------
Loss before provision for
income taxes (747,675) (3,242,109) (3,251,428) (3,586,189)
Provision for income taxes -- -- 9,577 38,414
------------ ------------ ------------ ------------
Net loss (747,675) (3,242,109) (3,261,005) (3,624,603)
Preferred stock dividend -- -- -- (210,726)
------------ ------------ ------------ ------------
Net Loss attributable to common
shareholders $ (747,675) $ (3,242,109) $ (3,261,005) $ (3,835,329)
============ ============ ============ ============
Basic and diluted net loss per
common share $ (0.02) $ (0.07) $ (0.05) $ (0.05)
------------ ------------ ------------ ------------
Weighted average number of common
shares outstanding 48,452,249 48,452,249 65,264,393 71,334,830
============ ============ ============ ============
Consolidated Balance Sheet Data:
As of December 31,
--------------------------------------------------------
2002 2003 2004 2005
------------ ------------ ------------ ------------
Cash, cash equivalents and
securities available for sale $ 97,206 $ 103,392 $ 3,495,779 $ 12,371,248
Total assets 1,360,627 1,526,120 12,537,891 23,652,831
Total debt and capital lease 1,175,000 4,300,000 2,805,917 99,907
obligations
Total liabilities 2,088,302 4,995,904 5,321,274 2,420,929
Total stockholders' equity
(deficit) (727,675) (3,469,784) 7,216,617 21,231,902
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS:
The following discussion and analysis should be read in conjunction with
Ionatron's consolidated financial statements and the related notes that are
included elsewhere herein.
Ionatron was formed to develop and market Directed Energy Weapon technology
products. Our goal is to produce products that incorporate our technology for
initial sale to U.S. Government customers for specific applications and
platforms. Through North Star, Ionatron is involved in the design and
manufacture of a broad range of high voltage equipment for the defense,
aerospace, semi-conductor, and medical industries.
OVERVIEW:
Ionatron was formed on June 3, 2002 to develop and market Directed Energy Weapon
technology products for initial sale to the U.S. Government. Ionatron and the
U.S. Government have entered into several contracts for products and services as
well as Cooperative Research and Development Agreements for joint research on
Laser Induced Plasma Channel ("LIPC") based Directed Energy weapons. We expect
to offer U.S. Government approved versions of our products for commercial
security applications in the future. During 2002 and 2003, the Company engaged
in research and development and business development activities culminating in
our first U.S. Government contract in September of 2003. During 2004, we
demonstrated the laser guided man-made lightning Directed Energy technology in
the laboratory; demonstrated the technology effects on a variety of targets both
under U.S. Government contract; and using internal research and development
funding, delivered a compact laser source specifically designed to enable the
technology under a U.S. Government contract; and commenced a U.S. Government
contract for the development of a system on a mobile platform for field
demonstration and testing. In 2005, we continued development of laser sources,
advanced high voltage systems, and special-purpose optical systems, expanded
target effects testing under U.S. Government contracts, and furthered our
understanding of the underlying physics and continued to develop additional
intellectual property with internal funding. Additionally in 2005, we developed
a counter-IED ("Improved Explosive Device") vehicle for use in Iraq called the
Joint IED Neutralizer ("JIN").
On March 18, 2004, a subsidiary of U. S. Home & Garden Inc. "USHG", a
non-operating, publicly traded company, merged into Ionatron Technologies, Inc.,
formerly Ionatron, Inc. (the "Merger"). Following the Merger, USHG shareholders
held 33.89% and Ionatron shareholders held 66.11% of the outstanding USHG common
stock. The combination has been accounted for as a recapitalization of Ionatron,
Inc., from our inception on June 3, 2002, and the issuance of 19,346,090 common
shares and approximately 5.5 million options and warrants to the USHG
shareholders on the date of merger in exchange for $8.8 million in cash.
In September 2004, we completed the acquisition of substantially all the assets
of North Star Research Corporation, a New Mexico corporation engaged in the
business of designing and manufacturing a broad range of high voltage equipment
for the defense, aerospace, semi-conductor, and medical industries.
As consideration for North Star Research's assets, the Company paid $700,000,
issued 199,063 shares of our common stock, and assumed liabilities for warranty
claims and other accrued expenses. We recognized goodwill of $1,487,884 and
intangible assets of $886,000 in the acquisition. The transaction was effected
through a newly formed subsidiary, North Star Power Engineering, Inc. ("North
Star"), a Delaware corporation, and was funded through cash on hand.
On October 18, 2005 our Board of Directors approved the elimination of the 10%
Series A Convertible Preferred Stock. No shares of 10% Preferred Stock were
outstanding. Our Board also approved the designation of 950,000 shares of Series
A Convertible Preferred Stock. On October 27, 2005 we sold an aggregate of
720,000 shares (the "Offered Shares") of our 6.5% Series A Redeemable
Convertible Preferred Stock (the "Series A Preferred Stock") with a stated value
of $25 per share for aggregate gross proceeds of $18 million (the "Financing").
The net proceeds received from the Financing, after deducting placement agent
fees and expenses and other expenses were approximately $16.6 million. We used a
portion of the net proceeds from the Financing to repay the $2.9 million
principal amount outstanding and owed to the Company's Chairman of the Board
under our revolving credit facility.
17
OPERATING SEGMENTS:
We are currently engaged in developing and marketing through two distinct
segments: (1) Ionatron, Inc., where the focus is on Directed Energy Weapon
technology products for sale to the U.S. Government and (2) North Star, where
the focus is on the manufacture of custom high voltage equipment for sale to
Ionatron and in a more broad-based market.
CRITICAL ACCOUNTING POLICIES:
USE OF ESTIMATES:
Our consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States "GAAP", which require
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes. We have identified
the following significant accounting policies that require a higher degree of
judgment and complexity. See Note 1 to the Consolidated Financial Statements to
our Financial Statements, which is incorporated herein by reference for
information with respect to other significant accounting policies.
REVENUE RECOGNITION:
Revenue has been derived from ongoing contract work for systems development,
effects testing and the design and development of a demonstration system for a
government customer as well as the development of our JIN technology. It is
expected that continued work on effects testing, design and development of
specific Ionatron LIPC systems, advanced design and proof of principle on an
existing contract, compact laser source development, high voltage source
development, optics development and the manufacture of a transportable
demonstrator, and additional activities with the JIN technology will contribute
to revenue going forward in 2006. This work is expected to be generally
performed under cost-plus contracts with U.S. Government customers.
Revenue under long-term U.S. Government contracts is recorded under the
percentage of completion method. Revenue, billable monthly, under cost plus
fixed fee contracts is recorded as costs are incurred and includes estimated
earned fees in the proportion that costs incurred to date bear to total
estimated costs. Costs include direct labor, direct materials, subcontractor
costs and overhead. Revisions in earnings estimated during the course of work
are reflected during the accounting period in which the facts become known. When
the current contract estimate indicates a loss, provision is made for the total
anticipated loss in the period in which the facts become known.
The asset caption "accounts receivable" includes costs and estimated earnings in
excess of billings on uncompleted contracts, which represents revenue recognized
in excess of amounts billed. Such revenue is billable under the terms of the
contracts at the end of the year, yet was not invoiced until the following year
and is generally expected to be collected within 60 days. The liability
"billings in excess of costs and estimated earnings on uncompleted contracts"
represents billings in excess of revenue recognized.
Revenue for other products and services is recognized when such products and
services are delivered or performed and, in connection with certain sales to
government agencies, when the products and services are accepted, which is
normally negotiated as part of the initial contract. Revenue from commercial,
non-governmental, customers is based on fixed price contracts where the sale is
recognized upon acceptance of the product or performance of the service and when
payment is assured.
COST OF REVENUE:
Cost of revenue is recorded as costs are incurred. Costs include direct labor,
direct materials, subcontractor costs and manufacturing and administrative
overhead. General and administrative expenses allowable under the terms of the
contracts are allocated per contract depending on its direct labor and material
proportion to total direct labor and material of all contracts.
As contracts can extend over one or more accounting periods, revisions in costs
estimated during the course of work are reflected during the accounting period
in which the facts become known.
18
INTANGIBLE ASSETS:
We account for goodwill and other indefinite life intangible assets based on the
method of accounting prescribed by the provisions of SFAS 142, "Goodwill and
Other Intangible Assets," and we have determined that Ionatron, Inc. and North
Star are separate reporting units. We believe that the North Star Research trade
name is an indefinite life intangible asset.
Goodwill and other indefinite life intangible assets will be tested annually for
impairment or more frequently if events or changes in circumstances indicate
that the assets might be impaired. In assessing the recoverability of goodwill
and indefinite life intangible assets, we must make assumptions about the
estimated future cash flows and other factors to determine the fair value of
these assets.
Assumptions about future revenue and cash flows require significant judgment
because of the current state of the economy and the fluctuation of actual
revenue and the timing of expenses. We develop future cash flows based on
projected sales with the assumption that expenses will grow at rates consistent
with historical rates. If the expected cash flows are not realized, impairment
losses may be recorded in the future.
For goodwill, the impairment evaluation includes a comparison of the carrying
value of the reporting unit (including goodwill) to that reporting unit's fair
value. If the reporting unit's estimated fair value exceeds the reporting unit's
carrying value, no impairment of goodwill exists. If the fair value of the
reporting unit does not exceed the unit's carrying value, then an additional
analysis is performed to allocate the fair value of the reporting unit to all of
the assets and liabilities of that unit. If the excess of the fair value of the
reporting unit over the fair value of the identifiable assets and liabilities is
less than the carrying value of the unit's goodwill, an impairment charge is
recorded for the difference.
The impairment evaluation for other indefinite life intangible assets is
performed by a comparison of the asset's carrying value to the asset's fair
value. When the carrying value exceeds fair value an impairment charge is
recorded for the amount of the difference. An intangible asset is determined to
have an indefinite useful life when there are no legal, regulatory, contractual,
competitive, economic, or any other factors that may limit the period over which
the asset is expected to contribute directly or indirectly to our future cash
flows. In addition, each reporting period, we evaluate the remaining useful life
of an intangible asset that is not being amortized to determine whether events
and circumstances continue to support an indefinite useful life. If an
intangible asset that is not being amortized is determined to have a finite
useful life, the asset will be amortized prospectively over the estimated
remaining useful life and be accounted for in the same manner as intangible
assets subject to amortization.
RESULTS OF OPERATIONS:
Our consolidated financial information for the years ending December 31, 2005,
2004 and 2003 is as follows:
2005 2004 2003
-------------------------------------------
Revenue $ 18,875,928 $ 10,930,522 $ 383,273
Cost of revenue 17,757,305 10,094,379 356,822
Operating expenses:
General and administrative 3,613,151 2,565,778 1,681,174
Selling and marketing 525,067 544,564 239,847
Research and development 1,266,382 808,242 1,151,350
Other (expense) income:
Interest expense (227,106) (215,593) (196,189)
Interest income 111,760 46,122 --
Other income 815,134 484 --
-------------------------------------------
Loss before provision for
income taxes (3,586,189) (3,251,428) (3,242,109)
Provision for income taxes 38,414 9,577 --
-------------------------------------------
Net loss $ (3,624,603) $ (3,261,005) $ (3,242,109)
===========================================
19
REVENUE:
The increase in revenue for 2005 over 2004 was due to additional governmental
contracts regarding our LIPC technology as well as work on our JIN product and
the inclusion of North Star's results for the entire year in 2005, following the
acquisition on September 30, 2004. The increase in revenue for 2004 compared to
2003 was attributed to an increase in the number of governmental contracts as
well as the maturity of initial government contracts started in 2003. The
revenue in 2003 was derived from the initial work on U.S. Government contracts.
COST OF REVENUE:
The increase in cost of revenue in 2005 is directly related to our increased
revenue. Cost of revenue also increased in 2004 when compared to 2003 due to the
increase in the number of contracts and completion of 2003 contracts.
GENERAL AND ADMINISTRATIVE:
The increase in general and administrative expenses during 2005 was primarily
due to the increase in the number of employees and office and manufacturing
space. Increases during 2005 compared to 2004 were experienced in recruiting
(70%), payroll costs (12%), rent (47%), utilities (70%), insurance (48%), office
expense (74%) and professional fees (14%), which were offset by a 41% increase
in allocated indirect costs. The increase in general and administrative in 2004
was primarily related to professional fees in connection with the Merger in
March 2004, acquisition of North Star, compliance with Sarbanes-Oxley ("SOX")
Section 404 requirements and the additional costs of being a publicly traded
company as well as a 38% increase in depreciation and a 126% increase in
recruiting costs. Rent expense increased 16% due to the three months of rent
expense related to the North Star acquisition.
We are mandated to comply with the SOX Section 404 requirements for a review of
the control over our financial reporting environment. This review was initiated
in 2004 and continued in 2005. The expense related to SOX compliance was
approximately $557,000 and $660,000 for 2004 and 2005, respectively.
SELLING AND MARKETING:
Selling and marketing expenses remained stable in 2005, decreasing by
approximately $19,000, as we maintained the same level of business development
activity as that in 2004. The increase in selling and marketing expenses of
approximately $305,000 during 2004 primarily resulted from an increase in
business development activity as we broadened our efforts to inform potential
customers of our LIPC technology in pursuit of Government contracts. Business
development activities included briefing of Government officials, submission of
bids and proposals, and participation in trade shows and industry conferences.
RESEARCH AND DEVELOPMENT:
In 2005 research and development increased approximately $458,000 which is
reflective of management's desire to develop our LIPC technology at a rate
faster than the current rate supported by our customers. The decrease in
research and development expenses during 2004 as compared to 2003 was primarily
due to the shifts from internally funded proof of concept and research and
development to production and research and development under contracts.
INTEREST EXPENSE:
The interest expense on our credit line payable with our Chairman increased
approximately $12,000 and $19,000 from 2004 to 2005 and 2003 to 2004,
respectively primarily as a result of an increase of the prime interest rate
from 4.0% in July 2003 to 7.0% in November 2005, when the note was paid off. See
"Liquidity and Capital Resources" for further information concerning the
restructuring of the credit line agreement.
20
INTEREST INCOME:
The interest income in 2004 was a result of the investment of the cash acquired
in the merger with USHG into a short-term investment fund. Interest income in
2005 reflects the interest income from the merger cash as well as the cash
received from the issuance of our Series A Preferred Stock which was invested in
a number of interest generating securities and a money market fund.
OTHER INCOME:
Other income in 2005 primarily reflects $800,000 received from the sale of $1.6
million principal amount note from Easy Gardner which we received in the Merger
with USHG and we recorded the book value of the note at zero at the time of the
acquisition due to uncertainty as to its collectibility.
NORTH STAR OPERATIONS:
Our consolidated financial information contains the results of North Star for
the period September 30, 2004 to December 31, 2004 and for 2005. Contributing to
the increase in revenue, North Star's revenue, net of intersegment transactions,
increased from approximately $360,000 for the last three months of 2004, to
approximately $1,140,000 for the whole year in 2005. Cost of revenue for North
Star, net of intersegment activity, increased from approximately $282,000 for
the last three months of 2004, to approximately $1,552,000 for the whole year in
2005. Net of intersegment transactions, North Star had a net loss for 2005 of
approximately $233,000, and approximately $33,000 for the last three months of
2004. Management is attentive to North Star's financial performance and intends
to review the effectiveness of its cost and revenue position and has instituted
management changes at the subsidiary in an effort to improve North Star's
financial results.
NET LOSS:
Net loss for the year ended December 31, 2005 increased approximately $364,000
to approximately $3,625,000 compared to 2004. The increase in our net loss is
attributable to a limited amount of work performed under contracts in the first
and second quarter, a 41% increase in general and administrative expenses
primarily due to our 62% increase in staff and associated staffing costs, and
the increases in rent, insurance and utilities. Research and development expense
increased by 57% from 2004, as we focused more of our resources into further
development of our core technology. Increased expenses were offset by the
$66,000 increase in interest income, and the $800,000 gain on sale of the note
receivable.
The net loss of approximately $3,261,000 for 2004 represented a slight increase
from the 2003 net loss of approximately $3,242,000. For 2004, general and
administrative expenses increased 53% compared to 2003 primarily due to
additional professional fees resulting from the Merger with USHG, the
acquisition of North Star, and compliance costs related to the SOX Section 404.
Selling and marketing expenses increased 127% compared to 2003, resulting from
an increase in business development activity as we broadened our efforts to
inform potential customers of our technology in pursuit of Government contracts.
Offsetting the impact of these increases, 2004 research and development expenses
decreased by 30% from 2003 as expected due to the shift from internal research
and development to development under contracts. Net of intersegment
transactions, North Star had a net loss for 2005 of approximately $233,000, and
approximately $33,000 for the last three months of 2004.
