Arotech Corporation Form 10-Q for f/q/e 2006-03-31
OMB
APPROVAL
|
OMB
Number: 3235-0070
Expires: January
31, 2008
Estimated
average burden
hours
per response 192.00
|
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
T QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED March
31, 2006.
Commission
file number: 0-23336
AROTECH
CORPORATION
|
(Exact
name of registrant as specified in its charter)
|
Delaware
|
|
95-4302784
|
(State
or other jurisdiction of
incorporation
or organization)
|
|
(I.R.S.
Employer
Identification
No.)
|
1229
Oak Valley Drive, Ann Arbor, Michigan
|
|
48108
|
(Address
of principal executive offices)
|
|
(Zip
Code)
|
(800)
281-0356
|
(Registrant’s
telephone number, including area
code)
|
354
Industry Drive, Auburn, Alabama 36830
|
(Former
address, if changed since last
report)
|
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days. Yes
£ No
T
Indicate
by check mark whether the registrant is 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: T Non-accelerated
filer: £
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes
£ No
T
APPLICABLE
ONLY TO CORPORATE ISSUERS:
The
number of shares outstanding of the issuer’s common stock as of May 15, 2006 was
118,567,381.
Potential
persons who are to respond to the collection of
information
contained in this form are not required to respond
unless
the form displays a currently valid OMB control
number.
|
INDEX
PART
I - FINANCIAL INFORMATION
|
Item
1 -Financial Statements:
|
Consolidated
Balance Sheets at March 31, 2006 and December 31, 2005
|
3
|
Consolidated
Statements of Operations for the Three Months Ended March 31, 2006
and
2005
|
5
|
Consolidated
Statements of Changes in Stockholders’ Equity during the Three-Month
Period Ended March 31, 2006
|
6
|
Consolidated
Statements of Cash Flows for the Three Months Ended March 31, 2006
and
2005
|
7
|
Note
to the Interim Consolidated Financial Statements
|
9
|
|
|
Item
2 - Management’s Discussion and Analysis of Financial Condition and
Results of Operations
|
20
|
|
|
Item
3 - Quantitative and Qualitative Disclosures about Market
Risk
|
29
|
|
|
Item
4 - Controls and Procedures
|
30
|
PART
II - OTHER INFORMATION
|
Item
1A - Risk Factors
|
32
|
|
|
Item
6 - Exhibits
|
49
|
ITEM
1.
|
INTERIM
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
(U.S.
Dollars)
|
|
|
March
31, 2006
|
|
|
December
31, 2005
|
|
ASSETS
|
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
CURRENT
ASSETS:
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
5,311,913
|
|
$
|
6,150,652
|
|
Restricted
collateral deposits
|
|
|
6,809,420
|
|
|
3,897,113
|
|
Available-for-sale
marketable securities
|
|
|
35,899
|
|
|
35,984
|
|
Trade
receivables (net of allowance for doubtful accounts in the amount
of
$158,142 and $176,180 as of March 31, 2006 and December 31, 2005,
respectively)
|
|
|
7,757,463
|
|
|
11,747,876
|
|
Unbilled
receivables
|
|
|
5,316,019
|
|
|
5,228,504
|
|
Other
accounts receivable and prepaid expenses
|
|
|
1,949,638
|
|
|
2,114,331
|
|
Inventories
|
|
|
7,580,417
|
|
|
7,815,806
|
|
|
|
|
|
|
|
|
|
Total
current assets
|
|
|
34,760,769
|
|
|
36,990,266
|
|
|
|
|
|
|
|
|
|
SEVERANCE
PAY FUND
|
|
|
2,134,487
|
|
|
2,072,034
|
|
|
|
|
|
|
|
|
|
RESTRICTED
DEPOSITS
|
|
|
525,245
|
|
|
779,286
|
|
|
|
|
|
|
|
|
|
PROPERTY
AND EQUIPMENT, NET
|
|
|
3,990,190
|
|
|
4,252,931
|
|
|
|
|
|
|
|
|
|
INVESTMENT
IN AFFILIATED COMPANY
|
|
|
75,972
|
|
|
37,500
|
|
|
|
|
|
|
|
|
|
OTHER
INTANGIBLE ASSETS, NET
|
|
|
10,641,740
|
|
|
11,027,499
|
|
|
|
|
|
|
|
|
|
GOODWILL
|
|
|
29,481,061
|
|
|
29,559,157
|
|
|
|
|
|
|
|
|
|
|
|
$
|
81,609,464
|
|
$
|
84,718,673
|
|
The
accompanying notes are an integral part of the Consolidated Financial
Statements.
AROTECH
CORPORATION
CONSOLIDATED
BALANCE SHEETS
(U.S.
Dollars, except share data)
|
|
|
March
31, 2006
|
|
|
December
31, 2005
|
|
|
|
|
(Unaudited)
|
|
|
|
|
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES:
|
|
|
|
|
|
|
|
Trade
payables
|
|
$ |
2,917,518
|
|
$
|
5,830,820
|
|
Other
accounts payable and accrued expenses
|
|
|
4,905,004
|
|
|
5,586,061
|
|
Current
portion of promissory notes due to purchase of
subsidiaries
|
|
|
453,764
|
|
|
453,764
|
|
Short-term
bank loans and current portion of long-term loans
|
|
|
1,892,771
|
|
|
2,036,977
|
|
Deferred
revenues
|
|
|
1,122,440
|
|
|
603,022
|
|
Convertible
debenture
|
|
|
9,512,011
|
|
|
11,492,238
|
|
Liability
in connection with warrants issuance
|
|
|
784,266
|
|
|
44,047
|
|
Liabilities
of discontinued operation
|
|
|
-
|
|
|
120,000
|
|
|
|
|
|
|
|
|
|
Total
current liabilities
|
|
|
21,587,774
|
|
|
26,166,929
|
|
|
|
|
|
|
|
|
|
LONG
TERM LIABILITIES
|
|
|
|
|
|
|
|
Accrued
severance pay
|
|
|
3,860,040
|
|
|
3,657,328
|
|
Convertible
debenture
|
|
|
8,590,454
|
|
|
8,590,233
|
|
|
|
|
|
|
|
|
|
Total
long-term liabilities
|
|
|
12,450,494
|
|
|
12,247,561
|
|
|
|
|
|
|
|
|
|
MINORITY
INTEREST
|
|
|
16,754
|
|
|
38,927
|
|
|
|
|
|
|
|
|
|
SHAREHOLDERS’
EQUITY:
|
|
|
|
|
|
|
|
Share
capital -
|
|
|
|
|
|
|
|
Common
stock - $0.01 par value each;
|
|
|
|
|
|
|
|
Authorized:
250,000,000 shares as of March 31, 2006 and December 31, 2005; Issued:
102,305,926 shares as of March 31, 2006 and 87,096,711
shares as of December 31, 2005; Outstanding - 101,750,593
shares as of March 31, 2006 and 86,541,378
shares as of December 31, 2005
|
|
|
1,023,062
|
|
|
870,969
|
|
Preferred
shares - $0.01 par value each;
|
|
|
|
|
|
|
|
Authorized:
1,000,000 shares as of March
31, 2006
and December 31, 2005; No shares issued and outstanding as of March
31, 2006
and December 31, 2005
|
|
|
-
|
|
|
-
|
|
Additional
paid-in capital
|
|
|
199,618,737
|
|
|
193,560,579
|
|
Accumulated
deficit
|
|
|
(147,210,412
|
)
|
|
(142,996,964
|
)
|
Treasury
stock, at cost (common stock - 555,333 shares as of March
31, 2006
and December 31, 2005)
|
|
|
(3,537,106
|
)
|
|
(3,537,106
|
)
|
Notes
receivable from stockholders
|
|
|
(1,845,047
|
)
|
|
(1,256,777
|
)
|
Accumulated
other comprehensive loss
|
|
|
(494,792
|
)
|
|
(375,445
|
)
|
|
|
|
|
|
|
|
|
Total
shareholders’ equity
|
|
|
47,554,442
|
|
|
46,265,256
|
|
|
|
|
|
|
|
|
|
|
|
$
|
81,609,464
|
|
$
|
84,718,673
|
|
The
accompanying notes are an integral part of the Consolidated Financial
Statements.
AROTECH
CORPORATION
(U.S.
Dollars, except share data)
|
|
Three
months ended March 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
8,896,412
|
|
$
|
10,387,445
|
|
|
|
|
|
|
|
|
|
Cost
of revenues
|
|
|
6,652,752
|
|
|
6,371,874
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
2,243,660
|
|
|
4,015,571
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
Research
and development
|
|
|
304,612
|
|
|
414,678
|
|
Selling
and marketing
|
|
|
899,268
|
|
|
1,158,820
|
|
General
and administrative
|
|
|
3,102,536
|
|
|
3,356,412
|
|
Amortization
of intangible assets
|
|
|
510,692
|
|
|
823,088
|
|
Impairment
of intangible assets
|
|
|
204,059
|
|
|
-
|
|
Total
operating costs and expenses
|
|
|
5,021,167
|
|
|
5,752,998
|
|
|
|
|
|
|
|
|
|
Operating
loss
|
|
|
(2,777,507
|
)
|
|
(1,737,427
|
)
|
Other
income
|
|
|
17,506
|
|
|
-
|
|
Financial
expenses, net
|
|
|
(1,461,136
|
)
|
|
(468,855
|
)
|
|
|
|
|
|
|
|
|
Loss
before minority interest in loss (earnings) of subsidiaries, earnings
from
affiliated company and tax expenses
|
|
|
(4,221,137
|
)
|
|
(2,206,282
|
)
|
Income
taxes
|
|
|
(39,972
|
)
|
|
(217,264
|
)
|
Earnings
from affiliated company
|
|
|
38,472
|
|
|
-
|
|
Minority
interest in loss (earnings) of subsidiaries
|
|
|
9,189
|
|
|
(32,954
|
)
|
Net
loss
|
|
$
|
(4,213,448
|
)
|
$
|
(2,456,500
|
)
|
Deemed
dividend to certain stockholders
|
|
$
|
(317,207
|
)
|
$
|
-
|
|
Net
loss attributable to common stockholders
|
|
$
|
(4,530,655
|
)
|
$
|
(2,456,500
|
)
|
|
|
|
|
|
|
|
|
Basic
and diluted net loss per share from continuing operations
|
|
$
|
(0.05
|
)
|
$
|
(0.03
|
)
|
Basic
and diluted net loss per share
|
|
$
|
(0.05
|
)
|
$
|
(0.03
|
)
|
|
|
|
|
|
|
|
|
Weighted
average number of shares used in computing basic net loss per
share
|
|
|
90,722,273
|
|
|
80,102,089
|
|
The
accompanying notes are an integral part of the Consolidated Financial
Statements.