21
QUARTERLY OPERATING RESULTS (UNAUDITED):
Quarterly operating results for 2005, 2004 and 2003 were as follows:
1st 2nd 3rd 4th
------------------------------------------------------
2005
Revenue $ 2,570,271 $ 3,956,522 $ 6,219,161 $ 6,129,974
Cost of revenue 2,404,486 3,775,826 5,560,579 6,016,414
Total expenses 1,803,806 1,882,099 1,009,440 9,467
----------- ----------- ----------- -----------
Loss before provisions for
income taxes (1,638,021) (1,701,403) (350,858) 104,093
Provision for income taxes 9,577 9,293 10,477 9,067
----------- ----------- ----------- -----------
Net loss $(1,647,598) $(1,710,696) $ (361,335) $ 95,026
Preferred stock dividend -- -- -- (210,726)
----------- ----------- ----------- -----------
Net loss attributable to common
stockholders $(1,647,598) $(1,710,696) $ (361,335) $ (115,700)
=========== =========== =========== ===========
Basic and diluted net loss per
common share (0.02) (0.02) (0.01) (0.00)
2004
Revenue $ 272,442 $ 1,833,572 $ 2,628,982 $ 6,195,526
Cost of revenue 255,000 1,726,753 2,441,243 5,671,383
Total expenses 933,336 1,461,522 1,083,765 609,418
----------- ----------- ----------- -----------
Loss before provisions for
income taxes (915,894) (1,354,703) (896,026) (85,275)
Provision for income taxes -- -- -- 9,577
----------- ----------- ----------- -----------
Net loss available to common
stockholders $ (915,894) $(1,354,703) (896,026) (94,852)
=========== =========== =========== ===========
Basic and diluted net loss per
common share (0.02) (0.02) (0.01) (0.001)
2003
Revenue $ -- $ -- $ 148,586 $ 234,687
Cost of revenue -- -- 137,874 218,948
Total expenses 992,861 1,051,565 826,360 397,774
----------- ----------- ----------- -----------
Net loss attributable to common
stockholders $ (992,861) $(1,051,565) $ (815,648) $ (382,035)
=========== =========== =========== ===========
Basic and diluted net loss per
common share (0.02) (0.02) (0.02) (0.01)
LIQUIDITY AND CAPITAL RESOURCES:
Our cash position decreased during 2005 by approximately $2.1 million primarily
as a result of approximately $4.6 million used in operating activities and
approximately $12.1 million used in investing activities, offset by
approximately $14.6 million provided by financing activities. At December 31,
2005, we had approximately $371,000 of cash and cash equivalents, and $12
million of securities available-for-sale.
During 2005, we used approximately $4.6 million in cash in operating activities
primarily consisting of our net loss of approximately $3.6 million, an increase
in accounts receivable of $870,000, an increase in inventory of $1,007,000 and a
decrease in accounts payable of $641,000, offset by depreciation and
amortization of $966,000 and an increase in accrued expenses of $350,000
22
Investing activities in 2005 used $12.1 million of cash, of which $12.0 million
was from the investment of proceeds from the issuance of our Series A Preferred
Stock. Cash provided by financing activities was $14.6 million, consisting of
$16.6 million in net proceeds from the issuance of our Series A Preferred Stock
and $831,000 of proceeds received from the exercise of stock options and
warrants, offset by the $2.9 million repayment of the note payable to our
Chairman.
The Company's cash position increased during 2004 by $2.4 million primarily as a
result of the merger with USHG that provided $8.8 million of cash. At December
31, 2004, the Company had approximately $3.5 million of cash, cash equivalents
and securities available-for-sale.
During 2004, we used $5.6 million in operating activities, consisting primarily
of our net loss of $3.3 million and increases in accounts receivable of $4.1
million and prepaid expenses of $357,000, partially offset by an increase in
accounts payable of $1.3 million and depreciation and amortization of $887,000.
In 2004, we used $2.6 million in investing activities, consisting of purchases
of $1.1 million of equipment and a net use of $573,000 in connection with the
acquisition of North Star.
During 2004, financing activities provided $10.5 million of cash, consisting of
$8.8 million of cash acquired in the Merger with USHG, $1.2 million from option
exercises and $500,000 of net proceeds from the issuance of a note to our
Chairman.
We anticipate that short-term and long-term funding needs will be provided from
the cash flow from working on government contracts. We believe that we have
sufficient working capital to fulfill existing contracts and expected contracts
in 2006 and into 2007. The transportable demonstrator contract and at least two
of the other Ionatron contracts, that presently represent a major portion of our
current activity, are on a cost plus fixed fee basis. This means all work
performed is done at our government-approved rates, which include general and
administrative costs, overhead, labor and materials, fees and profit. These
costs are accrued as incurred and billed monthly. Other contracts are at fixed
prices which have commercial type gross margins associated with them.
BACK-LOG OF ORDERS
At December 31, 2005, we had a backlog (that is, work load remaining on signed
contracts) of approximately $8.6 million to be completed within the next twelve
months. On January 25, 2006 we signed an approximately $2.8 million contract
with the U.S. Navy for the further development of LIPC.
CONTRACTUAL OBLIGATIONS:
Payment by Period
----------------------------------------------------------
More
Less than 1 to 3 3 to 5 than 5
Total 1 Year Years Years Years
----------------------------------------------------------
Capital leases $ 109,416 $ 43,560 $ 65,621 $ 235 $ --
Insurance premium financing 216,043 216,043 -- -- --
Operating leases 3,916,033 746,194 1,346,712 1,111,564 711,563
----------------------------------------------------------
Total $4,241,492 $1,005,797 $1,412,333 $1,111,799 $ 711,563
==========================================================
Interest expense on insurance premium financing was not included in the above
table but is expected to total approximately $4,700 next year. Also not included
in the above table are the dividends that are approximately $796,000 in less
than 1 year, and approximately $1.171 million each year thereafter, assuming no
conversion to common stock.
23
PREFERRED STOCK DIVIDEND:
The Series A Preferred Stock has a liquidation preference of $25.00 per Share.
The Series A Preferred Stock bears dividends at the rate of 6.5% of the
liquidation preference per share per annum, which accrues from the date of
issuance, and is payable quarterly when declared. Dividends are payable in: (i)
cash, (ii) shares of our common stock (valued for such purpose at 95% of the
weighted average of the last sales prices of our common stock for each of the
trading days in the ten trading day period ending on the third trading day prior
to the applicable dividend payment date), provided that the issuance and/or
resale of all such shares of our common stock are then covered by an effective
registration statement or (iii) any combination of the foregoing.
CAPITAL LEASES:
We rent office equipment under capital lease agreements with approximately
$1,474 in monthly payments. We also rent two vehicles for use in our operations
under capital lease agreements with approximately $2,155 in monthly payments.
OPERATING LEASES:
We generally operate in leased premises under operating leases that have options
permitting renewals for additional periods. In addition to minimum fixed
rentals, the leases typically contain scheduled escalation clauses resulting in
a deferred rent accrual at December 31, 2005 of $82,623. We account for the
escalation provision by straight-line inclusion in the rent expense. Total rent
expense on premises amounted to $733,000 for 2005, $411,000 for 2004, and
$355,000 for 2003. We also have operating leases on vehicles at our Tucson and
Albuquerque facilities which expire in 2006.
RECENT ACCOUNTING PRONOUNCEMENTS:
SFAS 123(R) became effective for Ionatron on January 1, 2006, at which time we
adopted the Standard using the modified prospective method. SFAS 123(R) requires
all public companies to record compensation cost for stock options and other
share based payments provided to employees in return for employee service. The
cost is measured at the fair value of the options or shares when granted, and
this cost is expensed over the employee service period. We are unable to
accurately predict the amount of compensation expense for stock options and
share based payments that will be granted after the effective date.
Compensation cost is also recognized for all stock options and share based
payments that were granted prior to the effective date for which the requisite
service has not yet been rendered. Compensation cost related to stock options
and share based payments granted prior to the effective date will be $1,310,821
in 2006, $1,031,398 in 2007 and $835,190 in 2008.
Pro-forma compensation costs and the pro-forma effect on net income and earnings
per share for all stock options and share based payments for which the requisite
service was rendered prior to the effective date will continue to be disclosed
in the notes to financial statements.
We will continue to use the Black Scholes Option Pricing Model to estimate the
fair value of stock options granted to employees and others for services.
SFAS No. 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. This
requirement will reduce net operating cash flows and increase net financing cash
flows in periods after adoption. We cannot estimate what those amounts will be
in the future because they depend on, among other things, when employees
exercise stock options.
24
In November 2005, the FASB issued FASB Staff Position 115-1 and 124-1, "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments" ("FSP 115-1 and 124-1"). This guidance will be applicable for
Ionatron in the first quarter of 2006 and provides additional guidance on when
an investment in a debt or equity security should be considered impaired and
when that impairment should be considered other-than-temporary and recognized as
a loss in earnings. Specifically, the guidance clarifies that an investor should
recognize an impairment loss no later than when the impairment is deemed
other-than-temporary, even if a decision to sell has not been made. The FSP also
requires certain disclosures about unrealized losses that have not been
recognized as other-than-temporary impairments. We do not believe the adoption
of FSP 115-1 and 124-1 will have a material impact on our financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK:
In the normal course of business, our financial position is subject to a variety
of risks, such as the collectibility of our accounts receivable and the
recoverability of the carrying values of our long-term assets. We do not
presently enter into any transactions involving derivative financial instruments
for risk management or other purposes.
Our available cash balances are invested on a short-term basis and are not
subject to significant risks associated with changes in interest rates.
Substantially all of our cash flows are derived from our operations within the
United States and we are not subject to market risk associated with changes in
foreign exchange rates.
During 2005, we were exposed to market risk for the impact of interest rate
changes, as the interest rate of our borrowings under our revolving credit
agreement with our Chairman was subject to changes based on changes in the prime
interest rate. For 2005, a 1% increase in interest rates would have increased
our net loss by $26,292. However, this line of credit was paid in full in
November 2005.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA:
The Company's financial statements, the related notes and the Independent
Registered Public Accountant's Report thereon, are included in Ionatron's 2005
Financial Statements and are filed as a part of this report on page F-1
following the signatures.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE:
There were no changes in or disagreements with accountants on accounting and
financial disclosure.
ITEM 9A. CONTROLS AND PROCEDURES:
CONCLUSION REGARDING THE EFFECTIVENESS OF DISCLOSURE CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer/Chief
Financial Officer, evaluated the effectiveness of our disclosure controls and
procedures as of December 31, 2005. The term "disclosure controls and
procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934 (the "Exchange Act"), means controls and other procedures
of a company that are designed to ensure that information required to be
disclosed by a company in the reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the SEC's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by a company in the reports
that it files or submits under the Exchange Act is accumulated and communicated
to the company's management, including its principal executive and principal
financial officers, as appropriate to allow timely decisions regarding required
disclosure. Management recognizes that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving their objectives and management necessarily applies its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Rules 13a-15(f) or
15d-15(f) under the Exchange Act. Internal control over financial reporting is a
process designed by, or under the supervision of, our principal executive and
principal financial officers and effected by our Board of Directors, management
and other personnel, to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles. Internal
control over financial reporting includes those policies and procedures that:
25
o Pertain to the maintenance of records that in reasonable detail accurately
and fairly reflect the transactions and dispositions of the company's
assets;
o Provide reasonable assurance that transactions are recorded as necessary
to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the
company are being made only in accordance with authorizations of the
management and directors of the company; and
o Provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the company's assets that
could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial
reporting as of December 31, 2005. In making this assessment, management used
the criteria set forth in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (the "COSO").
A material weakness is a control deficiency, or a combination of control
deficiencies, that result in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected.
In connection with management's assessment of our internal controls over
financial reporting described above, management identified internal control
deficiencies, none of which individually were considered material; however, when
considered in the aggregate, represented a material weakness in internal control
over the financial reporting. The control deficiencies generally resulted from
turnover of key personnel in various positions of accounting and financial
reporting resulting in an insufficient complement of personnel with a level of
accounting knowledge, experience and training in the application of generally
accepted accounting principles commensurate with the company's financial
reporting requirements. These deficiencies were manifested in (i) the period-end
closing process as the preparation of the Form 10-K including financial
statements and related disclosures was not completed in accordance with
management's established timeline, thus not allowing for an effective iterative
review process to occur, and (ii) a number of adjustments to the financial
statements for the year ended December 31, 2005. None of the adjustments were
material individually or in the aggregate.
Management has concluded that, as a result of this material weakness, we did not
maintain effective internal control over financial reporting as of December 31,
2005, based on the criteria in Internal Control-Integrated Framework issued by
COSO.
Management has addressed the deficiencies noted above and as of March 15, 2006
the accounting and financial reporting positions which had been vacated have
been filled with experienced personnel who will review and monitor transactions,
accounting processes and control activities.
Management's assessment of the effectiveness of our internal control over
financial reporting as of December 31, 2005 has been audited by BDO Seidman LLP,
an independent registered public accounting firm, as stated in their report,
which is included in this item below.
March 10, 2006
Thomas Dearmin
President, Chief Executive Officer and Chief Financial Officer
26
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING:
There has been no change in Ionatron's internal control over financial reporting
during the year ended December 31, 2005 that has materially affected, or is
reasonable to materially affect, Ionatron's internal control over financial
reporting.
Report of Independent Registered Public Accounting Firm on Internal Control Over
Financial Reporting
Board of Directors and Stockholders
Ionatron, Inc.
Tucson, Arizona
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting that Ionatron,
Inc. did not maintain effective internal control over financial reporting as of
December 31, 2005, because the effect of the material weakness identified in
management's assessment based on criteria established in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). The Company's management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on management's assessment and an
opinion on the effectiveness of the Company's internal control over financial
reporting based on our audit.
We conducted our audit 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 effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with accounting principles generally accepted in the United States of America. A
company's internal control over financial reporting includes those policies and
procedures that (i) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the
assets of the company; (ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with accounting principles generally accepted in the United States of
America, and that receipts and expenditures of the company are being made only
in accordance with authorizations of management and directors of the company;
and (iii) provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use, or disposition of the company's assets that
could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. The following material weakness has been identified and included in
management's assessment. Management identified internal control deficiencies,
none of which individually were considered material; however, when considered in
the aggregate, represented a material weakness in internal control over the
financial reporting. The control deficiencies generally resulted from turnover
of key personnel in various positions of accounting and financial reporting
resulting in an insufficient complement of personnel with a level of accounting
knowledge, experience and training in the application of generally accepted
accounting principles commensurate with the Company's financial reporting
requirements. These deficiencies were manifested in (i) the period-end closing
process as the preparation of the Form 10-K including financial statements and
related disclosures was not completed in accordance with management's
established timeline, thus not allowing for an effective iterative review
process to occur, and (ii) a number of adjustments to the financial statements
for the year ended December 31, 2005. None of the adjustments were material
individually or in the aggregate. This material weakness was considered in
determining the nature, timing, and extent of audit tests applied in our audit
of the 2005 financial statements, and this report does not affect our report
dated March 10, 2006 on those financial statements.
27
In our opinion, management's assessment that Ionatron, Inc. did not maintain
effective internal control over financial reporting as of December 31, 2005, is
fairly stated, in all material respects, based on the criteria established in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Also in our opinion, because of
the effect of the material weakness described above on the achievement of the
objectives of the control criteria, Ionatron, Inc. has not maintained effective
internal control over financial reporting as of December 31, 2005, based on the
criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets as
of December 31, 2005 and 2004 and the related consolidated statements of
operations, stockholders' equity (deficit) and cash flows for each of the three
years in the period ended December 31, 2005 and our report dated March 10, 2006
expressed an unqualified opinion thereon.
We do not express an opinion or any other form of assurance on management's
statements referring to Ionatron, Inc.'s actions to address any deficiencies.
/s/ BDO Seidman, LLP
Phoenix, Arizona
March 10, 2006
ITEM 9B. OTHER INFORMATION:
On March 11, 2006, Thomas Steffens resigned as Executive Vice President and
Director. Mr. Steffens did not resign due to any matter relating to a
disagreement with us regarding our operations, policies or procedures.
On March 14, 2006, the Compensation Committee of the Board of Directors ratified
the payment of an approximately $41,000 cash bonus, which was paid to Bernard
Walik, our Executive Vice President-Operations, in August and September 2005.
28
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT:
The following is information with respect to our executive officers and
directors:
Name Age Principal Position
- ------------------------------- --- ------------------------------------------
Robert Howard 82 Director, Chairman of the Board
Thomas C. Dearmin 48 Director, Chief Executive Officer,
President and Chief Financial Officer
Joseph C. Hayden 47 Executive Vice President - Programs
Stephen W. McCahon 46 Executive Vice President - Engineering
Bernie Walik 53 Executive Vice President - Operations
Stephen A. McCommon 56 Vice President Finance and Chief
Accounting Officer
George P. Farley 67 Director
James K. Harlan 54 Director
David C. Hurley 65 Director
James A. McDivitt 76 Director
Robert Howard: Robert Howard has been the Chairman of the Board of Directors of
Ionatron since its inception in 2002. From 1969 to April 1980, he, as Founder,
served as President and Chairman of the Board of Centronics Data Computer Corp.
("Centronics"), a manufacturer of a variety of computer printers, including the
first impact dot matrix printer, of which he was the inventor. He resigned from
Centronics' Board of Directors in 1983. Commencing in mid-1982, Mr. Howard,
doing business as RH Research, developed the Color Ink Jet technology upon which
iCAD, Inc. ("iCAD") was initially based. He contributed this technology, without
compensation, to iCAD. Since its establishment in 1984, Mr. Howard has been the
founder and Chairman of the Board of Directors of iCAD, a company now involved,
among other things, in the manufacture and sale of computer aided devices
("CAD") used for early detection of Breast Cancer. Starting in December of 1993,
Mr. Howard was Chairman of the Board of Presstek, Inc. ("Presstek"), a public
company, which has developed proprietary digital imaging and consumables
technologies for the printing and graphic arts industries from June 1988 to
September 1998 and then served as Chairman Emeritus of the Board of Presstek
from September 1998 to December 2000. In 2001 Mr. Howard financed this venture,
and together with Mr. Dearmin, Mr. Hayden and Mr. McCahon started the
development work that in 2002 became Ionatron, Inc.
Thomas C. Dearmin: Thomas C. Dearmin has been our President, Chief Executive
Officer and Chief Financial Officer as well as a Director of Ionatron since its
inception in 2002. From 1999 to 2002, Mr. Dearmin also was the President and
Chief Executive Officer of Lasertel Inc., a company Mr. Dearmin started and had
operational in 9 months, manufacturing high power semiconductor lasers. From
1992 to 1998, Mr. Dearmin was one of the co-founders and Vice President of Opto
Power Corporation, one of the first high power semiconductor laser manufacturers
to commercialize high power laser diodes. Opto Power also designed and built
semiconductor laser prototypes for US Military applications. Opto Power became
the largest supplier of high power fiber coupled laser diodes in the world,
which created new applications in the defense, medical, industrial and graphic
arts areas. Opto Power Corporation became a wholly owned division of Spectra
Physics Lasers which went public in 1998. Prior to 1992, Mr. Dearmin was part of
the original high power semiconductor group at Ensign Bickford Aerospace and was
head of Business Development for that group. Mr. Dearmin worked on new novel
military applications of lasers and laser systems, as well as the first
successful diode laser for on press digital imaging in graphic arts. Prior to
1986, Mr. Dearmin worked in various capacities in the Gallium Arsenide
semiconductor area, which involved metal organic chemical vapor deposition and
molecular beam epitaxy processes of various structures for digital electronic
devices, as well as photonic devices, such as night vision photocathodes for
military operations and high power lasers. Mr. Dearmin holds patents in the area
of semiconductor laser fabrication as well as high power laser diode
applications.
29
Joseph C. Hayden: Joseph C. Hayden has been the Executive Vice President -
Programs for Ionatron since December 2004. Prior to that, Mr. Hayden was the
Executive Vice President of Business Operations from 2003 to 2004. Mr. Hayden
has over 25 years experience in managing large engineering projects and high
technology research and development. Mr. Hayden is responsible for Contract Bid
and Proposals, administration of existing contracts, and Program Management for
Ionatron. Prior to the founding of Ionatron, Mr. Hayden worked at Raytheon, Inc.
("Raytheon") and also at two other start-up companies. A graduate of the U.S.
Naval Academy, Mr. Hayden was a U.S. Navy Surface Warfare Officer and Nuclear
Engineer before leaving the service to work in industry.
Stephen W. McCahon: Stephen W. McCahon has been the Executive Vice President -
Engineering for Ionatron since 2003. Dr. McCahon has an extensive background in
optical physics, solid-state physics, ultra-short pulse lasers and non-linear
optics, and a broad background in Electrical Engineering (BSEE, MSEE, PH.D.
EE/Physics). Dr. McCahon has more than 40 scientific publications and holds 10
issued patents with 3 pending. Dr. McCahon's most recent position, from 1986 to
2003, had been Chief Engineer of Raytheon's Directed Energy Weapon Product Line.
Previously, he had been a Member of the Research Staff at Hughes Research
Laboratories in Malibu, CA (Currently known as HRL Laboratories).
Bernie Walik: Bernie Walik has been Executive Vice President of Operations since
March 2005 and was, Vice President Operations from May 2004 until March 2005.
Mr. Walik has over 25 years of laser/optics experience in both established and
start-up companies. Prior to joining Ionatron, from March 2000 through May 2004,
Mr. Walik was COO of Lasertel Inc., a manufacturer of high-power multi mode
diode lasers. He was also Vice President of Manufacturing at Opto Power
Corporation. During his tenure, Opto Power became the industry's first
high-volume low cost production facility for high power diode lasers. Mr. Walik
has held senior management positions on operations and manufacturing with
industry leading companies in the design and manufacture of lasers for
industrial, defense, medical and commercial global markets.
Stephen A. McCommon: Stephen A. McCommon has been the Vice President Finance and
Chief Accounting Officer at Ionatron from March 2005 and prior thereto was the
Accounting Manager since July 2004. Mr. McCommon has over 26 years experience in
financial reporting and internal auditing for publicly held companies with
additional experience in accounting systems conversions and regulatory
compliance. Prior to his joining Ionatron, from March 2003 to July 2004, Mr.
McCommon was an independent accounting consultant for various companies. He was
the Controller of Molecular Diagnostics, Inc., a multi-national medical
technology products company, from February 2002 to March 2003. He was the
Corporate Controller of Heartland Technology, Inc. a hardware technology company
from November 1999 to November 2001, and the Controller/General Manager of The
Executive Registry, a privately held internet company from October 1998 to
October 1999.
George P. Farley: George P. Farley, a certified public accountant, has been a
member of our Board of Directors and Audit Committee Chairman since March 2004.
Mr. Farley has been providing financial consulting services for the past five
years. Mr. Farley serves as a Director and a member of the Audit Committee of
iCad, Inc. He has also served as a Director and member of the Audit Committee of
Preserver Insurance Company, Inc. and Acorn Holdings Corp and as a Director for
Olympia Leather Company, Inc. From November 1997 to August 1999, Mr. Farley was
a Chief Financial Officer of Talk.com, Inc., which provides telecommunication
services. Mr. Farley was also a director of Talk.com, Inc. Mr. Farley joined BDO
Seidman, LLP in 1962 and was a partner at BDO Seidman, LLP from 1972 to 1995
with extensive experience in accounting, auditing and SEC matters.
James K. Harlan: James K. Harlan has been a member of our Board of Directors
since March 2004. Mr. Harlan is Executive Vice President and Chief Financial
Officer of HNG Storage, LP, a natural gas storage development and operations
business that he helped found in 1992. From 1991 to 1997, Mr. Harlan served as
Group Development Manager for the Pacific Resources Group which was engaged with
various manufacturing and distribution businesses and joint ventures in Asia,
Australia, and North America. He also served as operations research and planning
analyst for the White House Office of Energy Policy and Planning from 1977 to
1978, the Department of Energy from 1978 to 1981, and U.S. Synthetic Fuels
Corporation from 1981 to 1984. He has a PhD in Public Policy with an operations
research dissertation from Harvard University and a BS in Chemical Engineering
from Washington University in St. Louis. Mr. Harlan is a member of the Board of
Directors of iCAD where he Chairs the Audit Committee.
30
David C. Hurley: David C. Hurley has been a member of our Board of Directors
since March 2004 and Lead Independent Director and Chairman of our Compensation
Committee and our Nominating and Corporate Governance Committee since March
2006. Mr. Hurley was appointed Vice Chairman of PrivatAir of Geneva, Switzerland
on February 1, 2003, relinquishing the role of Chief Executive Officer, a
position he held following the acquisition of Flight Services Group ("FSG") by
PrivatAir in 2000. PrivatAir has major business aviation operations in over
fifteen bases in the U.S. and aircraft service operations at Le Bourget, Paris,
France; Dusseldorf, Munich and Hamburg Germany; and Geneva, Switzerland. Mr.
Hurley founded FSG in 1984. FSG is one of the world's largest providers of
corporate aircraft management, executive charter and aircraft sales and
acquisitions in the U.S. Mr. Hurley has over 30 years experience in marketing
and sales in the aerospace and telecommunications industries. Before founding
FSG, he served as the Senior Vice President of Domestic and International Sales
for Canadair Challenger. He also served as Regional Manager of the Cessna
Aircraft Company and as Director of Marketing, Government and Military Products
Division, for the Harris Intertype Corporation. Mr. Hurley serves on the Boards
of the Smithsonian Institution' s National Air and Space Museum, Washington,
D.C.; BE Aerospace, Inc., a public company, Wellington, FL; Hexcel Corp., a
public company listed on the New York Stock Exchange, Stamford, CT; Genesee &
Wyoming, Inc., a public company listed on the New York Stock Exchange,
Greenwich, CT; The Corporate Angel Network, White Plains, N.Y., the Wings Club,
New York City, and Aerosat, Inc., Manchester, NH. He is an alumnus of Hartwick
College and served three years in the Special Services Branch of the US Army,
receiving an honorable discharge.
James A. McDivitt: James A. McDivitt has served as a member of our Board of
Directors since February 2006. Mr. McDivitt currently serves as a director of
Silicon Graphics Inc., a publicly traded company. From 1981 until his retirement
in 1995, Mr. McDivitt was employed at Rockwell International Corporation, most
recently as its Senior Vice President, Government Operations and International.
Mr. McDivitt joined Pullman Inc. in 1975 as its Executive Vice President and, in
October 1975 he became President of its Pullman Standard Division, The Railcar
Division, and later had additional responsibility for the leasing, engineering
and construction areas of the company. From 1972 through 1975, he was Executive
Vice President Corporate Affairs for Consumers Power Company. Mr. McDivitt
joined the United States Air Force in 1951 and retired with the rank of
Brigadier General in 1972. During his service with the U.S. Air Force, Mr.
McDivitt was selected as an astronaut in 1962 and was Command Pilot for Gemini
IV and Commander of Apollo 9 and Apollo Spacecraft Program Manager from 1969 to
1972, including Apollo 12 through 16 missions. Mr. McDivitt holds a B.S. degree
in Aeronautical Engineering from the University of Michigan.
DIRECTOR INDEPENDENCE
The Board has determined that Messrs. Farley, Harlan, Hurley and McDivitt meet
the director independence requirements of the Marketplace Rules of the
Association of Securities Dealers, Inc. applicable to NASDAQ listed companies.
The Board of Directors has designated David Hurley as our Lead Independent
Director.
COMMITTEES OF THE BOARD OF DIRECTORS:
AUDIT COMMITTEE: The Audit Committee of the Board of Directors is comprised of
Messrs. Farley, Harlan and Hurley. The Audit Committee makes recommendations
concerning the engagement of independent public accountants, reviews with the
independent public accountants the scope and results of the audit engagement,
approves professional services provided by the independent public accountants,
reviews the independence of the independent public accountants, considers the
range of audit and non-audit fees and reviews the adequacy of our internal
accounting controls. Mr. Farley has been designated the audit committee
financial expert serving on the Company's audit committee. Refer to Item 10.
above for Mr. Farley's qualifications.
COMPENSATION COMMITTEE: The Compensation Committee of the Board of Directors is
comprised of Messrs. Hurley and Harlan. The Committee is responsible for
establishing and maintaining executive compensation practices designed to
enhance Company profitability and enhance long-term shareholder value
NOMINATING AND CORPORATE GOVERNANCE COMMITTEE: The Nominating and Corporate
Governance Committee is comprised of Messrs. Harlan and McDivitt. The Committee
is responsible for establishing and maintaining corporate governance practices
designed to aid the long-term success of Ionatron and effectively enhance and
protect shareholder value.
31
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE:
Section 16(a) of the Securities Exchange Act of 1934 requires certain officers
and directors of Ionatron, Inc., and any persons who own more than ten-percent
of the common stock outstanding to file forms reporting their initial beneficial
ownership of shares and subsequent changes in that ownership with the Securities
and Exchange Commission and the NASDAQ National Market. Officers and directors
of Ionatron, Inc., and greater than ten-percent beneficial owners are also
required to furnish us with copies of all such Section 16(a) forms they file.
Based solely on a review of the copies of the forms furnished to us, or written
representations from certain reporting persons that no Form 5 filings were
required, we believe that during the 2005 fiscal year all section 16(a) filing
requirements were met.
CODE OF ETHICS:
Ionatron has adopted a Code of Business Conduct and Ethics that applies to all
of Ionatron's employees and directors, including its principal executive
officer, principal financial officer and principal accounting officer.
Ionatron's Code of Business Conduct and Ethics covers all areas of professional
conduct including, but not limited to, conflicts of interest, disclosure
obligations, insider trading, confidential information, as well as compliance
with all laws, rules and regulations applicable to Ionatron's business.
Upon request made to us in writing at the following address, our Code of Ethics
and Business Conduct will be provided without charge:
Ionatron, Inc.
Attn: Human Resources
3590 E Columbia St.
Tucson, AZ 85714
32
ITEM 11. EXECUTIVE COMPENSATION:
SUMMARY COMPENSATION TABLE
The following table discloses for the periods presented the compensation for the
person who served as our Chief Executive Officer and its four most highly
compensated other executive officers (not including the Chief Executive Officer)
whose total individual compensation exceeded $100,000 for our fiscal year ended
December 31, 2005 (the "Named Executives").
Long-Term
Compensation
--------------------
Annual Compensation Awards
---------------------------- --------------------
Other
Name and Principal Year Salary Bonus Annual Securities
Position Compensation Underlying Options
- ---------------------------------------------------------- --------------------
Thomas Dearmin 2005 $200,000 - - -
Chief Executive
Officer, 2004 200,000 - - -
President and Chief 2003 200,000 - - -
Financial Officer
Robert Howard (1) 2005 148,000 - - -
Chairman of the Board 2004 69,000 - - -
2003 - - - -
Joseph Hayden 2005 186,000 - - -
Executive Vice
President -Programs 2004 175,000 - - -
2003 175,000 - - -
Stephen William
McCahon 2005 184,000 - - -
Executive Vice
President -
Engineering 2004 175,000 - - -
2003 175,000 - - -
Bernie Walik 2005 198,000 41,000 - 200,000
Executive Vice
President
- -Operations(2) 2004 143,000 - - 100,000
None of the Named Executives received any long-term compensation awards during
2003, 2004 or 2005 except as noted in the table above.
- ------------------
(1) Mr. Howard is compensated at the rate of $150,000 per year. Mr. Howard did
not begin receiving any compensation until the third quarter of 2004.
(2) Mr. Walik joined the Company in May 2004.
33
OPTION GRANTS IN LAST FISCAL YEAR
The following table discloses the options granted to each of the Named
Executives in 2005.
- -------------------------------------------------------------------------------------------- -------------------------
Potential Realizable
Value at Assumed Annual
Rates of Stock Price
Appreciation For
Individual Grants Options Term
- ------------------------------------ ------------- -------------- ------------- ------------ -------------------------
Percent of
Number of Total
Securities Options
Underlying Granted to Exercise of
Options Employees in Base Price Expiration
Name Granted (#) 2005 ($/Sh) Date
- ------------------------------------ ------------- -------------- ------------- ------------ ------------ ------------
5% ($) 10% ($)
- ------------------------------------ ------------- -------------- ------------- ------------ ------------ ------------
(a) (b) ( c ) (d) (e) (f) (g)
- ------------------------------------ ------------- -------------- ------------- ------------ ------------ ------------
Thomas Dearmin - - - -
- ------------------------------------ ------------- -------------- ------------- ------------ ------------ ------------
Robert Howard - - - -
- ------------------------------------ ------------- -------------- ------------- ------------ ------------ ------------
Joseph Hayden - - - -
- ------------------------------------ ------------- -------------- ------------- ------------ ------------ ------------
Stephen William McCahon - - - -
- ------------------------------------ ------------- -------------- ------------- ------------ ------------ ------------
Bernie Walik 200,000 19% $7.16 01/28/10 $395,635 $874,250
- ------------------------------------ ------------- -------------- ------------- ------------ ------------ ------------
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
The following table discloses the options that were exercised by the Named
Executives in 2005 and the value of the remaining unexercised options at
December 31, 2005.
- ----------------------------------- --------------- --------------- --------------------- -------------------------
Number of
Securities
Underlying
Unexercised Options Value of Unexercised
at In-The-Money Options at
Shares Fiscal Year-End (#) Fiscal Year-End ($)
Acquired on Value Exercisable / Exercisable /
Name Exercise (#) Realized ($) Unexercisable Unexercisable
(a) (b) (c) (d) (e)
- ----------------------------------- --------------- --------------- --------------------- -------------------------
Thomas Dearmin - - - -
- ----------------------------------- --------------- --------------- --------------------- -------------------------
Robert Howard - - - -
- ----------------------------------- --------------- --------------- --------------------- -------------------------
Joseph Hayden - - - -
- ----------------------------------- --------------- --------------- --------------------- -------------------------
Stephen William McCahon - - - -
- ----------------------------------- --------------- --------------- --------------------- -------------------------
Bernie Walik 41,666 $285,187 35,001 /133,333 $198,507 / $520,331
- ----------------------------------- --------------- --------------- --------------------- -------------------------
DIRECTOR COMPENSATION:
None of our directors received any cash compensation for serving in such
capacity during 2005. During 2005, we granted stock options to purchase 50,000
shares of common stock at an exercise price of $8.40, the closing price of the
common stock on the date of the grant, to each of our independent directors,
except for George Farley, the Chairman of our Audit Committee, who received
stock options to purchase 75,000 shares of common stock at an exercise price of
$8.40.