AROTECH
CORPORATION
(U.S.
Dollars, except share data)
|
|
Common
Stock
|
|
Additional
paid-in
capital
|
|
Accumulated
deficit
|
|
Treasury
stock
|
|
Notes
receivable
from
shareholders
|
|
Accumulated
other
comprehensive
income
(loss)
|
|
Total
comprehensive
loss
|
|
Total
|
|
Shares
|
|
Amount
|
|
|
|
|
|
|
|
BALANCE
AT JANUARY 1, 2006 - NOTE 1
|
87,096,711
|
|
$ 870,969
|
|
$
193,560,579
|
|
$(142,996,964)
|
|
$(3,537,106)
|
|
$
(1,256,777)
|
|
$
(375,445)
|
|
$
-
|
|
$46,265,256
|
CHANGES
DURING THE THREE-MONTH
PERIOD ENDED MARCH 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal
installment of convertible debenture payment in shares
|
6,216,070
|
|
62,161
|
|
2,908,414
|
|
-
|
|
-
|
|
-
|
|
-
|
|
-
|
|
2,970,575
|
Warrants
exercise, net
|
8,993,145
|
|
89,932
|
|
2,907,585
|
|
-
|
|
-
|
|
(577,051)
|
|
-
|
|
-
|
|
2,420,466
|
Amortization
of deferred stock compensation
|
-
|
|
-
|
|
230,940
|
|
-
|
|
-
|
|
-
|
|
-
|
|
-
|
|
230,940
|
Interest
accrued on notes receivable from shareholders
|
-
|
|
-
|
|
11,219
|
|
-
|
|
-
|
|
(11,219)
|
|
-
|
|
-
|
|
-
|
Other
comprehensive loss - foreign currency translation
adjustment
|
-
|
|
-
|
|
-
|
|
-
|
|
-
|
|
-
|
|
(119,740)
|
|
(119,740)
|
|
(119,740)
|
Other
comprehensive loss - unrealized gain on available for sale marketable
securities
|
-
|
|
-
|
|
-
|
|
-
|
|
-
|
|
-
|
|
393
|
|
393
|
|
393
|
Net
loss
|
-
|
|
-
|
|
-
|
|
(4,213,448)
|
|
-
|
|
-
|
|
-
|
|
(4,213,448)
|
|
(4,213,448)
|
Total
comprehensive loss
|
-
|
|
-
|
|
-
|
|
-
|
|
-
|
|
-
|
|
-
|
|
$(4,332,795)
|
|
-
|
BALANCE
AT MARCH
31, 2006
- UNAUDITED
|
102,305,926
|
|
$1,023,062
|
|
$199,618,737
|
|
$
(147,210,412)
|
|
$(3,537,106)
|
|
$
(1,845,047)
|
|
$
(494,792)
|
|
|
|
$47,554,442
|
|
The
accompanying notes are an integral part of the Consolidated Financial
Statements.
AROTECH
CORPORATION
|
|
Three
months ended March 31,
|
|
|
2006
|
|
|
|
2005
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
Net
loss for the period before deemed dividend to certain stockholders
of
common stock
|
$
|
(4,213,448
|
)
|
|
$ |
(2,456,500)
|
Adjustments
required to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
Depreciation
|
|
380,078
|
|
|
|
298,110
|
Amortization
of intangible assets, capitalized software costs and impairment of
intangible assets
|
|
745,528
|
|
|
|
853,798
|
Amortization
of compensation related to warrants issued to the holders of convertible
debentures and beneficial conversion feature
|
|
483,609
|
|
|
|
392,543
|
Financial
expenses in connection with convertible debenture principal
repayment
|
|
506,960
|
|
|
|
-
|
Amortization
of deferred expenses related to convertible debenture
issuance
|
|
242,846
|
|
|
|
12,128
|
Remeasurement
of liability in connection with warrants granted
|
|
(35,270
|
)
|
|
|
-
|
Stock-based
compensation due to shares granted and to be granted to consultants
and
shares granted as a donation
|
|
-
|
|
|
|
58,560
|
Stock
based compensation due to options and shares granted to
employees
|
|
230,941
|
|
|
|
232,739
|
Adjustment
of stock based compensation related to non-recourse note granted
to
stockholder
|
|
-
|
|
|
|
(11,500)
|
Earnings
(loss) to minority
|
|
(9,189
|
)
|
|
|
32,954
|
Share
in earnings of affiliated company
|
|
(38,472
|
)
|
|
|
-
|
Interest
expenses accrued on promissory notes issued to purchase of
subsidiary
|
|
-
|
|
|
|
2,442
|
Interest
accrued on certificates of deposit due within one year
|
|
-
|
|
|
|
(58,188)
|
Amortization
of premium related to restricted securities
|
|
-
|
|
|
|
38,794
|
Liability
for employee rights upon retirement, net
|
|
115,997
|
|
|
|
57,666
|
Write-off
of inventory
|
|
70,577
|
|
|
|
-
|
Decrease
in deferred tax assets
|
|
7,564
|
|
|
|
72,624
|
Changes
in operating asset and liability items:
|
|
|
|
|
|
|
Decrease
in trade receivables and notes receivable
|
|
3,967,096
|
|
|
|
1,822,948
|
Increase
in unbilled receivables
|
|
(87,515
|
)
|
|
|
(349,083)
|
Increase
in other accounts receivable and prepaid expenses
|
|
(91,927
|
)
|
|
|
(194,297)
|
Decrease
(increase) in inventories
|
|
146,995
|
|
|
|
(1,447,620)
|
Decrease
in trade payables
|
|
(2,893,400
|
)
|
|
|
(2,130,990)
|
Increase
in deferred revenues
|
|
519,418
|
|
|
|
75,700
|
Decrease
in accounts payable and accruals
|
|
(639,714
|
)
|
|
|
(754,834)
|
Net
cash used in operating activities from continuing
operations
|
|
(591,326
|
)
|
|
|
(3,452,006)
|
Net
cash used in operating activities from discontinuing
operations
|
|
(120,000
|
)
|
|
|
-
|
Net
cash used in operating activities
|
|
(711,326
|
)
|
|
|
(3,452,006)
|
CASH
FLOWS FROM INVESTING ACTIVITIES: |
|
|
|
|
|
|
Repayment
of promissory note related to purchase of subsidiary
|
|
- |
|
|
|
(75,000)
|
Purchase
of property and equipment
|
|
(128,132 |
) |
|
|
(342,248)
|
Increase
in capitalized research and development projects
|
|
(202,607 |
) |
|
|
(37,293)
|
Increase
in restricted securities and deposits, net
|
|
(2,864,139 |
) |
|
|
(50,141)
|
Net
cash used in investing activities
|
|
(3,194,878 |
) |
|
|
(504,682)
|
FORWARD |
$ |
(3,906,204 |
)
|
|
$ |
(3,956,688)
|
|
|
|
|
The
accompanying notes are an integral part of the Consolidated Financial
Statements.
AROTECH
CORPORATION
CONSOLIDATED
STATEMENT OF CASH FLOWS (UNAUDITED)
(U.S. Dollars)
|
|
Three
months ended March 31,
|
|
|
|
2006
|
|
|
2005
|
|
FORWARD
|
|
$
|
(3,906,204
|
)
|
$
|
(3,956,688
|
)
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
Decrease
in short-term credit from banks
|
|
|
(133,747
|
)
|
|
(99,156
|
)
|
Proceeds
from exercise of options
|
|
|
-
|
|
|
15,000
|
|
Proceeds
from exercise of warrants
|
|
|
3,195,772
|
|
|
-
|
|
Repayment
of long-term loans
|
|
|
(9,906
|
)
|
|
(22,226
|
)
|
|
|
|
|
|
|
|
|
Net
cash provided by (used in) financing
activities
|
|
|
3,052,119
|
|
|
(106,382
|
)
|
|
|
|
|
|
|
|
|
DECREASE
IN CASH AND CASH EQUIVALENTS
|
|
|
(854,085
|
)
|
|
(4,063,070
|
)
|
|
|
|
|
|
|
|
|
CASH
EROSION DUE TO EXCHANGE RATE DIFFERENCES
|
|
|
15,347
|
|
|
698
|
|
|
|
|
|
|
|
|
|
BALANCE
OF CASH AND CASH EQUIVALENTS AT THE BEGINNING OF THE
PERIOD
|
|
|
6,150,651
|
|
|
6,734,512
|
|
|
|
|
|
|
|
|
|
BALANCE
OF CASH AND CASH EQUIVALENTS AT THE END OF THE
PERIOD
|
|
$
|
5,311,913
|
|
$
|
2,672,140
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTARY
INFORMATION ON NON-CASH TRANSACTIONS:
|
|
|
|
|
|
|
|
Payment
of principal installment of convertible debenture in
shares
|
|
$
|
2,463,615
|
|
$
|
-
|
|
Warrants
exercise against note receivable from shareholder
|
|
$
|
577,051
|
|
$
|
-
|
|
Liability
in connection with warrants issuance
|
|
$
|
775,305
|
|
$
|
-
|
|
The
accompanying notes are an integral part of the Consolidated Financial
Statements.
NOTE
1: BASIS
OF PRESENTATION
a. Company:
Arotech
Corporation (“Arotech” or the “Company”), and its subsidiaries provide
defense and security products for the military, law enforcement and homeland
security markets, including advanced zinc-air and lithium batteries and
chargers, multimedia interactive simulators/trainers and lightweight vehicle
armoring.