34
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDERS:
The following table sets forth information regarding the beneficial ownership of
our Common Stock, based on information provided by the persons named below in
publicly available filings, as of March 14, 2006:
o each of the our directors and executive officers;
o all directors and executive officers of our's as a group; and
o each person who is known by us to beneficially own more than five
percent of the outstanding shares of our Common Stock.
Unless otherwise indicated, the address of each beneficial owner is care of
Ionatron, 3590 East Columbia Street, Tucson, Arizona 85714. Unless otherwise
indicated, the Company believes that all persons named in the following table
have sole voting and investment power with respect to all shares of common stock
that they beneficially own.
For purposes of this table, a person is deemed to be the beneficial owner of the
securities if that person has the right to acquire such securities within 60
days of March 14, 2006 upon the exercise of options or warrants. In determining
the percentage ownership of the persons in the table below, we assumed in each
case that the person exercised all options and warrants which are currently held
by that person and which are exercisable within such 60 day period, but that
options and warrants held by all other persons were not exercised, and based the
percentage ownership on 72,339,453 shares outstanding on March 14, 2006.
Percentage
of Shares
Number of Shares Beneficially
Name and Address of Beneficial Owner Beneficially Owned Owned (1)
- -------------------------------------------- ------------------ ------------
Robert Howard 22,097,262(3) 30.5%
Thomas Dearmin 9,056,151 12.5
Joseph C. Hayden 6,111,868 8.4
Stephen McCahon 6,094,168 8.4
Bernie Walik 248,334(2) *
Stephen A. McCommon 53,000(2) *
George Farley 187,500(2) *
James Harlan 150,000(2) *
David Hurley 150,000(2) *
James A. McDivitt 150,000(2)
All directors and executive officers as
a group (10 persons) 46,798,283 63.9%
* Less than 1%
(1) Computed based upon the total number of shares of Common Stock and shares
of Common Stock underlying options held by that person exercisable within
60 days of March 14, 2006.
(2) Includes options exercisable within 60 days of March 14, 2006.
(3) Does not include shares of common stock owned by a family partnership, of
which Mr. Howard's wife is a partner and has an economic interest in
500,000 of the shares held by the partnership. Mr. Howard and his wife do
not have any voting or dispositive power over the shares held by the
partnership,
35
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS:
The following table details information regarding our existing equity
compensation plans as of December 31, 2005.
Equity Compensation Plan Information
- ------------------------------- ------------------ -------------- ---------------------
Number of
securities
remaining available
for future issuance
Number of Weighted- under equity
securities to be average compensation plans
issued upon exercise (excluding
exercise of price of securities
outstanding outstanding reflected in column
Plan category options options (a))
- ------------------------------- ------------------ -------------- ---------------------
(a) (b) ( c )
- ------------------------------- ------------------ -------------- ---------------------
Equity compensation plans
approved by security holders 2,857,365 $ 4.67 2,955,600
- ------------------------------- ------------------ -------------- ---------------------
Equity compensation plans not
approved by security holders 624,250 $ 2.44 -
- ------------------------------- ------------------ -------------- ---------------------
Total 3,481,615 $ 4.30 2,955,600
- ------------------------------- ------------------ -------------- ---------------------
Following is a description of our stock option plans and stock incentive plan.
Prior to the Merger, Ionatron did not have any stock option plans.
In September 1991, we adopted a stock option plan (the "1991 Plan") pursuant to
which 700,000 shares of Common Stock have been reserved for issuance upon the
exercise of options designated as either (i) options intended to constitute
incentive stock options ("ISOs") under the Internal Revenue Code of 1986, as
amended (the "Code") or (ii) non-qualified options ("NQOs"). ISOs may be granted
under the 1991 Plan to our employees and officers. NQOs may be granted to
consultants, directors (whether or not they are employees), and to our employees
or officers.
The purpose of the 1991 Plan is to encourage stock ownership by certain of our
directors, officers and employees and certain other persons instrumental to our
success and give them a greater personal interest in our success. The 1991 Plan
is administered by the Board of Directors. The Board, within the limitations of
the 1991 Plan, determines the persons to whom options will be granted, the
number of shares to be covered by each option, whether the options granted are
intended to be ISOs, the duration and rate of exercise of each option, the
option purchase price per share and the manner of exercise, the time, manner and
form of payment upon exercise of an option, and whether restrictions such as
repurchase rights in Ionatron Inc. are to be imposed on shares subject to
options.
ISOs granted under the 1991 Plan may not be granted at a price less than the
fair market value of the common stock on the date of grant (or 110% of fair
market value in the case of persons holding 10% or more of the voting stock of
Ionatron Inc.). The aggregate fair market value of shares for which ISOs granted
to any employee are exercisable for the first time by such employee during any
calendar year (under all of our stock option plans and those of any related
corporation) may not exceed $100,000. NQOs granted under the 1991 Plan may not
be granted at a price less than the fair market value of the Common Stock on the
date of grant. Options granted under the 1991 Plan will expire not more than ten
years from the date of grant (five years in the case of ISOs granted to persons
holding 10% or more of our voting stock).
We have adopted a Non-Employee Director Stock Option Plan (the "Director Plan").
Only non-employee directors of Ionatron Inc. are eligible to receive grants
under the Director Plan. The Director Plan provided that eligible directors
automatically receive a grant of options to purchase 5,000 shares of common
stock at fair market value upon first becoming a director and, thereafter, an
annual grant, in January of each year, of 5,000 options at fair market value.
Options to purchase an aggregate of up to 100,000 shares of Common Stock are
available for automatic grants under the Director Plan. No additional grants
shall be made under the Director Plan.
36
We have adopted a 1995 Stock Option Plan ("1995 Plan") which provides for grants
of options to purchase up to 1,500,000 shares of common stock. The Board of
Directors or the Stock Option Committee (the "Committee"), as the case may be,
will have discretion to determine the number of shares subject to each NQO
(subject to the number of shares available for grant under the 1995 Plan and
other limitations on grant set forth in the 1995 Plan), the exercise price
thereof (provided such price is not less than the par value of the underlying
shares of Common Stock), the term thereof (but not in excess of 10 years from
the date of grant, subject to earlier termination in certain circumstances), and
the manner in which the option becomes exercisable (amounts, intervals and other
conditions). Directors who are also employed by us will be eligible to be
granted ISOs or NQOs under such plan. The Board or Committee, as the case may
be, also has discretion to determine the number of shares subject to each ISO,
the exercise price and other terms and conditions thereof, but their discretion
as to the exercise price, the term of each ISO and the number of ISOs that may
vest in any calendar year is limited by the same Code provisions applicable to
ISOs granted under the 1995 Plan.
We have adopted a 1997 Stock Option Plan ("1997 Plan") which provides for grants
of options to purchase up to 1,500,000 shares of Common Stock. The Board of
Directors or the Committee of the 1997 Plan, as the case may be, will have
discretion to determine the number of shares subject to each NQO (subject to the
number of shares available for grant under the 1997 Plan and other limitations
on grant set forth in the 1997 Plan), the exercise price thereof (provided such
price is not less than the par value of the underlying shares of Common Stock),
the term thereof (but not in excess of 10 years from the date of grant, subject
to earlier termination in certain circumstances), and the manner in which the
option becomes exercisable (amounts, intervals and other conditions). Directors
who are also our employees will be eligible to be granted ISOs or NQOs under
such plan. The Board or Committee, as the case may be, also has discretion to
determine the number of shares subject to each ISO, the exercise price and other
terms and conditions thereof, but their discretion as to the exercise price, the
term of each ISO and the number of ISOs that may vest in any calendar year is
limited by the same Code provisions applicable to ISOs granted under the 1997
Plan.
We have also adopted a 1999 Stock Option Plan ("1999 Plan") which provides for
grants of options to purchase up to 900,000 shares of common stock. The Board of
Directors or the Committee of the 1999 Plan, as the case may be, will have
discretion to determine the number of shares subject to each NQO (subject to the
number of shares available for grant under the 1999 Plan and other limitations
on grant set forth in the 1999 Plan), the exercise price thereof (provided such
price is not less than the fair market value of the underlying shares of Common
Stock), the term thereof (but not in excess of 10 years from the date of grant,
subject to earlier termination in certain circumstances), and the manner in
which the option becomes exercisable (amounts, intervals and other conditions).
Directors who are also our employees will be eligible to be granted ISOs or NQOs
under such plan. The Board or Committee, as the case may be, also has discretion
to determine the number of shares subject to each ISO, the exercise price and
other terms and conditions thereof, but their discretion as to the exercise
price, the term of each ISO and the number of ISOs that may vest in any calendar
year is limited by the same Code provisions applicable to ISOs granted under the
1999 Plan.
We have adopted a 2004 Stock Incentive Plan ("2004 Plan"), which provides for
the grant of any or all of the following types of awards: (1) stock options,
which may be either incentive stock options or non-qualified stock options, (2)
restricted stock, (3) deferred stock and (4) other stock-based awards. A total
of 3,000,000 shares of common stock have been reserved for distribution pursuant
to the 2004 Plan. On June 28, 2005, the stockholders approved an amendment to
the 2004 Plan to (i) increase the number of shares of the Company's common
stock, $.001 par value, authorized for issuance under the 2004 Plan by 2,000,000
shares from 3,000,000 shares to 5,000,000 shares, and (ii) set the maximum
number of shares of common stock which may be issued upon the exercise of
incentive stock options at 3,000,000 shares. As of December 31, 2005 and 2004,
approximately 1,074,000 and 651,000 shares, respectively, of common stock
issuable upon exercise of options have been granted under the 2004 Plan.
We have, from time to time, also granted non-plan options to certain officers,
directors, employees and consultants.
37
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS:
Our Chairman, a significant stockholder, has provided funds from the inception
of the Company under a revolving credit arrangement. The maximum amount borrowed
was $5.3 million. After pay down of $500,000 and contribution of $2 million of
the revolving credit into equity in the first quarter of 2004, the remainder of
$2.8 million was incorporated into a new $3 million revolving credit arrangement
with the same terms as the original revolving credit agreement. The note payable
to stockholder bears interest at a variable annual rate equal to the prime rate
plus two percent (2%), is due upon demand subject to Board approval, and was
collateralized by the assets of our subsidiary, Ionatron Technologies, Inc. In
September 2005, we borrowed an additional $100,000 under a line of credit from
our Chairman. The line of credit was paid in full in November 2005. The maximum
amount outstanding under the revolving credit arrangements during 2005 was $2.9
million. Interest under the line of credit was approximately $213,000 for the
year ended December 31, 2005.
We lease office, manufacturing and storage space at our Tucson facility at an
annual rental of $330,000 under a non-cancelable operating lease agreement from
a company that is partially owned by Messrs. Howard, Dearmin, Hayden, McCahon
and Walik. The lease expires in November 2012, contains renewal options and an
escalation provision in 2007 that increases our annual rent by $49,500. We
account for the escalation provision by straight-lining the rent expense. We are
also responsible for certain property related costs, including insurance,
utilities and property taxes.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES:
The following is a summary of the fees billed to the Company by BDO Seidman, LLP
for professional services rendered for the years ended December 31, 2004 and
2005:
2004 2005
-------- --------
Audit Fees $554,000 $611,000
Audit-Related Fees 95,000 9,000
Tax Fees 14,000 9,000
On March 18, 2004, U.S. Home & Garden ("USHG") merged into Ionatron, Inc. Prior
to the Merger, BDO Seidman, LLP was the auditor for both USHG and Ionatron. The
fees billed to USHG were zero for 2004. Fees for audit services include fees
associated with the annual audit of the Company and its subsidiaries, the review
of the Company's quarterly reports on Form 10-Q and the internal control
evaluation under Section 404 of the Sarbanes-Oxley Act of 2002. Audit-related
fees principally include the audit of the historical financial statements of
North Star in 2004 and review of private placement for 2005. Tax fees
include tax compliance, tax advice and tax planning related to federal and state
tax matters.
PRE-APPROVAL POLICIES AND PROCEDURES
Consistent with the Securities and Exchange Commission requirements regarding
auditor independence, our Audit Committee has adopted a policy to pre-approve
all audit and permissible non-audit services provided by our principal
accountant. Under the policy, the Audit Committee must approve non-audit
services prior to the commencement of the specified service. Our principal
accountants have verified, and will verify annually, to our Audit Committee that
they have not performed, and will not perform any prohibited non-audit service.
38
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES:
The following documents are filed or incorporated by reference as part of this
report:
1. Consolidated Financial Statements from Ionatron's 2005 Financial
Statements which are incorporated herein by reference:
a. Management's Report on Internal Control Over Financial Reporting.
b. Report of Independent Registered Public Accounting Firm on Internal
Control Over Financial Reporting.
c. Report of Independent Registered Public Accountant Firm on Financial
Statements.
d. Consolidated Statements of Operations for the years ended December
31, 2005, 2004 and 2003.
e. Consolidated Balance Sheets as of December 31, 2005 and 2004.
f. Consolidated Statements of Stockholders' Equity (Deficit) for the
years ended December 31, 2005, 2004 and 2003.
g. Consolidated Statements of Cash Flows for the years ended December
31, 2005, 2004 and 2003.
h. Notes to the Consolidated Financial Statements.
2. Consolidated Financial Statement Schedules required to be filed by Item 8
of this Form:
Ionatron, Inc
Schedule II - Valuation and Qualifying Accounts
For the years ended December 31, 2005 and 2004
Allowance for Doubtful Accounts
2004 2005
-------- ---------
Balance at beginning of year $ 17,423 $ --
Provision 17,423 38,847
Write offs -- (13,150)
Other -- (4,283)
-------- --------
Balance at end of year $ 17,423 $ 38,837
======== ========
Aggregate Product Warranty Liability:
2004 2005
-------- ---------
Balance at beginning of year $ -- $ 40,000
September 30, 2004 acquisition 40,000 --
Payments made under warranties -- (16,500)
Change for accruals related to product warranties -- --
Change for accruals related to preexisting
warranties -- (23,500)
-------- --------
Balance at end of year $ 40,000 $ --
======== ========
Reserve For Loss on Projects
2004 2005
-------- ---------
Balance at beginning of year $ -- $ --
Provision -- 29,469
Write offs -- (29,469)
Other -- --
-------- --------
Balance at end of year $ -- $ --
======== ========
There were no valuation or qualifying account balances or activity for 2003.
39
3. Exhibits:
EXHIBIT DESCRIPTION
NUMBER
-----------------------------------------------------------------------------
2.1 Amended and Restated Plan and Agreement of Merger entered into as
of March 17, 2004, by and among U.S. Home & Garden, Inc.
("USHG"), Ionatron Acquisition Corp., a wholly-owned subsidiary
of USHG, Robert Kassel (for purposes of Sections 5.9, 6.2(d),
6.2(j), 9.4 and 10.10 only), Fred Heiden (for purposes of Section
9.4 only), and Ionatron, Inc. and Robert Howard, Stephen W.
McCahon, Thomas C. Dearmin and Joseph C. Hayden (incorporated by
reference to the comparable exhibit filed with the Registrant's
Form 8-K filed with the SEC on March 24, 2004).
3.1 Certificate of Incorporation, as amended, (incorporated by
reference to the comparable exhibit filed with the Registrant's
Form 10-KSB for the fiscal year ended June 30, 1995).
3.2 Certificate of Amendment of Certificate of Incorporation if the
Registrant filed with the Secretary of State of the State of
Delaware on April 29, 2004 (incorporated by reference to the
comparable exhibit filed with the Registrant's Form 10-Q for the
quarterly period ended March 31, 2004).
3.3 Certificate of Elimination of the 10% Series A Convertible
Preferred Stock of the Registrant (incorporated by reference to the
comparable exhibit filed with the Registrant's Form 8-K filed with
the SEC on October 28, 2005).
40
EXHIBIT DESCRIPTION
NUMBER
3.4 Certificate of Designation of the 6.5% Series A Redeemable
Convertible Preferred Stock of the Registrant (incorporated by
reference to the comparable exhibit filed with the Registrant's 8-K
filed with the SEC on October 28, 2005).
3.5 By-laws of the Registrant (incorporated by reference to Exhibit
3(b) of the Registrant's Registration Statement on Form S-1
(Registration No. 33-45428)).
4.1 Form of certificate evidencing Common Stock, $.001 par value, of
the Registrant (incorporated by reference to Exhibit 4.1 of the
Registrant's Registration Statement on Form S-1 (Registration No.
333-38483)).
4.2 Rights Agreement dated as of October 1, 1998 between the Registrant
and Continental Stock Transfer & Trust Company (incorporated by
reference to Exhibit 4.1 filed with the Registrant's Current Report
on Form 8-K for the event dated October 1, 1998).
4.3 Form of Registration Rights Agreement by and among the Registrant
and each of the Purchasers named on the schedule thereto
(incorporated by reference to the comparable exhibit filed with the
Registrant's Form 8-K filed with the SEC on October 28, 2005).
10.1 1991 Stock Option Plan (incorporated by reference to Exhibit 10.5
of the Registrant's Registration Statement on Form S-1
(Registration No. 33-45428).