The
Company is primarily operating through IES Interactive Training, Inc. (“IES”), a
wholly-owned subsidiary
based in
Littleton, Colorado; FAAC Corporation, a wholly-owned subsidiary based in Ann
Arbor, Michigan, and FAAC’s 80%-owned United Kingdom subsidiary FAAC
Limited;
Electric Fuel Battery Corporation, a wholly-owned subsidiary based in Auburn,
Alabama; Electric Fuel Ltd. (“EFL”) a wholly-owned subsidiary based in Beit
Shemesh, Israel; Epsilor
Electronic Industries, Ltd., a wholly-owned subsidiary located in Dimona,
Israel; MDT
Protective Industries, Ltd. (“MDT”), a
majority-owned subsidiary based in Lod, Israel; MDT Armor Corporation, a
majority-owned subsidiary based in Auburn, Alabama; and Armour of America,
Incorporated, a wholly-owned subsidiary based in Los Angeles,
California.
b. Basis
of
presentation:
The
accompanying interim consolidated financial statements have been prepared by
Arotech Corporation in accordance with generally accepted accounting principles
for interim financial information, with the instructions to Form 10-Q and with
Article 10 of Regulation S-X, and include the accounts of Arotech Corporation
and its subsidiaries. Certain information and footnote disclosures, normally
included in complete financial statements prepared in accordance with generally
accepted accounting principles, have been condensed or omitted. In the opinion
of the Company, the unaudited financial statements reflect all adjustments
(consisting only of normal recurring adjustments) necessary for a fair
presentation of its financial position at March 31, 2006, its operating results
for the three-month periods ended March 31, 2006 and 2005 and its cash flow
for
the three month periods ended March 31, 2006 and 2005.
The
results of operations for the three months ended March 31, 2006 are not
necessarily indicative of results that may be expected for any other interim
period or for the full fiscal year ending December 31, 2006.
The
balance sheet at December 31, 2005 has been derived from the audited financial
statements at that date but does not include all the information and footnotes
required by generally accepted accounting principles for complete financial
statements. These consolidated financial statements should be read in
conjunction with the audited financial statements included in the Company’s
Annual Report on Form 10-K for the year ended December 31, 2005.
c. Accounting
for stock-based compensation:
In
December 2004, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based
Payments” (“SFAS No. 123(R)”), which is a revision of FASB No. 123, “Accounting
for Stock-Based Compensation” (“SFAS No. 123”). Generally, the approach in SFAS
No. 123(R) is similar to the approach described in Statement 123. However,
SFAS
No. 123 permitted, but did not require, share-based payments to employees to
be
recognized based on their fair values, while SFAS No. 123(R)
requires
all share-based payments to employees to be recognized based on their fair
values. SFAS No. 123(R) also revises, clarifies and expands guidance in several
areas, including measuring fair value, classifying an award as equity or as
a
liability and attributing compensation cost to reporting periods. The Company
has elected the modified prospective application method and is expensing all
unvested stock options outstanding as of January 1, 2006. The compensation
expense is recognized over the requisite service period that still has not
been
rendered and is based upon the original grant date fair value of the award
as
calculated for recognition of the pro forma disclosure under SFAS No. 123.
For
the three months ended March 31, 2006 the compensation expense recorded related
to stock options and restricted shares was $47,664 and $183,277and has been
included in reported net income for the first quarter of 2006.
The
remaining total compensation cost related to non-vested stock options and
restricted share awards not yet recognized in the income statement as of March
31, 2006 was $270,508, of which $115,819 was for stock options and $154,689
was
for restricted shares. The weighted average period over which this compensation
cost is expected to be recognized is one year.
Per
the
requirements of SFAS No. 123(R) the balance of deferred stock compensation
in
stockholders’ equity arising from the issuance of restricted stock has been
reclassified as paid-in-capital as of March 31, 2006 and as of December 31,
2005.
Pro
forma
information under SFAS No. 123:
|
|
|
Three
months ended March 31,
2005
|
|
|
|
|
Unaudited
(U.S.
Dollars, except per share data)
|
|
Net
loss as reported
|
|
$
|
(2,456,500
|
)
|
Add
- stock-based compensation expense determined under APB 25
|
|
|
232,739
|
|
Deduct
- stock based compensation expense determined under fair value method
for
all awards
|
|
|
(449,592
|
)
|
|
|
|
|
|
Pro
forma net loss
|
|
$
|
(2,673,353
|
)
|
Loss
per share:
|
|
|
|
|
Basic
and diluted, as reported
|
|
$
|
(0.03
|
)
|
Pro
forma basic and diluted
|
|
$
|
(0.03
|
)
|
A
summary
of the status of the Company’s plans and other share options to employees and
restricted shares (except for options granted to consultants) granted as of
March 31 2006, and changes during the three months then ended, is presented
below:
|
|
2006
|
|
|
|
Amount
|
|
|
Weighted
average
exercise
price
|
|
Options
and restricted shares outstanding at beginning of quarter
|
|
|
9,244,949
|
|
$
|
0.67
|
|
Changes
during quarter:
|
|
|
|
|
|
|
|
Granted
|
|
|
-
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
-
|
|
Forfeited
|
|
|
(29,000
|
)
|
|
0.67
|
|
Options
outstanding at March 31, 2006
|
|
|
9,215,949
|
|
$
|
0.67
|
|
Options
exercisable at end of quarter
|
|
|
8,134,885
|
|
$
|
0.70
|
|
The
weighted-average remaining contractual term of the outstanding options at March
31, 2006 was 4.79 years.
The
Company applies SFAS No. 123 and Emerging Issues Task Force No. 96-18,
“Accounting for Equity Instruments That Are Issued to Other Than Employees
for
Acquiring, or in Conjunction with Selling, Goods or Services” (“EITF 96-18”),
with respect to options and warrants issued to non-employees. SFAS No. 123
and
EITF 96-18 require the use of option valuation models to measure the fair
value
of the options and warrants at the measurement date.
d. Reclassification:
Certain
comparative data in these financial statements have been reclassified to conform
with the current year’s presentation
NOTE
2: INVENTORIES
Inventories
are stated at the lower of cost or market value. Cost is determined using the
average cost method. The Company periodically evaluates the quantities on hand
relative to current and historical selling prices and historical and projected
sales volume. Based on these evaluations, provisions are made in each period
to
write down inventory to its net realizable value. Inventory write-offs are
provided to cover risks arising from slow-moving items, technological
obsolescence, excess inventories, and for market prices lower than cost. In
the
three months ended March 31, 2006, the Company wrote off and wrote down
inventory in the amount of $70,577. Inventories are composed of the
following:
|
|
March
31, 2006
|
|
December
31, 2005
|
|
|
|
(Unaudited)
|
|
|
|
Raw
and packaging materials
|
|
$
|
3,051,044
|
|
$
|
3,296,453
|
Work-in-progress
|
|
|
3,248,502
|
|
|
3,697,361
|
Finished
goods
|
|
|
1,280,871
|
|
|
821,992
|
|
|
$
|
7,580,417
|
|
$
|
7,815,806
|
NOTE
3: IMPACT
OF RECENTLY ISSUED ACCOUNTING STANDARDS
In
February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments” (“SFAS No. 155”), which amends SFAS No. 133, “Accounting
for Derivative Instruments and Hedging Activities” (“SFAS No. 133”) and SFAS No.
140, “Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities” (“SFAS No. 140”). SFAS No. 155 provides guidance
to simplify the accounting for certain hybrid instruments by permitting fair
value remeasurement for any hybrid financial instrument that contains an
embedded derivative, as well as clarifying that beneficial interests in
securitized financial assets are subject to SFAS 133. In addition, SFAS No.
155
eliminates a restriction on the passive derivative instruments that a qualifying
special-purpose entity may hold under SFAS No. 140. SFAS No. 155 is effective
for all financial instruments acquired, issued or subject to a new basis
occurring
after
the
beginning of an entity’s first fiscal year that begins after September 15, 2006.
The Company believes that the adoption of this statement will not have a
material effect on its financial condition or results of operations.
In
March
2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
Assets” (“SFAS No. 156”), which amends SFAS No. 140. SFAS No. 156 provides
guidance addressing the recognition and measurement of separately recognized
servicing assets and liabilities, common with mortgage securitization
activities, and provides an approach to simplify efforts to obtain hedge
accounting treatment. SFAS No. 156 is effective for all separately recognized
servicing assets and liabilities acquired or issued after the beginning of
an
entity’s fiscal year that begins after September 15, 2006, with early adoption
being permitted. The Company believes that the adoption of this statement will
not have a material effect on its financial condition or results of
operations
NOTE
4: SEGMENT
INFORMATION
a. General:
The
Company and its subsidiaries operate primarily in three business segments and
follow the requirements of SFAS No. 131.
The
Company’s reportable operating segments have been determined in accordance with
the Company’s internal management structure, which is organized based on
operating activities. The accounting policies of the operating segments are
the
same as those used by the Company in the preparation of its annual financial
statement. The Company evaluates performance based upon two primary factors,
one
is the segment’s operating income and the other is the segment’s contribution to
the Company’s future strategic growth.
b. The
following is information about reported segment revenues, income (losses) and
assets for the three months ended March
31,
2006
and
2005:
|
|
|
Simulation
and Training
|
|
|
Battery
and
Power
Systems
|
|
|
Armor
|
|
|
All
Others
|
|
|
Total
|
|
Three
months ended March
31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
from outside customers
|
|
$
|
4,936,565
|
|
$
|
2,041,942
|
|
$
|
1,917,905
|
|
$
|
-
|
|
$
|
8,896,412
|
|
Depreciation,
amortization and impairment expenses (1)
|
|
|
(433,709
|
)
|
|
(232,197
|
)
|
|
(399,874
|
)
|
|
(59,826
|
)
|
|
(1,125,606
|
)
|
Direct
expenses (2)
|
|
|
(4,195,347
|
)
|
|
(2,151,262
|
)
|
|
(2,356,205
|
)
|
|
(1,820,304
|
)
|
|
(10,523,118
|
)
|
Segment
income (loss)
|
|
$
|
307,509
|
|
$
|
(341,517
|
)
|
$
|
(838,174
|
)
|
$
|
(1,880,130
|
)
|
|
(2,752,312
|
)
|
Financial
income (after deduction of minority interest)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,461,136
|
)
|
Loss
from continuing operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(4,213,448
|
)
|
Segment
assets
(3), (4)
|
|
$
|
32,615,793
|
|
$
|
12,012,941
|
|
$
|
6,421,605
|
|
$
|
643,069
|
|
$
|
51,693,408
|
|
|
|
|
Simulation
and Training
|
|
|
Battery
and
Power
Systems
|
|
|
Armor
|
|
|
All
Others
|
|
|
Total
|
|
Three
months ended March
31, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
from outside customers
|
|
$
|
4,115,651
|
|
$
|
3,006,138
|
|
$
|
3,265,656
|
|
$
|
-
|
|
$
|
10,387,445
|
|
Depreciation
expenses and amortization (1)
|
|
|
(402,660
|
)
|
|
(222,699
|
)
|
|
(491,548
|
)
|
|
(35,000
|
)
|
|
(1,151,907
|
)
|
Direct
expenses (2)
|
|
|
(3,508,124
|
)
|
|
(2,756,990
|
)
|
|
(3,316,049
|
)
|
|
(1,641,897
|
)
|
|
(11,223,060
|
)
|
Segment
income (loss)
|
|
$
|
204,867
|
|
$
|
26,449
|
|
$
|
(541,941
|
)
|
$
|
(1,676,897
|
)
|
|
(1,987,522
|
)
|
Financial
income (after deduction of minority interest)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(468,978
|
)
|
Loss
from continuing operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(2,456,500
|
)
|
Segment
assets
(3)
|
|
$
|
31,783,459
|
|
$
|
13,265,919
|
|
$
|
20,816,358
|
|
$
|
759,121
|
|
$
|
66,624,857
|
|
(1) Includes
depreciation of property and equipment, amortization expenses of intangible
assets and impairment of goodwill and other intangible assets.
(2) Including,
inter
alia,
sales
and marketing, general and administrative and tax expenses.
(3) Consisting
of property and equipment, inventory and intangible assets.
(4) Out
of
those amounts, goodwill in our Simulation and Training, Battery and Power
Systems and Armor Divisions stood at $23,605,069, $4,902,639 and $973,352,
respectively, as of March 31, 2006 and $22,845,372, $5,244,396 and $11,579,443,
respectively, as of March 31, 2005.
NOTE
5: CONVERTIBLE
DEBENTURES AND DETACHABLE WARRANTS
a. 8%
Secured Convertible Debentures due September 30, 2006 and issued in September
2003
Pursuant
to the terms of a Securities Purchase Agreement dated September 30, 2003, the
Company, in September 2003, issued and sold to a group of institutional
investors an aggregate principal amount of 8% secured convertible debentures
in
the amount of $5.0 million due September 30, 2006. These debentures are
convertible at any time prior to September 30, 2006 at a conversion price of
$1.15 per share.
As
part
of the Securities Purchase Agreement dated September 30, 2003, the Company
issued to the purchasers of its 8% secured convertible debentures due September
30, 2006, warrants to purchase an aggregate of 1,250,000 shares of common stock
at any time prior to September 30, 2006 at a price of $1.4375 per
share.
As
of
March 31, 2006, principal amount of $150,000 remained outstanding under these
convertible debentures.
This
transaction was accounted according to APB No. 14 “Accounting for Convertible
Debt and Debt Issued with Stock Purchase Warrants” (“APB No. 14”) and Emerging
Issue Task Force No. 00-27 “Application of Issue No. 98-5 to Certain Convertible
Instruments” (“EITF 00-27”). The fair value of these warrants was determined
using the Black-Scholes pricing model, assuming a risk-free interest rate of
1.95%, a volatility factor 98%, dividend yields of 0% and a contractual life
of
three years.
In
connection with these convertible debentures, the Company will recognize
financial expenses of $2,963,043 with respect to the beneficial conversion
feature, which is being amortized from the date of issuance to the stated
redemption date - September 30, 2006 - as financial expenses.
During
the three months ended March 31, 2006, the Company recorded an expense of
$7,299, which was attributable to amortization of debt discount and beneficial
conversion feature related to the convertible debenture over its term. These
expenses were included in the financial expenses. See also note
6.b.
b.
|
8%
Secured Convertible Debentures due September 30, 2006 and issued
in
December 2003
|
Pursuant
to the terms of a Securities Purchase Agreement dated September 30, 2003, the
Company, in December 2003, issued and sold to a group of institutional investors
an aggregate principal amount of 8% secured convertible debentures in the amount
of $6.0 million due September 30, 2006. These debentures are convertible at
any
time prior to September 30, 2006 at a conversion price of $1.45 per
share.
As
of
March 31, 2006, principal amount of $4,387,500 remained outstanding under these
convertible debentures.
As
a
further part of the Securities Purchase Agreement dated September 30, 2003,
the
Company issued to the purchasers of its 8% secured convertible debentures due
September 30, 2006, warrants to purchase an aggregate of 1,500,000 shares of
common stock at any time prior to December 31, 2006 at a price of $1.8125 per
share. Additionally, the Company issued to the investors supplemental warrants
to purchase an aggregate of 1,038,000 shares of common stock at any time prior
to June 18, 2009 at a price of $2.20 per share. See Note 6.c.
This
transaction was accounted according to APB No. 14 and EITF 00-27. The fair
value
of the warrants granted in respect of convertible debentures was determined
using the Black-Scholes pricing model, assuming a risk-free interest rate of
2.45%, a volatility factor 98%, dividend yields of 0% and a contractual life
of
three years.
In
connection with these convertible debentures, the Company will recognize
financial expenses of $6,000,000 with respect to the beneficial conversion
feature, which is being amortized from the date of issuance to the stated
redemption date - September 30, 2006 - as financial expenses.
During
the three months ended March 31, 2006, the Company recorded an expense of
$385,244, which was attributable to amortization of the beneficial conversion
feature of the convertible debenture over its term. These expenses were included
in the financial expenses.
See
also
note 6.c.
c. Senior
Secured Convertible Notes due March 31, 2008
Pursuant
to the terms of a Securities Purchase Agreement dated September 29, 2005 (the
“Purchase Agreement”) by and between the Company and certain institutional
investors, the Company issued and sold to the investors an aggregate of $17.5
million principal amount of senior secured notes having a final maturity date
of
March 31, 2008.
Under
the
terms of the Purchase Agreement, the Company granted the investors (i) a second
position security interest in the stock of MDT Armor Corporation, IES
Interactive Training, Inc. and M.D.T. Protective Industries, Ltd. (junior to
the
security interest of the holders of the Com-
pany’s
8%
secured convertible debentures due September 30, 2006) and in the assets of
FAAC
Incorporated (junior to a bank that extends to FAAC Incorporated a $5 million
line of credit) and in any stock that the Company acquires in future
acquisitions, and (ii) a first position security interest in the assets of
all
of the Company’s other active United States subsidiaries. The Company’s active
United States subsidiaries are also acting as guarantors of the Company’s
obligations under the Notes.
As
of
March 31, 2006, principal amount of $14.6 million remained outstanding under
these convertible notes.
The
Notes
are convertible at the investors’ option at a fixed conversion price of $1.00.
The Notes bear interest at a rate equal to six month LIBOR plus 6% per annum,
subject to a floor of 10% and a cap of 12.5%. The Company will repay the
principal amount of the Notes over a period of two and one-half years, with
the
principal amount being amortized in twelve payments payable at the Company’s
option in cash and/or stock, provided certain conditions are met. In the event
the Company elects to make such payments in stock, the price used to determine
the number of shares to be issued will be calculated using an 8% discount to
the
average trading price of our common stock during 17 of the 20 consecutive
trading days ending two days before the payment date.
As
a
further part of the Securities Purchase Agreement dated September 29, 2005,
the
Company issued warrants, which are not exercisable for the six month period
following closing, to purchase up to 5,250,000 shares of common stock (30%
warrant coverage) at an exercise price of $1.10 per share. These warrants are
exercisable until the one-year anniversary of the effective date of the
registration statement registering the shares of common stock underlying the
warrants.
This
transaction was accounted according to APB No. 14 and EITF 00-27. The fair
value
of the warrants granted in respect of convertible debentures was determined
using the Black-Scholes pricing model, assuming a risk-free interest rate of
3.87%, a volatility factor 53%, divi-dend yields of 0% and a contractual life
of
one year.
In
connection with these convertible notes, the Company will recognize financial
expenses of $422,034 with respect to the beneficial compensation related to
the
warrants issued to the holders of the convertible debenture, which is being
amortized from the date of issuance to the stated redemption date - March 31,
2008 - as financial expenses.
As
to
EITF 00-19, since the terms of the warrants referred to above provided that
upon
exercise of a warrant the Company could issue only stock that had been
registered with the SEC (which occurred in December 2005) and therefore freely
tradable, in accordance with Emerging Issues Task Force No 00-19 “Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company’s Own Stock,” their fair value was recorded as a liability at the
closing date. Such fair value was remeasured at each subsequent cut-off date.
The fair value of these warrants was remeasured as at March 31, 2006 using
the
Black-Scholes pricing model assuming a risk free interest rate of 4.79%, a
volatility factor of 81%, dividend yields of 0% and a contractual life of
approximately six months. The change in the fair value of the warrants in the
amount of $39,407 has been recorded as finance expense during the three months
ended March 31, 2006.
The
Company has also considered EITF No. 05-2, “The Meaning of ‘Conventional
Convertible Debt Instrument’ in EITF Issue No. 00-19, ‘Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own
Stock.’” Accordingly, the Company has concluded that these convertible notes
would be considered as conventional convertible debt and therefore EITF 00-19
does not apply to them.
During
the three months ended March 31, 2006, the Company recorded an expense of
$91,066, which was attributable to amortization of the beneficial conversion
feature of the convertible notes over their term. These expenses were included
in the financial expenses.
See
also
Note 9.d.
NOTE
6: WARRANTS
a.
|
Warrants
issued in June 2003
|
In
June
2003, warrants to purchase a total of 412,122 shares of common stock, having
an
aggregate exercise price of $337,940, were exercised. These warrants had
originally been issued in May 2001 at an exercise price of $3.22 per share,
but
were repriced immediately prior to exercise to $0.82 per share. In connection
with this repricing, the holder of these 412,122 warrants received an aggregate
of 274,748 new five-year warrants to purchase shares at an exercise price of
$1.45 per share and exercisable after January 1, 2004. In March 2006, these
new
warrants were repriced to an exercise price of $0.40 per share and exercised.