10.2 1995 Stock Option Plan, as amended (incorporated by reference to
the comparable exhibit filed with the Registrant's Form 10-K for
the fiscal year ended June 30, 1999).
10.4 1997 Stock Option Plan, as amended (incorporated by reference to
the comparable exhibit filed with the Registrant's Form 10-K for
the fiscal year ended June 30, 1999).
10.5 1999 Stock Option Plan (incorporated by reference to Exhibit A
filed with the Registrant's Proxy Statement dated May 14, 1999
filed on Schedule 14A).
10.6 2004 Stock Incentive Plan (incorporated by reference to Appendix B
to the Registrant's Proxy Statement on Schedule 14A filed with the
SEC on May 25, 2005).
10.7 Tenant Use Contract between the Company and Mason Technology Inc.
dated July 14, 2004 (incorporated by reference to the comparable
exhibit filed with the Registrant's Form 10-Q for the quarterly
period ended September 30, 2004).
10.8 Lease, dated August, 1995 by and between McLeod Business
Properties, as Lessor and North Star Research Acquisition Corp.
(formerly North Star Research Corporation), as amended.
10.9 Form of 2004 Stock Incentive Plan Non-Qualifying Stock Option
Agreement for Directors (incorporated by reference to the
comparable exhibit filed with the Registrant's Form 10-Q for the
quarterly period ended June 30, 2005).
21 Subsidiaries
23 Consent of BDO Seidman, LLP
41
EXHIBIT DESCRIPTION
NUMBER
31.1 Certification of Chief Executive and Chief Financial Officer
pursuant to Rule 13a-14 or 15d-14 of the Securities Exchange Act of
1934, as adopted pursuant to Section 302 of the Sarbanes Oxley Act
of 2002.
32.1 Chief Executive Officer and Chief Financial Officer Certification
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
42
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 the 16th day of March
2006.
IONATRON, INC.
By /s/ Thomas C. Dearmin
--------------------------------
Thomas C. Dearmin
Chief Executive Officer, President and
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on the 16th day of March, 2006 by the following persons on
behalf of the registrant and in the capacity indicated.
Name Title
/s/ Robert Howard Chairman, Director and Secretary
- -----------------
Robert Howard
/s/ Thomas C. Dearmin Chief Executive Officer, Director,
- --------------------- President and Chief Financial Officer
Thomas C. Dearmin
/s/ Joseph Hayden Executive Vice President Programs
- -----------------
Joseph Hayden
/s/ Stephen W. McCahon Executive Vice President Engineering
- ----------------------
Stephen W. McCahon
/s/ Stephen A. McCommon Vice President Finance and Chief
- ----------------------- Accounting Officer
Stephen A. McCommon
/s/ George P. Farley Director
- --------------------
George P. Farley
/s/ James K. Harlan Director
- -------------------
James K. Harlan
/s/ David C. Hurley Director
- -------------------
David C. Hurley
43
IONATRON, INC.
FINANCIAL STATEMENTS
FOR THE YEAR ENDED DECEMBER 31, 2005
INDEX
Page No.
Report of Independent Registered Public Accounting Firm on Financial
Statements and Schedule.................................................F - 2
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Statements of Operations................................F - 3
Consolidated Balance Sheets..........................................F - 4
Consolidated Statements of Stockholders' Equity (Deficit)............F - 5
Consolidated Statements of Cash Flows................................F - 6
Notes to the Consolidated Financial Statements.......................F - 8
F - 1
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Ionatron, Inc.
Tucson, Arizona
We have audited the accompanying consolidated balance sheets of Ionatron, Inc.
as of December 31, 2005 and 2004 and the related consolidated statements of
operations, stockholders' equity (deficit), and cash flows for each of the three
years in the period ended December 31, 2005. We have also audited the schedule
listed in the accompanying index. 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 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 and schedule are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements and schedule, assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall
presentation of the financial statements and schedule. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Ionatron, Inc. at
December 31, 2005 and 2004, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 2005, in conformity
with accounting principles generally accepted in the United States of America.
Also, in our opinion, the schedule presents fairly, in all material respects,
the information set forth therein.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Ionatron,
Inc.'s internal control over financial reporting as of December 31, 2005, based
on criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our
report dated March 10, 2006 expressed an unqualified opinion on management's
assessment of the effectiveness of Ionatron, Inc.'s internal control over
financial reporting and an adverse opinion on the effectiveness of Ionatron,
Inc.'s internal control over financial reporting because of a material weakness.
/s/ BDO Seidman LLP
Phoenix, Arizona
March 10, 2006
F - 2
IONATRON, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31,
2005 2004 2003
-------------------------------------------
Revenue $ 18,875,928 $ 10,930,522 $ 383,273
Cost of revenue 17,757,305 10,094,379 356,822
-------------------------------------------
Gross profit 1,118,623 836,143 26,451
Operating expenses:
General and administrative 3,613,151 2,565,778 1,681,174
Selling and marketing 525,067 544,564 239,847
Research and development 1,266,382 808,242 1,151,350
-------------------------------------------
Total operating expenses 5,404,600 3,918,584 3,072,371
-------------------------------------------
Operating loss (4,285,977) (3,082,441) (3,045,920)
Other income (expense)
Interest expense (227,106) (215,593) (196,189)
Interest income 111,760 46,122 --
Other income (expense) 815,134 484 --
-------------------------------------------
Total other income (expense) 699,788 (168,987) (196,189)
-------------------------------------------
Loss before provision for income
taxes (3,586,189) (3,251,428) (3,242,109)
Provision for income taxes 38,414 9,577 --
-------------------------------------------
Net loss (3,624,603) (3,261,005) (3,242,109)
Preferred stock dividends (210,726) -- --
-------------------------------------------
Net loss attributable to common
stockholders $ (3,835,329) $ (3,261,005) $ (3,242,109)
===========================================
Net loss per common share - basic
and diluted $ (0.05) (0.05) (0.07)
-------------------------------------------
Weighted average number of common
shares outstanding, basic and
diluted 71,334,830 65,264,393 48,452,249
===========================================
See accompanying notes to consolidated financial statements.
F - 3
IONATRON, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
ASSETS 2005 2004
-----------------------------
Current assets
Cash and cash equivalents $ 371,248 $ 2,495,779
Accounts receivable - net 5,367,691 4,497,350
Inventory 1,348,700 341,334
Securities available-for-sale 12,000,000 1,000,000
Prepaid expenses 536,927 404,619
Other receivables 20,085 30,403
-----------------------------
Total current assets 19,644,651 8,769,485
Property and equipment - net 1,732,796 1,416,072
Goodwill 1,487,884 1,487,884
Intangible assets - net 787,500 864,450
-----------------------------
TOTAL ASSETS $ 23,652,831 $ 12,537,891
=============================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Note payable to stockholder $ -- $ 2,800,000
Accounts payable 997,589 1,639,018
Accrued expenses 500,656 279,204
Accrued compensation 391,912 309,818
Insurance premium financing 216,043 199,171
Billings in excess of costs 84,208 25,695
Current portion of capital lease
obligations 37,617 2,435
-----------------------------
Total current liabilities 2,228,025 5,255,341
Capital lease obligations 62,290 3,482
Deferred tax liabilities 47,991 9,577
Deferred rent 82,623 52,874
-----------------------------
Total liabilities 2,420,929 5,321,274
-----------------------------
Commitments and contingencies -- --
Stockholders' equity
Series A Convertible Preferred stock,
$.001 par value, 950,000 shares
authorized and 720,000 shares issued
and outstanding at December 31, 2005 720 --
Common stock, $.001 par value,
100,000,000 shares authorized;
71,996,111 shares issued and
outstanding at December 31, 2005;
70,846,204 shares issued and
outstanding at December 31, 2004 71,996 70,846
Additional paid-in capital 28,044,794 10,406,776
Accumulated deficit (6,885,608) (3,261,005)
-----------------------------
Total stockholders' equity 21,231,902 7,216,617
-----------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 23,652,831 $ 12,537,891
=============================
See accompanying notes to consolidated financial statements.
F - 4
IONATRON, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Preferred Stock Common Stock
------------------------------------------------------
Shares Amount Shares Amount
------------------------------------------------------
Balance as of December 31, 2002 -- -- 48,452,249 $ 48,452
Issuance of warrants for cash -- -- -- --
Net loss for the year -- -- -- --
------------------------------------------------------
Balance as of December 31, 2003 -- -- 48,452,249 48,452
Transfer of deficit on termination of
Subchapter S election -- -- -- --
Contribution of note payable to
stockholders' equity -- -- -- --
Issuance of common stock in the Merger -- -- 19,346,090 19,346
Issuance of common stock in North Star
acquisition -- -- 199,063 199
Exercise of stock options and warrants -- -- 2,848,802 2,849
Options issued for services performed -- -- -- --
Net loss for the year -- -- -- --
------------------------------------------------------
Balance as of December 31, 2004 -- -- 70,846,204 70,846
Exercise of stock options and warrants -- -- 1,139,907 1,140
Options issued for services performed -- -- -- --
Sale of Series A Preferred Stock net of
offering costs 720,000 720 -- --
Shares issued for services performed -- -- 10,000 10
Net loss for the year -- -- -- --
------------------------------------------------------
Balance as of December 31, 2005 720,000 $ 720 71,996,111 $ 71,996
======================================================
Additional Total
Paid-in Accumulated Stockholders'
Capital Deficit Equity (Deficit)
---------------------------------------------
Balance as of December 31, 2002 $ (28,452) $ (747,675) $ (727,675)
Issuance of warrants for cash 500,000 -- 500,000
Net loss for the year -- (3,242,109) (3,242,109)
---------------------------------------------
Balance as of December 31, 2003 471,548 (3,989,784) (3,469,784)
Transfer of deficit on termination of
Subchapter S election (3,989,784) 3,989,784 --
Contribution of note payable to
stockholders' equity 2,000,000 -- 2,000,000
Issuance of common stock in the Merger 8,797,227 -- 8,816,573
Issuance of common stock in North Star
acquisition 1,699,801 -- 1,700,000
Exercise of stock options and warrants 1,221,629 -- 1,224,478
Options issued for services performed 206,355 -- 206,355
Net loss for the year -- (3,261,005) (3,261,005)
---------------------------------------------
Balance as of December 31, 2004 10,406,776 (3,261,005) 7,216,617
Exercise of stock options and warrants 829,860 -- 831,000
Options issued for services performed 154,495 -- 154,495
Sale of Series A Preferred Stock net of
offering costs 16,578,473 -- 16,579,193
Shares issued for services performed 75,190 -- 75,200
Net loss for the year -- (3,624,603) (3,624,603)
---------------------------------------------
Balance as of December 31, 2005 $ 28,044,794 $ (6,885,608) $ 21,231,902
=============================================
See accompanying notes to the consolidated financial statements.
F - 5
IONATRON, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31
2005 2004 2003
------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (3,624,603) $ (3,261,005) $ (3,242,109)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 965,918 887,154 645,002
Loss on equipment disposal 48,726 470 --
Deferred income tax provision 38,414 9,577 --
Stock and option compensation 185,828 206,355 --
Changes in working capital components:
Accounts receivable (870,341) (4,148,541) (104,454)
Other receivables 10,318 (30,403) (7,482)
Inventory (1,007,366) (320,334) (21,000)
Prepaid expenses (88,441) (356,714) (46,105)
Accounts payable (641,429) 1,277,429 (537,626)
Billings in excess of costs 58,513 25,695 --
Accrued expenses 350,167 141,414 320,228
-----------------------------------------
Net cash used in operating activities (4,574,296) (5,568,903) (2,993,546)
-----------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment (1,139,571) (1,115,672) (625,268)
Proceeds from sale of
municipal bonds
available-for-sale 1,000,000 6,000,000 --
Purchases of
available-for-sale --
marketable securities (12,000,000) (7,000,000) --
Proceeds from disposal
of equipment -- 3,208 --
Receivables from
stockholder -- 107,482 --
Acquisition of business,
net of cash acquired -- (573,234) --
-----------------------------------------
Net cash used in investing activities (12,139,571) (2,578,216) (625,268)
-----------------------------------------
F - 6
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from note
payable to stockholder 100,000 1,000,000 3,125,000
Proceeds from issuance
of Series A
Convertible
Preferred Stock 18,000,000 -- --
Fees paid for financing
transactions (1,420,807) -- --
Repayment on note
payable to stockholder (2,900,000) (500,000) --
Principal payments on
capital lease obligations (20,574) (1,545) --
Cash acquired from the
Merger -- 8,816,573 --
Proceeds from issuance
of warrants -- -- 500,000
Exercise of stock
options and warrants 831,000 1,224,478 --
-----------------------------------------
Net cash provided by financing activities 14,589,619 10,539,506 3,625,000
-----------------------------------------
Net increase (decrease) in cash and cash equivalents (2,124,531) 2,392,387 6,186
Cash and cash equivalents, beginning of period 2,495,779 103,392 97,206
-----------------------------------------
Cash and cash equivalents, end of period $ 371,248 $ 2,495,779 $ 103,392
=========================================
See non-cash investing and financing activities at Note 14
See accompanying notes to consolidated financial statements.
F -7
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
ORGANIZATION OF BUSINESS AND BASIS OF PRESENTATION:
The consolidated financial statements include the accounts of Ionatron, Inc. and
its wholly owned subsidiaries, Ionatron Technologies, Inc. and North Star Power
Engineering, Inc. ("North Star") (collectively, "Company," "Ionatron," "we,"
"our" or "us"). All intercompany balances and transactions have been eliminated.
Certain reclassifications have been made to prior period financial statement
amounts to conform to the current presentation.
NATURE OF BUSINESS AND SUMMARY OF OPERATIONS:
Ionatron was formed on June 3, 2002 to develop and market Directed Energy Weapon
technology products for initial sale to the U.S. Government. Ionatron and the
U.S. Government have entered into several contracts for products and services as
well as Cooperative Research and Development Agreements for joint research on
Laser Induced Plasma Channel ("LIPC") based directed energy weapons. We expect
to offer U.S. Government approved versions of our products for commercial
security applications in the future. During 2002 and 2003, the Company engaged
in research and development and business development activities culminating in
our first U.S. Government contract in September of 2003. During 2004, we
demonstrated the laser guided man-made lightning directed energy technology in
the laboratory; demonstrated the technology effects on a variety of targets both
under U.S. Government contract and using internal research and development
funding; delivered a compact laser source specifically designed to enable the
technology under a U.S. Government contract; and commenced a U.S. Government
contract for the development of a system on a mobile platform for field
demonstration and testing. In 2005, we continued development of laser sources,
advanced high voltage systems, and special-purpose optical systems, expanded
target effects testing under U.S. Government contracts, and furthered our
understanding of the underlying physics and continued to capture critical
intellectual property with internal funding. Additionally in 2005, we developed
a counter-IED ("Improved Explosive Device") vehicle for use in Iraq called the
Joint IED Neutralizer ("JIN").
Through North Star, we are involved in the design and manufacture of a broad
range of high voltage equipment for the defense, aerospace, semi-conductor, and
medical industries. North Star power supplies are utilized in Ionatron products.
MERGER AND RECAPITALIZATION:
On March 18, 2004, a subsidiary of U. S. Home & Garden, Inc. ("USHG"), a
non-operating, publicly traded company merged into Ionatron, Inc. (the
"Merger"). Following the Merger, USHG stockholders held 33.89 % and Ionatron
stockholders held 66.11% of USHG common stock on a fully diluted basis. The
combination has been accounted for as a recapitalization of Ionatron, Inc.,
effective from our inception on June 3, 2002, and the issuance of 19,346,090
common shares and approximately 5.5 million options and warrants to the USHG
stockholders on the date of merger in exchange for $8.8 million in cash. We also
acquired in the Merger a $1.6 million principal amount subordinated promissory
note from a highly leveraged entity. This note matures in 2009 and accrues
interest on a compound basis at the rate of 9% per annum until maturity. At the
time of the Merger, we recorded a 100% valuation allowance for this note due to
the uncertainty of collectibility. During 2005, we received $800,000 from the
sale of this note which is included in "other income" on the accompanying
Consolidated Statements of Operations.
The consolidated financial statements reflect the historical results of
Ionatron, Inc., prior to March 18, 2004, and the consolidated results of
operations of the Company since March 18, 2004. As a result of the Merger, all
pre-merger outstanding shares of Ionatron common stock were converted to
48,452,249 shares of USHG common stock.
F - 8
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
USE OF ESTIMATES:
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States ("GAAP") requires
our management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Such estimates and
assumptions could change in the future as more information becomes known which
could impact the amounts reported and disclosed herein. Significant estimates
include the purchase price allocation with respect to the North Star
acquisition, and estimates as they relate to contract accounting and revenue
recognition.
REVENUE RECOGNITION:
Revenue under long-term U.S. Government contracts is recorded under the
percentage of completion method. Revenue, billable monthly, under cost plus
fixed fee contracts is recorded as costs are incurred and includes estimated
earned fees in the proportion that costs incurred to date bear to total
estimated costs. Costs include direct labor, direct materials, subcontractor
costs and manufacturing and administrative overhead allowable under the
contract. As contracts can extend over one or more accounting periods, revisions
in earnings estimated during the course of work are reflected during the
accounting period in which the facts become known. When the current contract
estimate indicates a loss, provision is made for the total anticipated loss in
the current period. Gross revenue is presented as we do not generally provide an
allowance for returns from our customers.