In
connection with this repricing, the holder of these warrants received new
warrants to purchase 109,899 shares at an exercise price of $0.594. As a result
of this repricing of the existing warrants and the issuance of these new
warrants, the Company recorded a deemed dividend in the amount of $28,369 in
the
first quarter of 2006.
b.
|
Warrants
issued in December 2003
|
In
connection with the transactions described in Note 5.a., the Company, in
September 2003, issued warrants to purchase an aggregate of 1,250,000 shares
of
common stock at any time prior to September 30, 2006 at a price of $1.4375
per
share. In March 2006, 125,000 of these warrants were repriced to an exercise
price of $0.40 per share and exercised. In connection with this repricing,
the
holder of these warrants received a new warrant to purchase 50,000 shares at
an
exercise price of $0.594. As a result of this repricing of the existing warrants
and the issuance of these new warrants, the Company recorded a deemed dividend
in the amount of $24,531 in the first quarter of 2006.
c.
|
Warrants
issued in September 2003
|
In
connection with the transactions described in Note 5.b., the Company, in
December 2003, issued supplemental warrants to purchase an aggregate of
1,038,000 shares of common stock at any time prior to June 18, 2009 at a price
of $2.20 per share. In February and March 2006, an aggregate of 778,500 of
these
warrants were repriced to an exercise price of $0.40 per share and exercised.
In
connection with this repricing, the holders of these warrants received new
warrants to purchase an aggregate of 311,400 shares at an exercise price of
$0.594. As a result of this repricing of the existing warrants and the issuance
of these new warrants, the Company recorded a deemed dividend in the amount
of
$35,157 in the first quarter of 2006.
See
also
Note 9.a.
d.
|
Warrants
issued in September 2003
|
Pursuant
to the terms of a Securities Purchase Agreement dated January 7, 2004 by and
between the Company and several institutional investors, the Company issued
and
sold (i) an aggregate of 9,840,426 shares of the Company’s common stock at a
purchase price of $1.88 per share, and (ii) three-year warrants to purchase
up
to an aggregate of 9,840,426 shares of the Company’s common stock at any time
beginning six months after closing at an exercise price per share of $1.88.
In
March 2006, 797,872 of these warrants were repriced to an exercise price of
$0.40 per share and exercised. In connection with this repricing, the holder
of
these warrants received a new warrant to purchase an aggregate of 319,149 shares
at an exercise price of $0.594. As a result of this repricing of the existing
warrants and the issuance of these new warrants, the Company recorded a deemed
dividend in the amount of $153,234 in the first quarter of 2006.
See
also
Note 9.b.
e.
|
Warrants
issued in July 2004
|
On
July
14, 2004, warrants to purchase 8,814,235 shares of common stock were exercised.
In connection with this transaction, the Company issued to the holders of those
exercising warrants an aggregate of 8,717,265 new five-year warrants to purchase
shares of common stock at an exercise price of $1.38 per share. In February
and
March 2006, an aggregate of 7,017,025 of these warrants were repriced to an
exercise price of $0.40 per share and exercised. In connection with this
repricing, the holders of these warrants received new warrants to purchase
an
aggregate of 2,806,810 shares at an exercise price of $0.594. As a result of
this repricing of the existing warrants and the issuance of these new warrants,
the Company recorded a deemed dividend in the amount of $75,916 in the first
quarter of 2006.
See
also
Note 9.c.
f. As
to
EITF 00-19, since the terms of the warrants referred to above provided
that
the
warrants were exercisable subject to the Company obtaining stockholder
approval,
in
accordance with Emerging Issues Task Force No 00-19 “Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own
Stock,” their fair value was recorded as a liability at the closing date. Such
fair value was remeasured at each subsequent cut-off date. The fair value of
these warrants was remeasured as at March 31, 2006 using the Black-Scholes
pricing model assuming a risk free interest rate of 4.73%, a volatility factor
of 79%, dividend yields of 0% and a contractual life of approximately two years.
The change in the fair value of the warrants between the date of the grant
and
March 31, 2006 in the amount of $74,677 has been recorded as finance
income.
NOTE
7: IMPAIRMENT
OF GOODWILL
SFAS
No.
142 requires goodwill to be tested for impairment on adoption of the Statement,
at least annually thereafter, and between annual tests in certain circumstances,
and written down when impaired, rather than being amortized as previous
accounting standards required. Goodwill is tested for impairment by comparing
the fair value of the Company’s reportable units with their carrying value. Fair
value is determined using discounted cash flows. Significant estimates
used
in
the
methodologies include estimates of future cash flows, future short-term and
long-term growth rates, weighted average cost of capital and estimates of market
multiples for the reportable units.
During
2005, the Company performed impairment test of goodwill, based on management’s
projections and using expected future discounted operating cash flows and as
response to several factors. As of December 31, 2005, as a result of this
impairment test, the Company identified in AoA an impairment of goodwill in
the
amount of $11,757,812.
In
connection with the Company’s acquisition of AoA, the Company accrued during
2006 an amount of $204,059 in respect of an earnout obligation, which was
charged as an impairment of goodwill (see Note 8).
NOTE
8: CONTINGENT
LIABILITIES
In
connection with the Company’s acquisition of FAAC, the Company has a contingent
earnout obligation in an amount equal to the net income realized by the Company
from certain specific programs that were identified by the Company and the
former shareholders of FAAC as appropriate targets for revenue increases in
2005. Through March 31, 2006, the Company had accrued an amount of $603,764
in
respect of such earnout obligation against FAAC’s goodwill. Although the former
shareholders of FAAC have indicated to the Company their belief that the
specific programs identified include more orders than those with respect to
which the Company has made accrual in respect of this earnout obligation, the
Company believes there is no basis for this claim.
In
connection with the Company’s acquisition of AoA, the Company has a contingent
earnout obligation in an amount equal to the revenues realized by the Company
from certain specific programs that were identified by the Company and the
former shareholder of AoA as appropriate targets for revenue increases. The
earnout provides that if AoA receives certain types of orders from certain
specific customers prior to December 31, 2006 (“Additional Orders”), then upon
shipment of goods in connection with such Additional Orders, the former
shareholder of AoA will be paid an earnout based on revenues, up to a maximum
of
an additional $6 million. Through March 31, 2006 the Company had accrued an
amount of $1.4 million in respect of such earnout obligation (see Note
7).
NOTE
9: SUBSEQUENT
EVENTS
a.
|
Warrants
issued in September 2003
|
In
connection with the transactions described in Note 5.b., the Company, in
December 2003, issued supplemental warrants to purchase an aggregate of
1,038,000 shares of common stock at any time prior to June 18, 2009 at a price
of $2.20 per share. In April 2006, 155,700 of these warrants were repriced
to an
exercise price of $0.40 per share and exercised. In connection with this
repricing, the holder of these warrants received a new warrant to purchase
62,280 shares at an exercise price of $0.594. See also Note 6.c.
b.
|
Warrants
issued in September 2003
|
Pursuant
to the terms of a Securities Purchase Agreement dated January 7, 2004 by and
between the Company and several institutional investors, the Company issued
and
sold (i) an aggregate of
9,840,426
shares of the Company’s common stock at a purchase price of $1.88 per share, and
(ii) three-year warrants to purchase up to an aggregate of 9,840,426 shares
of
the Company’s common stock at any time beginning six months after closing at an
exercise price per share of $1.88. In April 2006, 1,063,829 of these warrants
were repriced to an exercise price of $0.40 per share and exercised. In
connection with this repricing, the holder of these warrants received a new
warrant to purchase 425,532 shares at an exercise price of $0.594. See also
Note
6.d.
c.
|
Warrants
issued in July 2004
|
On
July
14, 2004, warrants to purchase 8,814,235 shares of common stock were exercised.
In connection with this transaction, the Company issued to the holders of those
exercising warrants an aggregate of 8,717,265 new five-year warrants to purchase
shares of common stock at an exercise price of $1.38 per share. In April 2006,
225,000 of these warrants were repriced to an exercise price of $0.40 per share
and exercised. In connection with this repricing, the holder of these warrants
received a new warrant to purchase 90,000 shares at an exercise price of $0.594.
See also Note 6.e.
On
April
7,
2006,
the Company and each holder (each, an “Investor” and collectively, the
“Investors”) of its Senior Secured Convertible Notes due 2008 (the “Notes”)
entered into conversion agreements dated April
7,
2006 (collectively, the “Conversion Agreements”) pursuant to which an aggregate
of $6,148,903.60 principal amount of the Notes was
converted into 15,372,259 shares of the Company’s common stock. The amount
converted eliminated the Company’s obligation to make the installment payments
under the Notes on each of March 31, 2008, January 31, 2008, November 30, 2007
and September 30, 2007 (aggregating a total of $5,833,333.33). In addition,
as a
result of the conversion an additional $315,570.27 was applied against part
of
the installment payment due July 31, 2007. After giving effect to the
conversion, $8,434,429.73 of principal remained outstanding under the Notes.
Each Investor also agreed, among other things, to defer the installment payment
due on May 31, 2006 to July 31, 2006. See also Note 5.c.
This
report contains forward-looking statements made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. These
statements involve inherent risks and uncertainties. When used in this
discussion, the words “believes,” “anticipated,” “expects,” “estimates” and
similar expressions are intended to identify such forward-looking statements.
Such statements are subject to certain risks and uncertainties. Readers are
cautioned not to place undue reliance on these forward-looking statements,
which
speak only as of the date hereof. We undertake no obligation to publicly release
the result of any revisions to these forward-looking statements that may be
made
to reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events. Our actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors including, but not limited to, those set forth elsewhere in
this
report. Please see “Risk Factors,” below, and in our other filings with the
Securities and Exchange Commission.
Arotech™
is a trademark and Electric Fuel®
is a
registered trademark of Arotech Corporation. All company and pro-duct names
mentioned may be trademarks or registered trademarks of their respective
holders. Unless the context requires otherwise, all references to us refer
collectively to Arotech Corporation and its subsidiaries.
We
make available through our internet website free of charge our annual report
on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K,
amendments to such reports and other filings made by us with the SEC, as soon
as
practicable after we electronically files such reports and filings with the
SEC.
Our website address is www.arotech.com. The information contained in this
website is not incorporated by reference in this report.