The asset caption "accounts receivable" includes costs and estimated earnings in
excess of billings on uncompleted contracts, which represents revenue recognized
in excess of amounts billed. Such revenue is billable under the terms of
contracts at the end of the year, yet was not invoiced until the following year
and is generally expected to be collected within 60 days. The liability
"billings in excess of costs and estimated earnings on uncompleted contracts"
represents billings in excess of revenue recognized.
Revenue for other products and services is recognized when such products and
services are delivered or performed and, in connection with certain sales to
government agencies, when the products and services are accepted, which is
normally negotiated as part of the initial contract. Revenue from commercial,
non-governmental, customers is based on fixed price contracts where the sale is
recognized upon acceptance of the product or performance of the service and when
payment is assured.
COST OF REVENUE:
Cost of revenue is recorded as costs are incurred. Costs include direct labor,
direct materials, subcontractor costs and manufacturing and administrative
overhead. General and administrative expenses allowable under the terms of the
contracts are allocated per contract depending on its direct labor and material
proportion to total direct labor and material of all contracts.
As contracts can extend over one or more accounting periods, revisions in costs
estimated during the course of work are reflected during the accounting period
in which the facts become known.
NET LOSS PER COMMON SHARE:
Basic loss per common share is computed as net income (loss) attributable to
common stockholders divided by the weighted average number of common shares
outstanding for the period. Diluted loss per common share reflects the effect of
common shares issuable through exercise of stock options and warrants and common
shares issuable upon the conversion of convertible instruments. The dilutive
effect of options, warrants and our Series A Convertible Preferred Stock, which
were not included in the total of diluted shares because the effect was
antidilutive, was 2,255,263 and 2,735,877 for the years ended December 31, 2005
and 2004, respectively. Prior to the Merger on March 18, 2004, we did not have
any stock option plans.
F - 9
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
CASH AND CASH EQUIVALENTS:
Cash and cash equivalents are considered to be all highly liquid investments
purchased with an initial maturity of 3-months or less and municipal bonds with
a variable interest rate that is adjusted to the current market rate of interest
every seven days and are readily convertible into cash.
ACCOUNTS RECEIVABLE:
Our accounts receivable balance includes contract receivables related to
completed and in-progress contracts, retentions, and costs and estimated
earnings on uncompleted contracts.
INVENTORIES:
Inventories, consisting of materials, assemblies and sub-assemblies, are stated
at average cost. Manufactured products (work-in-process) include the costs of
materials, labor and manufacturing overhead. Our inventories consist of the
following at December 31, 2005 and 2004:
December 31,
----------------------
2005 2004
----------------------
Materials $ 815,788 $ 341,334
Work-in-process 532,912 --
----------------------
Total $1,348,700 $ 341,334
======================
Rapid technological change and new product introductions and enhancements could
result in excess or obsolete inventory. To minimize this risk, the Company
evaluates inventory levels and expected usage on a period basis and will record
adjustments as required.
INVESTMENTS:
Our investments are classified as available-for-sale and are reported at fair
value, with unrealized gains or losses, net of tax recorded in stockholders'
equity. Fair value for these securities is based on quoted market prices. The
cost of investments sold is based on the specific identification method.
Realized gains or losses on the sale or exchange of investments and declines in
value judged to be other than temporary are recorded as gains or losses in the
statement of operations. We consider numerous factors when assessing impairment
on investments; however, in general, investments are judged to be impaired if
the fair value is less than cost continuously for nine months, absent compelling
evidence to the contrary. Unrealized gains and losses are determined at each
balance sheet date and are recorded in other comprehensive income, if
applicable.
PROPERTY AND EQUIPMENT:
Property and equipment are recorded at cost. Depreciation and amortization are
calculated using the straight-line method over the estimated useful lives of the
assets from 3- to 10-years. Leasehold improvements are depreciated over the life
of the related lease or asset, whichever is shorter. Amortization of assets
acquired under capital leases is included in depreciation and amortization
expense.
Significant improvements extending the useful life of property are capitalized.
When property is retired or otherwise disposed of, the cost of the property and
the related accumulated depreciation are removed from the accounts, and any
resulting gains or losses are reflected in the consolidated statements of
operations. Repair and maintenance costs are expensed as incurred.
F - 10
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
COMPUTER SOFTWARE DEVELOPMENT COSTS:
Direct development costs associated with internal-use computer software are
accounted for under Statement of Position 98-1 "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" and are capitalized,
including external direct costs of material and services and payroll costs for
employees devoting time to the software projects, where applicable. Costs
incurred during the preliminary project stage, as well as for maintenance and
training, are expensed as incurred. Amortization is provided on a straight-line
basis over the shorter of 3 years or the estimated useful life of the software.
Amortization expense relative to capitalized computer software development costs
was $102,948, $49,117 and $15,233 for 2005, 2004 and 2003, respectively.
VALUATION OF LONG-LIVED ASSETS INCLUDING INTANGIBLES SUBJECT TO AMORTIZATION:
We review long-lived assets, including certain identifiable intangibles, for
possible impairment whenever events or changes in circumstances, such as the
rapid pace of technology, indicate that the carrying amount of a long-lived
asset may not be recoverable. We assess the recoverability of such long-lived
assets by determining whether the amortization of the balances over their
remaining lives can be recovered through undiscounted future operating cash
flows. The amount of impairment, if any, is measured based on projected
discounted future operating cash flows using a discount rate reflecting the
Company's average cost of funds. The assessment of the recoverability of
long-lived assets will be impacted if estimated future operating cash flows are
not achieved. Factors we consider important that could trigger an impairment
review include the following:
o Significant underperformance relative to historical or projected
future operating results,
o Significant changes in the manner of our use of the acquired assets
or the strategy for our overall business;
o Significant negative industry or economic trends; and
GOODWILL AND OTHER INDEFINITE LIFE INTANGIBLE ASSETS:
We account for goodwill and other indefinite life intangible assets based on the
method of accounting prescribed by the provisions of SFAS 142, "Goodwill and
Other Intangible Assets," and we have determined that Ionatron and North Star
represent two separate reporting units. Goodwill is allocated to our reporting
units based on the reporting units that will benefit from the acquired assets
and liabilities. We believe that the North Star Research trade name is an
indefinite life intangible asset.
Goodwill and other indefinite life intangible assets are tested annually for
impairment or more frequently if events or changes in circumstances indicate
that the assets might be impaired. In assessing the recoverability of goodwill
and other indefinite life intangible assets, we must make assumptions about the
estimated future cash flows and other factors to determine the fair value of
these assets.
Assumptions about future revenue and cash flows require significant judgment
because of the current state of the economy and the fluctuation of actual
revenue and the timing of expenses. We develop future cash flows based on
projected revenue with the assumption that expenses will grow at rates
consistent with historical rates. If the expected cash flows are not realized,
impairment losses may be recorded in the future.
For goodwill, the impairment evaluation includes a comparison of the carrying
value of the reporting unit (including goodwill) to that reporting unit's fair
value. If the reporting unit's estimated fair value exceeds the reporting unit's
carrying value, no impairment of goodwill exists. If the fair value of the
reporting unit does not exceed the unit's carrying value, then an additional
analysis is performed to allocate the fair value of the reporting unit to all of
the assets and liabilities of that unit. If the excess of the fair value of the
reporting unit over the fair value of the identifiable assets and liabilities is
less than the carrying value of the unit's goodwill, an impairment charge is
recorded for the difference.
F - 11
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
The impairment evaluation for other indefinite life intangible assets is
performed by a comparison of the asset's carrying value to the asset's fair
value. When the carrying value exceeds fair value an impairment charge is
recorded for the amount of the difference. An intangible asset is determined to
have an indefinite useful life when there are no legal, regulatory, contractual,
competitive, economic, or any other factors that may limit the period over which
the asset is expected to contribute directly or indirectly to the future cash
flows of the Company. In addition, each reporting period, we evaluate intangible
assets that are not being amortized to determine whether events and
circumstances continue to support an indefinite useful life. If an intangible
asset that is not being amortized is determined to have a finite useful life,
the asset will be amortized prospectively over the estimated remaining useful
life and accounted for in the same manner as intangible assets subject to
amortization.
INCOME TAXES:
Income taxes are accounted for under the asset and liability method.
Accordingly, deferred tax assets and liabilities are recognized currently for
the future tax consequences attributable to the temporary differences between
the financial statement carrying amounts of assets and liabilities and their
respective tax basis. Deferred tax assets and liabilities are measured using
enacted tax rates in effect for the year in which those temporary differences
are expected to be recovered or settled. A valuation allowance is recorded to
reduce the carrying amounts of deferred tax assets if it is more likely that
such assets will not be realized.
We consider all available evidence, both positive and negative, to determine
whether, based on the weight of that evidence, a valuation allowance is needed
for some portion or all of a net deferred tax asset. Judgment is used in
considering the relative impact of negative and positive evidence. In arriving
at these judgments, the weight given to the potential effect of negative and
positive evidence is commensurate with the extent to which it can be objectively
verified. We record a valuation allowance to reduce our deferred tax assets and
review the amount of such allowance annually. When we determine certain deferred
tax assets are more likely than not to be utilized, we will reduce our valuation
allowance accordingly.
Prior to January 1, 2004, we elected to be taxed as a Subchapter S-corporation
with the individual shareholders reporting their respective share of our losses
on their income tax return. Accordingly, we have no deferred tax assets or
liabilities arising prior to January 1, 2004.
We have provided a valuation allowance for the deferred tax assets related to
Ionatron's operations. We have also provided a valuation allowance for the
deferred tax assets related to the $27.1 million operating and $0.5 million
capital loss carryovers of USHG. The USHG operating losses are available for
deduction from our taxable income at a rate of approximately $2.8 million per
year. The tax benefits related to deduction of the USHG losses will be added to
paid-in capital, if realized.
STOCK-BASED COMPENSATION:
The Company has a number of stock-based employee compensation plans. The Company
generally grants stock options for a fixed number of shares to employees and
directors with an exercise price equal to the fair market value of the shares at
the date of grant. We account for our stock option awards under the intrinsic
value based method of accounting prescribed by APB Opinion 25, "Accounting for
Stock Issued to Employees," and related interpretations, including FASB
Interpretation No. 44 "Accounting for Certain Transactions Including Stock
Compensation, an interpretation of APB Opinion 25." Under the intrinsic value
based method, compensation cost is the excess of the quoted market price of the
stock at grant date or other measurement date over the amount an employee must
pay to acquire the stock.
The Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation," as
amended by Statement of Financial Accounting Standards No. 148, "Accounting for
Stock-Based Compensation--Transition and Disclosure." Accordingly, no
compensation cost has been recognized for employee stock option grants that do
not have an intrinsic value at the time of grant. Awards under the plans vest
over periods ranging from immediate vesting to five years, depending upon the
type of award. Non-employee stock-based transactions are accounted for under
SFAS No.123.
Pro-forma compensation and non-employee compensation are based on the fair value
of the options granted which has been estimated at the various dates of the
grants using the Black-Scholes option-pricing model with the following
assumptions:
F - 12
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
o Fair market value of the underlying common stock based on our
closing common stock price on the date the option is granted;
o Risk-free interest rate based on the weighted averaged 5-year U.S.
Treasury note strip rates;
o Volatility is based on comparable companies considered as we do not
have sufficient trading history for our common stock;
o No expected dividend yield based on future dividend payment plans;
and
o Expected life of the options is five years.
The chart below illustrates the assumptions used for the risk-free interest rate
and expected volatility:
Risk Free Interest
Rates Expected Volatility
-------------------- --------------------
From To From To
----- ---- ----- ----
For the year ended December 31, 2005 3.18% 4.32% 61% 75%
For the year ended December 31, 2004 2.91% 3.06% 75% 80%
Pro-forma compensation only applies to 2004 and 2005 as no stock options and
warrants existed prior to the Merger. The following table presents pro forma net
loss information as if compensation expense had been recognized for stock
options as determined under the fair-value-based method prescribed by SFAS 123
using the Black-Scholes options pricing model and amortized over the vesting
periods of the related options:
For the year ended December 31,
----------------------------------------
2005 2004 2003
----------- ----------- ------------
Net loss attributable to common
stockholders:
As reported $(3,835,329) $(3,261,005) $(3,242,109)
Pro forma stock compensation
expense (4,036,178) (1,020,523) --
----------- ----------- -----------
Pro forma $(7,871,507) $(4,281,528) $(3,242,109)
=========== =========== ===========
Net loss per share - basic and diluted:
As reported $ (0.05) $ (0.05) $ (0.07)
=========== =========== ===========
Pro forma $ (0.11) $ (0.07) $ (0.07)
=========== =========== ===========
Compensation expense recorded for shares and options delivered to non-employees
for the years ended December 31, 2005 and 2004 was approximately $186,000 and
$206,000, respectively which was charged to operating expenses with an
offsetting entry to additional paid-in capital. No compensation expense was
recorded for options to purchase shares or shares delivered for the year ended
December 31, 2003.
FAIR VALUE OF FINANCIAL INSTRUMENTS:
The carrying amount of accounts receivable, accounts payable, and accrued
expenses approximate fair value due to the short maturity of these instruments.
F - 13
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
CONCENTRATIONS OF CREDIT RISK:
We maintain cash balances at a major bank and, at times, balances exceed FDIC
limits. We generally do not have a significant concentration of credit risk on
accounts receivable from the U.S. Government.
ALLOWANCE FOR DOUBTFUL ACCOUNTS:
We do not generally provide an allowance for receivables from the U.S.
Government. We have non-government customers for which we provide for
potentially uncollectible accounts receivable by use of the allowance method.
The allowance is provided based upon a review of the individual accounts
outstanding, and the Company's prior history of uncollectible accounts
receivable.
BILLINGS IN EXCESS OF COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS:
Billings in excess of costs and estimated earnings on uncompleted contracts
consists of amounts for which contract billings have been presented but the
goods and services required under the contracts have not yet been provided and
the associated revenue has not been recognized.
RESEARCH AND DEVELOPMENT EXPENSES:
We expense our research and development costs as incurred.
COMPREHENSIVE INCOME:
We have no items of comprehensive income or expense in any of the periods
presented. Accordingly, our comprehensive income (loss) and net income (loss)
are equal for all periods presented.
NOTE 2 - NEW ACCOUNTING PRONOUNCEMENTS:
SFAS 123(R) became effective for Ionatron on January 1, 2006, at which time we
adopted the Standard using the modified prospective method. SFAS 123(R) requires
all public companies to record compensation cost for stock options and other
share based payments provided to employees in return for employee service. The
cost is measured at the fair value of the options or shares when granted, and
this cost is expensed over the employee service period. We are unable to
accurately predict the amount of compensation expense for stock options and
share based payments that will be granted after the effective date.
Compensation cost is also recognized for all stock options and share based
payments that were granted prior to the effective date for which the requisite
service has not yet been rendered. Compensation cost related to stock options
and share based payments granted prior to the effective date will be $ 1,310,821
in 2006, $ 1,031,398 in 2007 and $835,190 in 2008.
Pro-forma compensation costs and the pro-forma effect on net income and earnings
per share for all stock options and share based payments for which the requisite
service was rendered prior to the effective date will continue to be disclosed
in the notes to financial statements.
We will continue to use the Black Scholes Option Pricing Model to estimate the
fair value of stock options granted to employees and others for services.
SFAS No. 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. This
requirement will reduce net operating cash flows and increase net financing cash
flows in periods after adoption. We cannot estimate what those amounts will be
in the future because they depend on, among other things, when employees
exercise stock options.
F - 14
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
In November 2005, the FASB issued FASB Staff Position 115-1 and 124-1, "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments" ("FSP 115-1 and 124-1"). This guidance will be applicable for
Ionatron in the first quarter of 2006 and provides additional guidance on when
an investment in a debt or equity security should be considered impaired and
when that impairment should be considered other-than-temporary and recognized as
a loss in earnings. Specifically, the guidance clarifies that an investor should
recognize an impairment loss no later than when the impairment is deemed
other-than-temporary, even if a decision to sell has not been made. The FSP also
requires certain disclosures about unrealized losses that have not been
recognized as other-than-temporary impairments. We do not believe the adoption
of FSP 115-1 and 124-1 will have a material impact on our financial statements.
NOTE 3 - ACCOUNTS RECEIVABLE:
Our accounts receivable balance as of December 31, 2005 and 2004 includes
contract receivables related to completed and in progress contracts, retentions,
and costs and estimated earnings on uncompleted contracts. Costs and estimated
earnings on uncompleted contracts represent amounts that are billable under the
terms of contracts at the end of the year, were invoiced in the following year
and are generally expected to be collected within 60 days.