The
following discussion and analysis should be read in conjunction with the interim
financial statements and notes thereto appearing elsewhere in this Quarterly
Report. We have rounded amounts reported here to the nearest thousand, unless
such amounts are more than 1.0 million, in which event we have rounded such
amounts to the nearest hundred thousand.
Executive
Summary
Divisions
and Subsidiaries
We
operate primarily as a holding company, through our various subsidiaries, which
we have organized into three divisions. Our divisions and subsidiaries (all
100%
owned, unless otherwise noted) are as follows:
Ø |
Our
Simulation
and Training Division,
consisting of:
|
· |
FAAC
Incorporated, located in Ann Arbor, Michigan, which provides simulators,
systems engineering and software products to the United States military,
government and private industry (“FAAC”);
and
|
· |
IES
Interactive Training, Inc., located in Littleton, Colorado, which
provides
specialized “use of force” training for police, security personnel and the
military (“IES”).
|
Ø |
Our
Armor
Division,
consisting of:
|
· |
Armour
of America, located in Los Angeles, California, which manufacturers
ballistic and fragmentation armor kits for rotary and fixed wing
aircraft,
marine armor, personnel armor, military vehicles and architectural
applications, including both the LEGUARD Tactical Leg Armor and the
Armourfloat Ballistic Floatation Device, which is a unique vest that
is
certified by the U.S. Coast Guard (“AoA”);
|
· |
MDT
Protective Industries, Ltd., located in Lod, Israel, which specializes
in using state-of-the-art lightweight ceramic materials, special
ballistic
glass and advanced engineering processes to fully armor vans and
SUVs, and
is a leading supplier to the Israeli military, Israeli special forces
and
special services (“MDT”) (75.5% owned);
and
|
· |
MDT
Armor Corporation, located in Auburn, Alabama, which conducts MDT’s United
States activities (“MDT Armor”)
(88% owned).
|
Ø |
Our
Battery
and Power Systems Division,
consisting of:
|
· |
Epsilor
Electronic Industries, Ltd., located in Dimona, Israel (in Israel’s Negev
desert area), which develops and sells rechargeable and primary lithium
batteries and smart chargers to the military and to private industry
in
the Middle East, Europe and Asia (“Epsilor”);
|
· |
Electric
Fuel Battery Corporation, located in Auburn, Alabama, which manufactures
and sells Zinc-Air fuel sells, batteries and chargers for the military,
focusing on applications that demand high energy and light weight
(“EFB”);
and
|
· |
Electric
Fuel (E.F.L.) Ltd., located in Beit Shemesh, Israel, which produces
water-activated battery (“WAB”) lifejacket lights for commercial aviation
and marine applications, and which conducts our Electric Vehicle
effort,
focusing on obtaining and implementing demonstration projects in
the U.S.
and Europe, and on building broad industry partnerships that can
lead to
eventual commercialization of our Zinc-Air energy system for electric
vehicles (“EFL”).
|
We
are in
the process of relocating the operations of IES to Ann Arbor, Michigan (adjacent
to FAAC), and the operations of AoA to Auburn, Alabama (adjacent to MDT
Armor).
Overview
of Results of Operations
We
incurred significant operating losses for the years ended December 31, 2004
and
2005 and for the first three months of 2006. While we expect to continue to
derive revenues from the sale of products that our subsidiaries manufacture
and
the services that they provide, there can be no assurance that we will be able
to achieve or maintain profitability on a consistent basis.
During
2003 and 2004, we substantially increased our revenues and reduced our net
loss,
from $18.5 million in 2002 to $9.2 million in 2003 to $9.0 million in 2004.
This
was achieved through a combination of cost-cutting measures and increased
revenues, particularly from the sale of Zinc-Air batteries to the military
and
from sales of products manufactured by the subsidiaries we acquired in 2002
and
2004. However, in 2005 our net loss increased to $23.9 million on revenues
of
$49.0 million, and in the first three months of 2006 we had a net loss of $4.2
million on revenues of $8.9 million.
A
portion
of our operating loss during the first three months of 2006 arose as a result
of
non-cash charges. In addition to the charges in respect of the write-off of
goodwill described under “Critical Accounting Policies - Goodwill,” above, these
charges were primarily related to our acquisitions and financings. Because
we
anticipate continuing certain of these activities during the remainder of 2006,
we expect to continue to incur such non-cash charges in the future.
Acquisitions
In
acquisitions of subsidiaries, part of the purchase price is allocated to
intangible assets and goodwill. Amortization of intangible assets related to
acquisition of subsidiaries is recorded based on the estimated expected life
of
the assets. Accordingly, for a period of time following an acquisition, we
incur
a non-cash charge related to amortization of intangible assets in the amount
of
a fraction (based on the useful life of the intangible assets) of the amount
recorded as intangible assets. Such amortization charges will continue during
2006. We are required to review intangible assets for impairment whenever events
or changes in circumstances indicate that carrying amount of the assets may
not
be recoverable. If we determine, through the impairment review process, that
intangible asset has been impaired, we must record the impairment charge in
our
statement of operations.
In
the
case of goodwill, the assets recorded as goodwill are not amortized; instead,
we
are required to perform an annual impairment review. If we determine, through
the impairment review process, that goodwill has been impaired, we must record
the impairment charge in our statement of operations.
As
a
result of the application of the above accounting rules, we incurred non-cash
charges for amortization of intangible assets in the amount of $511,000 during
the first three months of 2006. In addition, we incurred non-cash charges for
impairment of goodwill in the amount of $204,000 during the first three months
of 2006 in respect of our subsidiary AoA.
Financings
The
non-cash charges that relate to our financings occurred in connection with
our
issuance of convertible debentures with warrants, and in connection with our
repricing of certain
warrants
and grants of new warrants. When we issue convertible debentures, we record
a
discount for a beneficial conversion feature that is amortized ratably over
the
life of the debenture. When a debenture is converted, however, the entire
remaining unamortized beneficial conversion feature expense is immediately
recognized in the quarter in which the debenture is converted. Similarly, when
we issue warrants in connection with convertible debentures, we record debt
discount for financial expenses that is amortized ratably over the term of
the
convertible debentures; when the convertible debentures are converted, the
entire remaining unamortized debt discount is immediately recognized in the
quarter in which the convertible debentures are converted. As and to the extent
that our remaining convertible debentures are converted, we would incur similar
non-cash charges going forward.
As
a
result of the application of the above accounting rule, we incurred non-cash
charges related to amortization of debt discount attributable to beneficial
conversion feature in the amount of $484,000 during the first three months
of
2006.
During
2004 and 2005, we issued restricted shares to certain of our employees. These
shares were issued as stock bonuses, and are restricted for a period of two
years from the date of issuance. Relevant accounting rules provide that the
aggregate amount of the difference between the purchase price of the restricted
shares (in this case, generally zero) and the market price of the shares on
the
date of grant is taken as a general and administrative expense, amortized over
the life of the period of the restriction.
As
a
result of the application of the above accounting rules, we incurred non-cash
charges related to stock-based compensation in the amount of $183,000 during
the
first three months of 2006.
As
a
result of stock options granted to employees and directors and the adoption
of
Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based
Payments,” we incurred non-cash charges related to stock-based compensation in
the amount of $48,000 during the first three months of 2006.
As
part
of our Securities Purchase Agreement dated September 29, 2005, we issued
warrants to purchase up to 5,250,000 shares of common stock. Because the
terms
of the warrants referred to above provided that upon exercise of a warrant
we
could issue only stock that had been registered with the SEC (which occurred
in
December 2005) and was therefore freely tradable, in accordance with Emerging
Issues Task Force No 00-19, “Accounting for Derivative Financial Instruments
Indexed to, and Potentially Settled in, a Company’s Own Stock,” the fair value
of the warrants was recorded as a liability at the closing date. Such fair
value
was remeasured at each subsequent cut-off date. The fair value of these warrants
was remeasured as at March 31, 2006 using the Black-Scholes pricing model
assuming a risk free interest rate of 4.79%, a volatility factor of 81%,
dividend yields of 0% and a contractual life of approximately half year.
The
change in the fair value of the warrants between the date of the grant and
March
31, 2006 in the amount of $39,000 has been recorded as finance
expense.
As
part
of the repricing and exercise of warrants described in note 6 to the financial
statements, we issued warrants to purchase up to 3,597,258 shares of common
stock. Since the terms of these warrants provided that
the
warrants were exercisable subject to the Company obtaining
stockholder
approval,
in
accordance with Emerging Issues Task Force No 00-19, “Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own
Stock,” the fair value of the warrants was recorded as a liability at the
closing date. Such fair value was remeasured at each subsequent cut-off date.
The fair value of these warrants was remeasured as at March 31, 2006 using
the
Black-Scholes pricing model assuming a risk free interest rate of 4.73%, a
volatility factor of 79%, dividend yields of 0% and a contractual life of
approximately two years. The change in the fair value of the warrants between
the date of the grant and March 31, 2006 in the amount of $75,000 has been
recorded as finance income.
Under
the
terms of our convertible notes, we have the option in respect of scheduled
principal repayments to force conversion of the payment amount at a conversion
price based upon the weighted average trading price of our common stock during
the 20 trading days prior to the conversion, less a discount of 8%. Because
of
this discount and the use in a conversion price that is based on the weighted
average trading price of our common stock during the 20 trading days prior
to
the conversion , we incurred a financial expense during the first three months
of 2006 of $507,000, which represent the shares issued multiplied by the
difference between the share price that was used for the conversion and the
share price at the day of the conversion.
Additionally,
in an effort to improve our cash situation and our shareholders’ equity, we have
periodically induced holders of certain of our warrants to exercise their
warrants by lowering the exercise price of the warrants in exchange for
immediate exercise of such warrants, and by issuing to such investors new
warrants. Under such circumstances, we record a deemed dividend in an amount
determined based upon the fair value of the new warrants (using the
Black-Scholes pricing model). As and to the extent that we engage in similar
warrant repricings and issuances in the future, we would incur similar non-cash
charges.
As
a
result of the application of the above accounting rule we recorded a deemed
dividend related to repricing of warrants and the grant of new warrants in
the
amount of $317,000 during the first three months of 2006.