Accounts receivable consist of the following as of December 31, 2005 and 2004:
December 31, December 31,
2005 2004
----------------------------
Completed contracts $ -- $ 17,432
Contracts in progress 3,375,104 2,264,509
Retained 100,000 100,000
Cost and estimated earnings on
uncompleted contracts 1,931,434 2,132,841
----------------------------
5,406,538 4,514,782
Less: Allowance for doubtful accounts 38,847 17,432
----------------------------
Total $ 5,367,691 $ 4,497,350
============================
Contract receivables at December 31, 2005 are expected to be collected within
one year. There are no claims or unapproved change orders included in contract
receivables at December 31, 2005 and 2004. The allowance for doubtful accounts
at December 31, 2005 represents an estimate for potentially uncollectible
accounts receivable related to non-governmental customers which is based upon a
review of the individual accounts outstanding and the Company's prior history of
uncollectible accounts receivable.
Costs and Estimated Earnings on Uncompleted Contracts
December 31, December 31,
2005 2004
----------------------------
Cost incurred on uncompleted contracts $14,457,299 $10,054,620
Estimated earnings 1,122,673 739,332
----------------------------
15,579,972 10,793,952
Less: Billings to date 13,732,746 8,686,806
----------------------------
Total 1,847,226 $ 2,107,146
============================
Included in accompanying balance sheet under the following
captions:
Accounts receivable 1,931,434 $ 2,132,841
Billings in excess of costs and estimated earnings
on uncompleted contracts (84,208) (25,695)
----------------------------
Total $ 1,847,226 $ 2,107,146
============================
F - 15
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
NOTE 4 - SECURITIES AVAILABLE-FOR-SALE:
Available-for-sale securities consist of the following as of December 31, 2005
and 2004:
December 31, December 31,
2005 2004
----------------------------
Asset Backed Securities Repriced
Monthly $ 3,000,000 --
Municipal Bonds 5,500,000 $ 1,000,000
----------------------------
Total Debt Securities 8,500,000 1,000,000
----------------------------
Preferred stock 3,500,000 --
----------------------------
Total Equity Securities 3,500,000 --
----------------------------
Total available-for-sale
securities $12,000,000 $ 1,000,000
============================
As of December 31, 2005 and 2004, there were no unrealized gains or losses
relative to available-for-sale securities. The above securities are Auction Rate
Securities.
NOTE 5 - PROPERTY AND EQUIPMENT:
Property and Equipment consist of the following as of December 31, 2005 and
2004:
December 31, December 31,
2005 2004
------------ ------------
Furniture and leasehold
improvements $ 487,913 $ 201,249
Equipment and software 2,530,777 2,957,035
----------- -----------
Total 3,018,690 3,158,284
Less accumulated depreciation and
amortization (1,285,894) (1,742,212)
----------- -----------
Net property and equipment $ 1,732,796 $ 1,416,072
=========== ===========
Included in property and equipment are assets under capitalized lease agreements
with an aggregate cost of $50,777 and $7,462, and related accumulated
amortization of $8,046 and $1,244 as of December 31, 2005 and 2004,
respectively. Amortization expense for these assets was $9,082, and $1,244 for
the years ended December 31, 2005, and 2004, respectively.
NOTE 6 - GOODWILL AND OTHER INTANGIBLE ASSETS:
We account for goodwill and indefinite life intangible assets based on the
method of accounting prescribed by the provisions of SFAS No. 142, "Goodwill and
Other Intangible Assets," and we have determined that Ionatron and North Star
are separate reporting units. We believe that the North Star trade name is an
indefinite life intangible asset.
Ionatron has the ability to continue the business of North Star and intends to
do so. The $603,000 value assigned to the trade name was determined by a
valuation analysis in connection with the acquisition of North Star. The value
is based on a discount of projected future cash flows. North Star is a segment
of Ionatron and the trade name is used in the continued promotion of North Star
products.
F - 16
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
While goodwill is not amortized, it is subject to periodic reviews for
impairment. Ionatron reviews intangible assets for impairment periodically (at
least annually) and whenever events or changes in business circumstances
indicate that the carrying value of the assets may not be recoverable. In
assessing the recoverability of goodwill and indefinite life intangible assets,
we must make assumptions about the estimated future cash flows and other factors
to determine the fair value of these assets.
Assumptions about future revenue and cash flows require significant judgment
because of the current state of the economy and the fluctuation of actual
revenue and the timing of expenses. We develop future cash flows based on
projected revenue with the assumption that expenses will grow at rates
consistent with historical rates. If the expected cash flows are not realized,
impairment losses may be recorded in the future.
For goodwill, the impairment evaluation includes a comparison of the carrying
value of the reporting unit (including goodwill) to that reporting unit's fair
value. If the reporting unit's estimated fair value exceeds the reporting unit's
carrying value, no impairment of goodwill exists. If the fair value of the
reporting unit does not exceed the unit's carrying value, then an additional
analysis is performed to allocate the fair value of the reporting unit to all of
the assets and liabilities of that unit. If the excess of the fair value of the
reporting unit over the fair value of the identifiable assets and liabilities is
less than the carrying value of the unit's goodwill, an impairment charge is
recorded for the difference.
The impairment evaluation for indefinite life intangible assets is performed by
a comparison of the asset's carrying value to the asset's fair value. When the
carrying value exceeds fair value an impairment charge is recorded for the
amount of the difference. An intangible asset is determined to have an
indefinite useful life when there are no legal, regulatory, contractual,
competitive, economic, or any other factors that may limit the period over which
the asset is expected to contribute directly or indirectly to our future cash
flows. In addition, each reporting period, we evaluate the remaining useful life
of an intangible asset that is not being amortized to determine whether events
and circumstances continue to support an indefinite useful life. If an
intangible asset that is not being amortized is determined to have a finite
useful life, the asset will be amortized prospectively over the estimated
remaining useful life and accounted for in the same manner as intangible assets
subject to amortization.
Intangible assets consist of the following as of December 31, 2005 and 2004:
December 31, 2005
------------------------------------------
Gross Carrying Accumulated Net Carrying
Amount Amortization Amount
-------------- ------------ ------------
Intangible Assets Subject to
Amortization
Patent $ 34,000 $ 8,500 $ 25,500
Contractual Backlog 37,000 37,000 --
Technological Know-How 212,000 53,000 159,000
------------------------------------------
Subtotal 283,000 98,500 184,500
Intangible Assets Not Subject
to Amortization
Tradename 603,000 -- 603,000
------------------------------------------
Intangible Assets - Net $ 886,000 $ 98,500 $ 787,500
==========================================
F - 17
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
December 31, 2004
------------------------------------------
Gross Carrying Accumulated Net Carrying
Amount Amortization Amount
-------------- ------------ ------------
Intangible Assets Subject to
Amortization
Patent $ 34,000 $ 1,700 $ 32,300
Contractual Backlog 37,000 9,250 27,750
Technological Know-How 212,000 10,600 201,400
------------------------------------------
Subtotal 283,000 21,550 261,450
Intangible Assets not Subject
to Amortization
Tradename 603,000 -- 603,000
------------------------------------------
Intangible Assets - Net $ 886,000 $ 21,550 $ 864,450
==========================================
Amortization expense related to purchased intangible assets was $76,950 and
$21,550 for the years ended December 31, 2005 and 2004, respectively. The
estimated amortizable life for Patents and Technological Know-How is 5 years and
the estimated amortizable life for contractual backlog is 1 year.
Estimated Amortization Expense:
- -------------------------------
For the year ended December 31, 2006 $ 49,200
For the year ended December 31, 2007 49,200
For the year ended December 31, 2008 49,200
For the year ended December 31, 2009 36,900
---------------
Total $ 184,500
===============
Goodwill of $1,487,884 relates to the acquisition of North Star in 2004. There
were no changes relative to goodwill during 2005.
NOTE 7 - ACCRUED EXPENSES:
Accrued expenses consist of the following as of December 31, 2005 and 2004:
2005 2004
---------------------------
Warranty Reserve -- 40,000
Accrued Professional Fees 123,000 216,000
Overdraft 87,698 --
Other Accrued 289,958 23,204
---------------------------
Total Accrued Expenses $500,656 $279,204
===========================
F - 18
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
NOTE 8 - NOTE PAYABLE TO STOCKHOLDER:
The Company's Chairman, a significant stockholder, has provided funds from the
inception of the Company under a revolving credit arrangement. The maximum
amount borrowed was $5.3 million. After pay down of $500,000 and contribution of
$2 million of the revolving credit into equity in the first quarter of 2004, the
remainder of $2.8 million was incorporated into a new $3 million revolving
credit arrangement with the same terms as the original revolving credit
agreement. The note payable to stockholder bears interest at a variable annual
rate equal to the prime rate plus two percent (2%), is due upon demand subject
to Board approval, and is collateralized by the assets of our subsidiary,
Ionatron Technologies, Inc. An additional $100,000 was borrowed under the line
of credit in September 2005, and the line of credit was paid in full in November
2005. $2.8 million was outstanding under the revolving credit arrangements at
December 31, 2004. Interest paid under the line of credit was approximately
$213,000 and $211,000 for the years ended December 31, 2005 and 2004,
respectively.
NOTE 9 - STOCKHOLDERS' EQUITY:
PREFERRED STOCK:
On October 18, 2005 the Company's Board of Directors approved the elimination of
the 10% Series A convertible Preferred Stock. No shares of 10% Preferred Stock
were outstanding. The Board also authorized the issuance of up to 950,000 of the
Company's Series A Redeemable Convertible Preferred Stock (the "Series A
Preferred Stock"). On October 27, 2005 the Company sold an aggregate of 720,000
shares of the Series A Redeemable Convertible Preferred Stock with a stated
value of $25 per share for aggregate gross proceeds of $18,000,000 (the
"Financing"). The net cash proceeds received from the Financing, after deducting
placement agent fees and expenses and other expenses were approximately $16.6
million. Separately, we issued 101,667 warrants with a fair value of
approximately $563,000 to the underwriters as additional compensation for this
transaction. The Company used a portion of the net proceeds from the Financing
to repay the then outstanding $2.9 million principal amount note payable to the
Company's Chairman of the Board under its revolving credit facility. At December
31, 2005, 720,000 shares of the Series A Preferred Stock were outstanding.
The Series A Preferred Stock has a liquidation preference of $25.00 per Share.
The Series A Preferred Stock bears dividends at the rate of 6.5% of the
liquidation preference per share per annum, which accrues from the date of
issuance, and is payable quarterly when declared. Dividends may be paid in: (i)
cash, (ii) shares of our common stock (valued for such purpose at 95% of the
weighted average of the last sales prices of our common stock for each of the
trading days in the ten trading day period ending on the third trading day prior
to the applicable dividend payment date), provided that the issuance and/or
resale of all such shares of our common stock are then covered by an effective
registration statement or (iii) any combination of the foregoing. If the Company
fails to make a dividend payment within five business days following a dividend
payment date, the dividend rate shall immediately and automatically increase by
1% from 6.5% of the liquidation preference per offered share of Series A
preferred stock to 7.5% of such liquidation preference for as long as such
failure continues and immediately return to 6.5% of the liquidation preference
per share of Series A preferred stock per annum at such time as such failure no
longer continues. As of December 31, 2005, the Company has cumulative dividends
of $210,726 which have not been declared.
Each share of Series A Preferred Stock is convertible at any time at the option
of the holder into a number of shares (the "Conversion Shares") of common stock
equal to the liquidation preference (plus any accrued and unpaid dividends for
periods prior to the dividend payment date immediately preceding the date of
conversion by the holder) divided by the conversion price (initially $12.00 per
share, subject to adjustment in the event of a stock dividend or split,
reorganization, recapitalization or similar event.) If the closing sale price of
the common stock is greater than 140% of the conversion price on 20 out of 30
trading days, the Company may redeem the Series A Preferred Stock in whole or in
part at any time commencing November 1, 2008 and continuing through October 31,
2010, upon at least 30 days' notice, at a redemption price, payable in cash,
equal to 100% of the liquidation preference of the shares to be redeemed, plus
accrued and unpaid dividends thereon to, but excluding, the redemption date,
subject to certain conditions. In addition, beginning November 1, 2010, the
Company may redeem the Series A Preferred Stock in whole or in part, upon at
least 30 days' notice, at a redemption price, payable in cash, equal to 100% of
the liquidation preference of the Series A Preferred Stock to be redeemed, plus
accrued and unpaid dividends thereon to, but excluding, the redemption date,
under certain conditions.
COMMON STOCK:
On April 29, 2004, our stockholders approved the increase in our authorized
common stock to 100,000,000 shares. A Rights Agreement commonly known as a
"poison pill", currently exists which provides that in the event an individual
or entity becomes a beneficial holder of 12% or more of the shares of our
capital stock, without the approval of the Board of Directors other stockholders
of the Company shall have the right to purchase shares of our (or in some cases,
the acquirer's) common stock from the Company at 50% of its then market value.
In connection with the Merger, the Board of Directors approved the acquisition
of greater than 12% of our capital stock by both our Chairman and Chief
Executive Officer.
F - 19
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
STOCK WARRANT AND DEVELOPMENT AGREEMENT:
In October 2003, we entered a Development Agreement with a third party whereby
the Company issued a warrant, which expires October 2008, to purchase 1,028,076
common shares at $0. All non-financial terms of development agreements are
considered classified information by the U.S. Government, including the identity
of the third party. The initial $500,000 payment under the agreement was
considered as payment for the warrant and was recorded as additional
paid-incapital. 1,028,076 shares of common stock issued in the Merger were held
in escrow pending issuance under the warrant. In a subsequent agreement with the
third party, we terminated the Development Agreement and the Warrant was
converted into 725,000 shares of common stock in November 2004.
STOCK OPTIONS AND WARRANTS:
At December 31, 2005, 2004 and 2003 there were outstanding options and warrants
to purchase approximately 4.0 million, 4.3 million and nil shares, respectively,
of common stock. Options and warrants issued by USHG covering approximately 5.5
million shares of common stock, exercisable at exercise prices ranging from
$0.25 to $5.00 until 2013, were outstanding at March 18, 2004, the date of the
Merger.
Of the total options granted during 2004, options to purchase 300,000 shares
with an exercise price of $3.00 were granted to consultants for services
provided in connection with the Merger, in which the value of the options and
related merger costs were both charged to additional paid-in capital, which
netted to zero. Options to purchase 100,000 shares with an exercise price of
$5.05 were granted to a non-employee for consultant services, the value of which
was charged to expense and recorded as additional paid-in capital. The
remainder, some of which vest at date of grant and others which vest over one
year to four year periods, were granted to directors and employees and have
exercise prices ranging from $2.85 to $8.79. On June 28, 2005, the stockholders
approved an amendment to the Company's 2004 Stock Incentive Plan ("2004 Plan")
to (i) increase the number of shares of the Company's common stock, $.001 par
value, authorized for issuance under the 2004 Plan by 2,000,000 shares from
3,000,000 shares to 5,000,000 shares, and (ii) set the maximum number of shares
of Common Stock which may be issued upon the exercise of incentive stock options
at 3,000,000 shares. As of December 31, 2005 and 2004, options to purchase
1,741,825 and 651,425 shares, respectively, have been granted under this plan.
The weighted average fair value per option for all options granted during 2005
and 2004, as determined on the grant date using the Black-Scholes option
valuation model, was $4.91 and $2.93, respectively. Prior to the Merger, USHG
maintained a number of Stock Compensation Option Plans which are included in the
following tables.
A summary of the activity of options follows:
Weighted
Number of Average
Options Exercise Price
--------------- ---------------
Outstanding March 18, 2004 3,908,833 $ 0.72
Granted 1,758,925 4.30
Exercised (1,955,083) 0.81
Forfeited (64,750) 4.33
--------------- ---------------
Outstanding December 31, 2004 3,647,925 2.34
Granted 1,090,400 8.14
Exercised (1,081,685) 1.21
Forfeited (175,025) 6.35
--------------- ---------------
Outstanding December 31, 2005 3,481,615 $ 4.30
=============== ===============
F - 20
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
Additional information about outstanding options to purchase the Company's
common stock as of December 31, 2005 is as follows:
Options Outstanding Options Exercisable
------------------------------------- ----------------------
Weighted
Average
Remaining Weighted Weighted
Number Contractual Average Average
Exercise of Life (In Exercise Number Exercise
Price Shares Years) Price of Shares Price
- -------------- --------- ------------- ---------- ---------- ----------
$0.48 - $0.75 1,096,750 3.21 $ 0.63 1,096,750 $ 0.63
$2.85 - $5.77 1,188,384 3.33 3.90 818,764 4.08
$6.00 - $8.79 1,196,481 4.22 8.06 420,838 8.05
--------- ------------- ---------- ---------- ----------
Total 3,481,615 3.60 $4.30 2,336,352 $ 3.17
========= ============= ========== ========== ==========
A summary of the activity of warrants follows:
Weighted
Number of Average
Underlying Exercise
Shares Price
------------- -------------
Outstanding March 18, 2004 1,597,426 $ 0.39
Exercised (989,966) 0.25
------------- -------------
Outstanding December 31, 2004 607,460 0.63
Issued 101,667 12.00
Exercised (119,300) 0.63
------------- -------------
Outstanding December 31, 2005 589,827 2.59
============= =============
Additional information about outstanding warrants to purchase the Company's
common stock as of December 31, 2005 is as follows:
Warrants Outstanding and Exercisable
---------------------------------------
Weighted
Average
Remaining
Number of Weighted
Contractual Avg.