Overview
of Operating Performance and Backlog
In
our
Simulation and Training Division, revenues grew from approximately $4.1 million
in the first three months of 2005 to $4.9 million in the first three months
of
2006. As of March 31, 2006, our backlog for our Simulation and Training Division
totaled $8.6 million, most of which was attributable to FAAC.
In
our
Battery and Power Systems Division, revenues decreased from approximately $3.0
million in the first three months of 2005 to approximately $2.0 million in
the
first three months of 2006. As of March 31, 2006, our backlog for our Battery
and Power Systems Division totaled $4.5 million.
In
our
Armor Division, revenues decreased from $3.3 million during the first three
months of 2005 to $1.9 million during the first three months of 2006. As of
March 31, 2006, our backlog for our Armor Division totaled $25.8
million.
Functional
Currency
We
consider the United States dollar to be the currency of the primary economic
environment in which we and our Israeli subsidiary EFL operate and, therefore,
both we and EFL have adopted and are using the United States dollar as our
functional currency. Transactions and balances originally denominated in U.S.
dollars are presented at the original amounts. Gains and losses arising from
non-dollar transactions and balances are included in net income.
The
majority of financial transactions of our Israeli subsidiaries MDT and Epsilor,
is in New Israel Shekels (“NIS”) and a substantial portion of MDT’s and
Epsilor’s costs is incurred in NIS. Management believes that the NIS is the
functional currency of MDT and Epsilor. Accordingly, the financial statements
of
MDT and Epsilor have been translated into U.S. dollars. All balance sheet
accounts have been translated using the exchange rates in effect at the balance
sheet date. Statement of operations amounts have been translated using the
average exchange rate for the period. The resulting translation adjustments
are
reported as a component of accumulated other comprehensive loss in shareholders’
equity.
Recent
Developments
Senior
Secured Note Conversions
In
April
2006, with the agreement of the holders of our Senior Secured Convertible
Notes,
we
prepaid the payments of September 30, 2007, November 30, 2007, January 31,
2008,
and March 31, 2008, as well as a small portion of the payment due July 31,
2007
- a total aggregate payment of $6,148,903.60 - in 15,372,259 shares of common
stock by requiring the holders to convert a portion of their Notes. We
are
investigating the appropriate accounting treatment of this transaction, which
will be reflected in our financial results during the second quarter of
2006.
Results
of Operations
Three
months ended March 31, 2006 compared to the three months ended March 31,
2005.
Revenues.
During
the three months ended March 31, 2006, we (through our subsidiaries) recognized
revenues as follows:
Ø |
IES
and FAAC recognized revenues from the sale of interactive use-of-force
training systems and from the provision of maintenance services in
connection with such systems.
|
Ø |
MDT,
MDT Armor and AoA recognized revenues from payments under vehicle
armoring
contracts, for service and repair of armored vehicles, and on sale
of
armoring products.
|
Ø |
EFB
and Epsilor recognized revenues from the sale of batteries, chargers
and
adapters to the military, and under certain development contracts
with the
U.S. Army.
|
Ø |
EFL
recognized revenues from the sale of water-activated battery (WAB)
lifejacket lights.
|
Revenues
for the three months ended March 31, 2006 totaled $8.9 million, compared to
$10.4 million in the comparable period in 2005, a decrease of $1.5 million,
or
14.4%. This decrease was primarily attributable to the following factors:
Ø |
Decreased
revenues from our Armor Division, particularly MDT and AoA ($1.3
million
less in 2006 versus 2005).
|
Ø |
Decreased
revenues from our Battery and Power Systems Division, particularly
Epsilor
($1.0 million less in 2006 versus
2005).
|
Ø |
This
decrease was offset to some extent by increased revenue from our
Simulation and Training Division, particularly
FAAC.
|
In
the
first quarter of 2006, revenues were $4.9
million
for the Simulation and Security Division (compared to $4.1 million in the first
quarter of 2005, an
increase of $821,000, or 19.9%, due
primarily to increased sales of FAAC); $2.0 million for the Battery and Power
Systems Division (compared to $3.0 million in the first quarter of
2005, a
decrease of $964,000, or 32.1%, due primarily to decreased sales of Epsilor,
offset to some extent by increased WAB revenues from our EFL subsidiary); and
$1.9 million for the Armor Division (compared to $3.3 million in the first
quarter of 2005, a
decrease of $1.3 million, or 41.3%, due
primarily to decreased revenues from MDT and AoA).
Cost
of revenues and gross profit. Cost
of
revenues totaled $6.7 million during the first quarter of 2006, compared to
$6.4
million in the first quarter of 2005, an
increase of $281,000, or 4.4%, due
primarily to decreased sales in our Battery and Power Systems division and
Armor
Division and the decrease in margins due to change in the mix of products and
customers in 2006 in comparison to 2005. In addition, we incurred substantial
expenses in respect of production of a new product in our Armor
Division.
Direct
expenses for our three divisions during the first quarter of 2006 were $4.2
million for the Simulation and Security Division (compared to $3.5 million
in
the first quarter of 2005, an
increase of $687,000, or 19.6%, due
primarily to increased sales of FAAC); $2.2 million for the Battery and Power
Systems Division (compared to $2.8 million in the first quarter of
2005, a
decrease of $606,000, or 22.0%, due primarily to decreased sales of Epsilor,
offset to some extent by increased WAB revenues from our EFL subsidiary; and
$2.4 million for the Armor Division (compared to $3.3 million in the first
quarter of 2005, a
decrease of $960,000, or 28.9%, due
primarily to decreased revenues from MDT and AoA)
Gross
profit was $2.2 million during the first quarter of 2006, compared to $4.0
million during the first quarter of 2005, a decrease of $1.8 million, or 44.1%.
This decrease was the direct result of all factors presented above, most notably
the decrease in our Armor Division revenues, the decrease in our Battery and
Power Systems Division revenue and the decrease in margins due to change in
the
mix of products and customers in 2006 in comparison to 2005.
Research
and development expenses.
Research
and development expenses for the first quarter of 2006 were $305,000, compared
to $415,000 during the first quarter of 2005, a decrease of $110,000, or 26.6%.
This decrease was primarily attributable to the consolidation of IES’s and
FAAC’s research and development operations, along with increases in capitalized
research and development projects.
Selling
and marketing expenses.
Selling
and marketing expenses for the first quarter of 2006 were $899,000, compared
to
$1.2 million the first quarter of 2005, a decrease of $260,000, or 22.4%. This
decrease was primarily attributable to the overall decrease in revenues and
their associated sales and marketing expenses.
General
and administrative expenses.
General
and administrative expenses for the first quarter of 2006 were $3.1 million
compared to $3.4 million in the first quarter of 2005, a decrease of $254,000,
or 7.6%. This decrease was primarily attributable to the following
factors:
Ø |
Decreases
in certain general and administrative expenses in comparison to 2005,
such
as auditing, legal expenses and travel expenses, as a result of
cost-cutting programs implemented by
management.
|
Ø |
Decrease
in general and administrative related to AoA (primarily legal and
payroll
expenses).
|
Financial
expenses, net.
Financial expenses totaled approximately $1.5 million in the first quarter
of
2006 compared to $469,000 in the first quarter of 2005, an increase of $992,000,
or 212%. The difference was due primarily to interest related to our convertible
notes that were issued in September 30, 2005, and financial expenses related
to
repayment by forced conversion of our convertible notes at an 8% discount to
average market price as provided under the terms of the convertible
notes.
Income
taxes. We
and
certain of our subsidiaries incurred net operating losses during the three
months ended March 31, 2006 and, accordingly, we were not required to make
any
provision for income taxes. With respect to some of our subsidiaries that
operated at a net profit during 2006, we were able to offset federal taxes
against our accumulated loss carry forward. We recorded a total of $40,000
in
tax expenses in the first quarter of 2006, mainly in respect of state taxes.
We
recorded a total of $217,000 in tax expenses in the first quarter of 2005 with
respect to certain of our subsidiaries that operated at a net profit during
2005, and we were not able to offset their taxes against our loss carry forward
and with respect to state taxes.
Amortization
of intangible assets.
Amortization of intangible assets totaled $511,000 in the first quarter of
2006,
compared to $823,000 in the first quarter of 2005, a
decrease of $312,000, or 38.0%, due primarily to a decrease in amortization
of
intangible assets related to our subsidiary AoA.
Impairment
of goodwill.
Current
accounting standards require us to test goodwill for impairment at least
annually, and between annual tests in certain circumstances; when we determine
goodwill is impaired, it must be written down, rather than being amortized
as
previous accounting standards required. Goodwill is tested for impairment by
comparing the fair value of our reportable units with their carrying value.
Fair
value is determined using discounted cash flows. Significant estimates used
in
the methodologies include estimates of future cash flows, future short-term
and
long-term growth rates, weighted average cost of capital and estimates of market
multiples for the reportable units. During the first quarter of 2006, we
recorded in our subsidiary AoA an impairment of goodwill in the amount of
$204,000.
Net
loss. Due
to
the factors cited above,
net
loss attributable to common stockholders increased from $2.5 million to $4.2
million, an increase of $1.8 million, or 71.5%.
Net
loss attributable to common stockholders.
Due to
deemed dividend that was recorded in the amount of $317,000 in 2006 due to
the
repricing of existing warrants and the issu-
ance
of
new warrants (see Note 6 to the financial statements), net loss attributable
to
common stockholders was $4.5 million in 2006, compared to $2.5 million in 2005,
an increase of $2.1 million, or 84.4%.
Liquidity
and Capital Resources
As
of
March 31, 2006, we had $5.3 million in cash, $6.8 million in restricted
collateral securities and cash deposits due within one year, $525,000 in
long-term restricted securities and deposits, and $36,000 in marketable
securities, as compared to at December 31, 2005, when we had $6.2 million in
cash, $3.9 million in restricted collateral securities and restricted
held-to-maturity securities due within one year, $779,000 in long-term
restricted deposits, and $36,000 in available-for-sale marketable securities.
The increase in restricted collateral securities and cash deposits was primarily
the result of warrant exercises in February and March of 2006 (see Note 6 to
the
financial statements).
We
used
available funds in the first quarter of 2006 primarily for sales and marketing,
continued research and development expenditures, and other working capital
needs. We increased our investment in fixed assets during the three months
ended
March 31, 2006 by $128,000 over the investment as at December 31, 2005,
primarily in the Battery and Power Systems and Armor Divisions. Our net fixed
assets amounted to $4.0 million at quarter end.