Exercise Life(In Exercise
Price Shares Years) Price
- -------------- ------------ ----------- ------------
$0.63 - $12.00 589,827 3.49 $ 2.59
- -------------- ------------ ----------- ------------
NOTE 10 - SIGNIFICANT CUSTOMERS:
The majority of our customers are either the U.S. Government or contractors to
the U.S. Government and represent 96%, 99% and 100% of revenue for 2005, 2004
and 2003 respectively.
F - 21
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
NOTE 11 - RETIREMENT PLANS:
We established a 401(k) plan for the benefit of our employees. We may make
discretionary contributions to the plan. In 2004, the Company contributed $3,600
to the 401(k) plan. In 2005 and 2003, the Company did not contribute to the
401(k) plan.
NOTE 12 - COMMITMENTS AND CONTINGENCIES:
OPERATING LEASES:
We lease office, manufacturing and storage space at our Tucson facility at an
annual rental of $330,000 under a non-cancelable operating lease agreement from
a company that is partially owned by our Chairman and other principal
stockholders. The lease expires in November 2012, contains renewal options and
an escalation provision at the end of 2007 that increases our annual rent by
$49,500. We account for the escalation provision by straight-lining the rent
expense. We are also responsible for certain property related costs, including
insurance, utilities and property taxes. Rent expense was approximately
$733,000, $411,000 and $355,000 for 2005, 2004 and 2003, respectively.
We lease office, manufacturing and storage space at our Albuquerque facility at
an annual rental of approximately $99,000 under a non-cancelable operating
lease. The lease expires in August 2007 and contains an escalation provision for
the last 12 months of the lease that increases our annual rent by $2,900. The
lease also contains an early termination provision effective after July 1, 2006
which is permissible with a 120 day advance notice and a payment of
approximately $15,000. We are also responsible for certain property related
costs, including insurance and utilities.
We also lease office space in New York City for use by our Chairman with a
monthly rental of $925. The lease is month to month and we pay a portion of the
rent and office supplies including telephone and photocopy usage.
On April 1, 2005 we took possession of the office, manufacturing and warehouse
facilities at the Stennis Space Center in Mississippi for which we had entered
into a non-cancelable operating lease in July 2004. Prior to taking possession
on April 1, 2005, the facility was being improved by the landlord to make the
space ready for lease and these improvements needed to be completed before we
could take possession. We did not have access to or control over the facility
prior to taking possession and had no financial obligations until the
improvements were completed to our satisfaction and the property was turned over
to us on April 1, 2005. We are also not subject to any incentives or allowances
for leasehold improvements from the landlord. The lease is for a five-year term
with the annual rent increasing from $266,000 in the first year to $280,000 in
the final year for an aggregate commitment of $1,367,000. We account for the
escalation provision by straight-lining the rent expense. The lease may be
renewed three times in five-year increments. Through September 2005 we have paid
a total of $44,000 in deposits on the facility.
In addition, on September 16, 2005 we took possession of office and
manufacturing space at a Tucson facility at an annual rental of $48,682 under a
non-cancelable operating lease agreement that expires on September 30, 2006. We
are also responsible for certain property related costs, including insurance,
utilities and property taxes.
The Company also leases vehicles in both the Tucson and Albuquerque facilities
under non-cancelable operating lease agreements to facilitate our material
purchasing activities. These lease commitments total approximately $1,062 per
month. We are responsible for registration, licensing and insurance costs.
F - 22
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
Future annual minimum lease payments under these operating lease agreements are
as follows:
Years ending
December 31, Amount
- ---------------------- ------------
2006 $ 746,194
2007 686,655
2008 660,057
2009 661,351
2010 450,213
Thereafter 711,563
------------
Total $ 3,916,033
============
The above table does not include future annual minimum lease payments for
additional space, proximate to our Tucson offices, acquired in January 2006
under an 11-month operating lease, with monthly rent of approximately $9,400.
CAPITAL LEASES:
We rent office equipment under capital lease agreements with approximately
$1,474 in monthly payments. We also rent two vehicles for use in our operations
under capital lease agreements with approximately $2,155 in monthly payments.
Future annual minimum lease payments under these leases are:
Years ending December 31, Amount
- -----------------------------------------------
2006 $ 43,560
2007 43,560
2008 22,061
2009 235
---------
Total payments 109,416
Less interest (9,509)
---------
Total principal 99,907
Less: Current portion of
capital lease obligations (37,617)
---------
Long-term capital lease
obligations $ 62,290
=========
GUARANTEES:
We agree to indemnify our officers and directors for certain events or
occurrences arising as a result of the officers or directors serving in such
capacity. The term of the indemnification period is for the officer's or
director's lifetime. The maximum amount of future payments that we could be
required to make under these indemnification agreements is unlimited. However,
we maintain a director's and officer's liability insurance policy that limits
our exposure and enables us to recover a portion of any future amounts paid. As
a result, we believe the estimated fair value of these indemnification
agreements is minimal because of our insurance coverage and we have not
recognized any liabilities for these agreements as of December 31, 2005 and
2004.
F - 23
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
LITIGATION:
We may from time to time be involved in legal proceedings arising from the
normal course of business. As of the date of this report, we were not involved
in any legal proceedings.
NOTE 13 - INCOME TAXES:
Prior to January 1, 2004, we elected to be taxed as a Subchapter S-corporation
with the individual shareholders reporting their respective share of our losses
on their income tax return. Accordingly, we have no deferred tax assets or
liabilities and no provision for income taxes arising in periods prior to 2004
except as discussed in the following paragraphs to this note. On January 1,
2004, we terminated our sub-chapter S election and converted to a C-corporation.
F - 24
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
The components of the provision for income taxes for the years ended December
31, 2005 and 2004 are as follows:
December 31,
----------------------------
2005 2004
----------------------------
Current:
Federal $ -- $ --
State -- --
------------- -------------
Total Current -- --
Deferred:
Federal 31,310 7,841
State 7,104 1,736
------------- -------------
Total Deferred 38,414 9,577
------------- -------------
Total provision for
income taxes $ 38,414 $ 9,577
============= =============
The reconciliation of the difference between income taxes at the statutory rate
and the income tax provision for the years ended December 31, 2005 and 2004 is
as follows:
December 31,
-----------------------------
2005 2004
----------- -----------
Computed tax at statutory rate $(1,303,953) $(1,175,634)
State taxes, net of federal benefit (4,618) (1,128)
Change in valuation allowance 1,197,401 1,165,026
Other permanent differences 72,756 2,159
----------- -----------
Provision for income taxes $ (38,414) $ (9,577)
=========== ===========
Deferred tax assets (liabilities) consist of the following:
December 31,
--------------------------------
2005 2004
------------ ------------
Accruals and Reserves $ 191,284 $ 166,817
Depreciation and Amortization 10,874 109,836
Tax Credit Carryforwards 550,216 366,221
Net Operating Loss Carryforwards 12,870,619 15,539,238
Capital Loss Carryforwards 176,935 176,775
Goodwill Amortization (47,991) (9,577)
Valuation Allowance (13,799,928) (16,358,887)
------------ ------------
Total Deferred Tax Liabilities $ (47,991) $ (9,577)
============ ============
The net change in the valuation allowance for the year ended December 31, 2005
decreased by approximately $2.6 million, which included the reduction of $4.5
million in Net Operating Loss Carryforwards. Management believes that sufficient
uncertainty exists regarding the future realization of the Company's deferred
tax assets and thus a full valuation allowance is required.
F - 25
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
As of December 31, 2005, we have cumulative federal and state net operating loss
carryforwards of approximately $35.9 million and $8.9 million, respectively,
which can be used to offset future income subject to taxes. Federal net
operating loss carryforwards begin to expire in 2020. State net operating loss
carryforwards begin to expire in 2007. Included in federal net operating loss
carryforwards is approximately $2.4 million related to stock based compensation
that will be credited to additional paid in capital when realized.
As of December 31, 2005, we have cumulative unused research and development tax
credits of approximately $157,000 and $149,000 which can be used to reduce
future federal and Arizona income taxes, respectively. We also have federal
minimum tax credit carryforwards of $244,000. Federal research and development
credit carryforwards begin to expire in 2025. The Arizona research and
development credits begin to expire in 2020. The federal minimum tax credit
carryforwards are not subject to expiration under current federal tax law.
Utilization of the company's net operating loss carryforwards and tax credits is
subject to substantial annual limitations due to the ownership change
limitations provided by the Internal Revenue Code and similar state provisions.
Such an annual limitation could result in the expiration of the net operating
loss carryforwards and tax credit carryforwards before utilization.
NOTE 14 - SUPPLEMENTAL CASH FLOW INFORMATION:
Year Ended December 31,
2005 2004 2003
--------------------------------------
Cash Paid During the Year For:
Interest $ 227,106 $ 215,593 $ 196,189
Income taxes -- 66,287 --
Non-Cash Investing and Financing Activities:
Conversion of note payable to common stock $ -- $ 2,000,000 $ --
Equipment purchased under capitalized lease 119,746 7,462 --
Shares issued in acquisition -- 1,700,000 --
Acquisition costs accrued -- 15,000 --
Fair value of warrants issued
to underwriters of the Series
A Preferred Stock issuance 562,930 -- --
Trade-in of equipment on capitalized lease 5,182 -- --
Assets and Liabilities in North Star Acquisition:
Current and other assets, net
of cash acquired -- (244,355) --
Property and equipment -- (20,333) --
Goodwill -- (1,487,889) --
Intangible assets -- (886,000) --
Account payable and accrued expenses -- 350,338 --
NOTE 15 - INDUSTRY SEGMENTS:
The Company is currently engaged in developing and marketing through two
distinct segments: (1) Ionatron, Inc., where the focus is on Directed Energy
Weapon technology products for sale to the U.S. Government and (2) North Star.,
which was acquired September, 30 2004, where the focus is on the manufacture of
custom high voltage equipment for sale in a more broad-based market. Prior to
the acquisition of North Star, there was only one segment.
F - 26
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
Selected Financial Data for our Reportable Segments for the Year Ended December
31, 2005
Depreciation
Business and Interest Interest Net Capital Identifiable
Segment Revenue Amortization Income Expense Loss Expenditures Assets
- ------------- ------------ ------------ ------------ ------------ ------------ ------------ ------------
Ionatron $ 17,736,319 $ 849,477 $ 110,447 $ 225,962 $ (3,391,292) $ 1,175,536 $ 23,537,651
North Star 2,553,603 116,158 1,313 1,144 (233,311) 84,064 2,843,183
------------ ------------ ------------ ------------ ------------ ------------ ------------
Total Company 20,289,922 965,635 111,760 227,106 (3,624,603) 1,259,600 26,380,834
Inter-segment (1,413,994) -- -- -- -- -- (313,003)
Investment in
Subsidiary -- -- -- -- -- -- (2,415,000)
------------ ------------ ------------ ------------ ------------ ------------ ------------
Consolidated
Company $ 18,875,928 $ 965,635 $ 111,760 $ 227,106 $ (3,624,603) $ 1,259,600 $ 23,652,831
============ ============ ============ ============ ============ ============ ============
Selected Financial Data for our Reportable Segments the Year Ended December 31,
2004
Depreciation
Business and Interest Interest Net Capital Identifiable
Segment Revenue Amortization Income Expense Loss Expenditures Assets
- ------------- ------------ ------------ ------------ ------------ ------------ ------------ ------------
Ionatron $ 10,570,396 $ 840,799 $ 45,907 $ 215,593 $ (3,227,793) $ 1,057,767 $ 12,371,883
North Star 568,001 36,355 215 -- (33,212) 65,367 2,753,210
------------ ------------ ------------ ------------ ------------ ------------ ------------
Total Company 11,138,397 877,154 46,122 215,593 (3,261,005) 1,123,134 15,125,093
Intersegment (207,875) -- -- -- -- -- (172,202)
Investment
in Subsidiary -- -- -- -- -- -- (2,415,000)
------------ ------------ ------------ ------------ ------------ ------------ ------------
Consolidated
Company $ 10,930,522 $ 877,154 $ 46,122 $ 215,593 $ (3,261,005) $ 1,123,134 $ 12,537,891
============ ============ ============ ============ ============ ============ ============
F - 27
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
NOTE 16 - QUARTERLY OPERATING RESULTS (UNAUDITED):
Quarterly operating results for 2005 and 2004 were as follows:
1st 2nd 3rd 4th
------------ ------------ ------------ -------------
2005
Revenue $ 2,570,271 $ 3,956,522 $ 6,219,161 $ 6,129,974
Gross profit 165,785 180,696 658,582 113,560
Operating loss (1,598,938) (1,645,900) (298,194) (742,945)
Net loss attributable to
common stockholders $ (1,647,598) $ (1,710,696) $ (361,335) $ (115,700)
Weighted average number of
common shares
outstanding, basic and diluted 70,969,510 71,212,062 71,354,540 71,766,778
Basic and diluted net loss per
common share (0.02) (0.02) (0.01) (0.00)
2004
Revenue $ 272,442 $ 1,833,572 $2,628,982 $ 6,195,526
Gross profit 17,442 106,819 187,739 524,143
Operating loss (841,378) (1,332,270) (863,139) (45,654)
Net loss attributable to
common stockholders $ (915,894) $ (1,354,703) $ (896,026) $ (94,852)
Weighted average number of
common shares
outstanding, basic and diluted 51,428,571 69,079,967 69,814,859 70,625,259
Basic and diluted net loss per
common share (0.02) (0.02) (0.01) (0.00)
NOTE 17 - SIGNIFICANT ASSET ACQUISITION:
In September 2004, Ionatron completed the acquisition of substantially all the
assets of North Star Research Corporation ("North Star Research"), a New Mexico
corporation engaged in the business of designing and manufacturing a broad range
of high voltage equipment for the defense, aerospace, semi-conductor, and
medical industries. As consideration for North Star Research's assets, the
Company paid $700,000, issued 199,063 shares of the Company's common stock
valued at $1,700,000, and assumed liabilities for warranty claims and other
accrued expenses. The Company recognized goodwill of $1,487,884, and intangible
assets of $886,000 in the acquisition. The assets acquired and liabilities
assumed were recorded under the purchase method of accounting. The transaction
was effected through a newly formed subsidiary, North Star Power Engineering,
Inc. ("North Star"), a Delaware corporation, and was funded through cash on
hand. The results of operations of North Star have been included in the
consolidated financial statements from September 30, 2004 to December 31, 2004.
F - 28
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
The following table summarizes the estimated fair values of the asset acquired
and liabilities assumed at the date of acquisition:
Purchase Price:
Cash and cash equivalents $ 700,000
Common stock 1,700,000
Advance to North Star 200,000
Acquisition costs 15,000
-----------
Total purchase price 2,615,000
-----------
Allocated as follows:
Working capital assumed:
Cash and cash equivalents 126,765
Accounts receivable 244,355
Accounts payable (30,892)
Warranty reserve (40,000)
Accrued expenses and other (35,670)
-----------
Net working capital 264,558
Fixed assets 20,334
Due to former owners (43,776)
-----------
Net book value of assets acquired and liabilities assumed 241,116
Excess purchase price to be allocated $ 2,373,884
===========
Allocated as follows:
Goodwill $ 1,487,884
Non-amortizable intangible assets 603,000
Amortizable intangible assets 283,000
-----------
Total allocated $ 2,373,884
===========
Of the $886,000 of acquired intangibles, $603,000 was assigned to Tradename
which is not subject to amortization. The remaining $283,000 of acquired
intangible assets have a weighted-average useful life of approximately five (5)
years. The intangible assets that make up that amount include Technological
know-how of $212,000 (5-year useful life), contractual backlog of $37,000
(1-year useful life), and a patent of $34,000 (5-year useful life).
The $1,487,884 was assigned to the North Star segment, all of which is expected
to be deductible for tax purposes.
F - 29
IONATRON, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
We allocate the purchase price of an acquired business, on a preliminary basis,
to the identified assets acquired based on their estimated fair values at the
dates of acquisition, with any residual amounts allocated to goodwill. The
purchase price allocations are considered preliminary until we have obtained all
required information to complete the allocation. Although the time required to
obtain the necessary information will vary with circumstances specific to an
individual acquisition, the allocation period for finalizing purchase price
allocations generally does not exceed one year from the date of consummation of
an acquisition. Adjustments to the allocation of purchase price may decrease or
increase those amounts allocated to goodwill.
The following unaudited Condensed Pro Forma Statements of Operations (the "Pro
Forma Financial Statements") are based on historical financial statements of the
Company and North Star after giving effect to the Company's purchase of
substantially all of the assets of North Star and assumption of liabilities for
warranty claims and other accrued expenses.
The Pro Forma Financial Statements were prepared as if the transaction has
occurred as of January 1, 2003 for the Statements of Operations. The Pro Forma
Financial Statements are not necessarily indicative of the future results of
operations of the Company after the purchase of North Star's net assets, or of
the results of operations of the Company had the purchase of North Star's net
assets occurred on the dates indicted above or been in effect for the period
presented.
Pro Forma
2004 2003
------------ ------------
Revenue $ 12,851,819 $ 3,645,876
Net loss $ (3,025,599) $ (3,208,984)
Net loss per share -
Basic and diluted $ (0.05) $ (0.07)
F-30