Net
cash
used in operating activities from continuing operations for the three months
ended March 31, 2006 and 2005 was $591,000 and $3.5 million, respectively,
a
decrease of $2.9 million. This decrease was primarily the result of a decrease
in trade receivables in comparison to the first quarter of 2005 and an increase
in inventories in 2005 in comparison to the first quarter of 2006.
Net
cash
used in investing activities for the three months ended March 31, 2006 and
2005
was $3.2 million and $505,000, an increase of $2.7 million. This increase was
primarily the result of warrant exercises during the first quarter of 2006,
the
proceeds of which were deposited in restricted accounts for the payment of
our
convertible debentures due in September 2006, resulting in an increase in
restricted securities and deposits.
Net
cash
provided by (used in) financing activities for the three months ended March
31,
2006 and 2005 was $3.1 million and $(106,000), respectively. This increase
was
primarily the result of warrant exercises in February and March of 2006 (see
Note 6 to the financial statements).
As
of
March 31, 2006, we had (based on the contractual amount of the debt and not
on
the accounting valuation of the debt, not taking into consideration trade
payables, other accounts payables and accrued severance pay) approximately
$8.8
million in long term bank and certificated debt outstanding, all of which was
convertible debt, and approximately $12.7 million in short-term debt (which
included short-term bank credit and convertible debentures in an amount of
$12.3
million, and liability due to acquisition of subsidiary in the amount of
$454,000).
Based
on
our internal forecasts, which are subject to all of the reservations regarding
“forward-looking statements” set forth above, we believe that our present cash
position, anticipated cash flows from operations, lines of credit and
anticipated additions to paid-in capital should be sufficient to satisfy our
current estimated cash requirements through the next twelve months. This
be-
lief
is
based on certain earnout and other assumptions that our management and our
subsidiaries managers believe to be reasonable, some of which are subject
to the
risk factors detailed under “Risk Factors” in Item IA of Part II, below,
including without limitation (i) that we will be able to refinance, restructure
or convert to equity our $10.3 million in convertible debt (debentures and
notes) that is due in 2006 (which does not include $1.9 million short-term
bank
credit), (ii) that our dispute with the former shareholders of FAAC will
ultimately be decided substantially in our favor, (iii) that the severance
and
retirement benefits that we owe to certain of our senior executives will
not
have to be paid ahead of their anticipated schedule, and (iv) that no other
earnout payments to the former shareholder of AoA will be required in excess
of
the funds being held by him in escrow to secure such earnout obligations.
In
this connection, we note that we can require the holders of our senior secured
convertible notes to convert a portion of their notes into shares of our
common
stock at the time principal payments are due only if such shares are registered
for resale and certain other conditions are met. We do not have a sufficient
number of shares of our stock registered for resale in order to continue
requiring the holders to convert a portion of their notes. We have accordingly
filed a registration statement with the SEC to register for resale more shares
of our common stock in order to continue requiring conversion of our notes
upon
principal payment becoming due. Any delay in the registration process, including
through routine SEC review of our registration statement or other filings
with
the SEC, could result in our having to pay scheduled principal repayments
on our
notes in cash, which would negatively impact our cash position and, if we
do not
have sufficient cash to make such payments in cash, could cause us to default
on
our notes. We also note that from time to time our working capital needs
are
partially dependent on our subsidiaries’ lines of credit. In the event that we
are unable to continue to make use of our subsidiaries’ lines of credit for
working capital on economically feasible terms, our business, operating results
and financial condition could be adversely affected.
Over
the
long term, we will need to become profitable, at least on a cash-flow basis,
and
maintain that profitability in order to avoid future capital requirements.
Additionally, we would need to raise additional capital in order to fund any
future acquisitions.
Interest
Rate Risk
It
is our
policy not to enter into interest rate derivative financial instruments, except
for hedging of foreign currency exposures discussed below. We do not currently
have any significant interest rate exposure.
Foreign
Currency Exchange Rate Risk
Since
a
significant part of our sales and expenses are denominated in U.S. dollars,
we
have experienced only insignificant foreign exchange gains and losses to date,
and do not expect to incur significant gains and losses in 2006. Certain of
our
research, development and production activities are carried out by our Israeli
subsidiary, EFL, at its facility in Beit Shemesh, and accordingly we have sales
and expenses in NIS. Additionally, our MDT and Epsilor subsidiaries operate
primarily in NIS. However, the majority of our sales are made outside Israel
in
U.S. dol-
lars,
and
a substantial portion of our costs are incurred in U.S. dollars. Therefore,
our
functional currency is the U.S. dollar.
While
we
conduct our business primarily in U.S. dollars, some of our agreements are
denominated in foreign currencies, and we occasionally hedge part of the risk
of
a devaluation of the U.S dollar, which could have an adverse effect on the
revenues that we incur in foreign currencies. We do not hold or issue derivative
financial instruments for trading or speculative purposes
Evaluation
of Disclosure Controls and Procedures
As
of
March 31, 2006, our management, including the principal executive officer and
principal financial officer, evaluated our disclosure controls and procedures
related to the recording, processing, summarization, and reporting of
information in our periodic reports that we file with the SEC. These disclosure
controls and procedures are intended to ensure that material information
relating to us, including our subsidiaries, is made known to our management,
including these officers, by other of our employees, and that this information
is recorded, processed, summarized, evaluated, and reported, as applicable,
within the time periods specified in the SEC’s rules and forms. Due to the
inherent limitations of control systems, not all misstatements may be detected.
These inherent limitations include the realities that judgments in
decision-making can be faulty and that breakdowns can occur because of simple
error or mistake. Any system of controls and procedures, no matter how well
designed and operated, can at best provide only reasonable assurance that the
objective of the system are met and management necessarily is required to apply
its judgment in evaluating the cost benefit relationship of possible controls
and procedures. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. Our controls and procedures are intended to provide
only reasonable, not absolute, assurance that the above objectives have been
met.
Our
management has not yet completed its annual assessment of the effectiveness
of
our internal control over financial reporting. However, based on their
evaluation as of March 31, 2006 and the material weakness described below,
our
principal executive officer and principal financial officer were able to
conclude that our disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934)
were not effective as of March 31, 2006 to ensure that the information required
to be disclosed by us in the reports that we file or submit under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within
the
time periods specified in SEC rules and forms.
Our
management has not completed implementation of the changes it believes are
required to remediate the previously reported material weakness for inadequate
controls related to revenue recognition at our FAAC subsidiary. The material
weakness arises from revenue
recognition calculations at FAAC not being reviewed by appropriate accounting
personnel to determine that revenue is recognized in accordance with company
policy and generally accepted accounting principles.
Management has identified that due to the reasons described above, we did not
consistently follow established internal control over financial reporting
procedures related to revenue recognition at our FAAC subsidiary. Because of
this material weakness and our management’s unfinished
annual
assessment of the effectiveness of our internal control over financial
reporting,
we have
concluded that we did not maintain effective internal control over financial
reporting as of March 31, 2006, based on the criteria set forth by the Committee
of Sponsoring Organizations (“COSO”) of the Treadway Commission in Internal
Control - Integrated Framework.
In
light
of the material weakness described above, our management performed additional
analyses and other post-closing procedures to ensure our consolidated financial
statements are prepared in accordance with generally accepted accounting
principles in the United States (U.S. GAAP). Accordingly, management believes
that the consolidated financial statements included in this report fairly
present in all material respects our financial position, results of operations
and cash flows for the periods presented.
Management’s
Response to the Material Weaknesses
In
response to the material weakness described above, we have undertaken the
following initiatives with respect to our internal controls and procedures
that
we believe are reasonably likely to improve and materially affect our internal
control over financial reporting. We anticipate that remediation will be
continuing throughout fiscal 2006, during which we expect to continue pursuing
appropriate corrective actions at FAAC, including the following:
Ø |
Revenue
recognition.
We will institute procedures at FAAC to determine that revenue recognition
calculations are reviewed by an appropriate accounting
person.
|
Our
management and Audit Committee will monitor closely the implementation of our
remediation plan. The effectiveness of the steps we intend to implement is
subject to continued management review, as well as Audit Committee oversight,
and we may make additional changes to our internal control over financial
reporting.
Our
management and Audit Committee have monitored and will continue to monitor
closely the implementation of our remediation plan. The effectiveness of the
steps we intend to implement is subject to continued management review, as
well
as Audit Committee oversight, and we may make additional changes to our internal
control over financial reporting.
Changes
in Internal Controls Over Financial Reporting
Except
as
noted above, there have been no changes in our internal control over financial
reporting that occurred during our last fiscal quarter to which this Quarterly
Report on Form 10-Q relates that have materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.
PART
II
The
following factors, among others, could cause actual results to differ materially
from those contained in forward-looking statements made in this Report and
presented elsewhere by management from time to time.
Business-Related
Risks
We
have had a history of losses and may incur future
losses.
We
were
incorporated in 1990 and began our operations in 1991. We have funded our
operations principally from funds raised in each of the initial public offering
of our common stock in February 1994; through subsequent public and private
offerings of our common stock and equity and debt securities convertible or
exercisable into shares of our common stock; research contracts and supply
contracts; funds received under research and development grants from the
Government of Israel; and sales of products that we and our subsidiaries
manufacture. We have incurred significant net losses since our inception.
Additionally, as of March 31, 2006, we had an accumulated deficit of
approximately $147.2 million. In an effort to reduce operating expenses and
maximize available resources, we intend to consolidate certain of our
subsidiaries, shift personnel and reassign responsibilities. We have also
substantially reduced certain senior employee salaries during 2005, cut
directors’ fees, and taken a variety of other measures to limit spending and
will continue to assess our internal processes to seek additional cost-structure
improvements. Although we believe that such steps will help to reduce our
operating expenses and maximize our available resources, there can be no
assurance that we will ever be able to achieve or maintain profitability
consistently or that our business will continue to exist.
Our
existing indebtedness may adversely affect our ability to obtain additional
funds and may increase our vulnerability to economic or business
downturns.
Our
bank
and certificated indebtedness (short and long term) aggregated approximately
$21.5 million principal amount as of March 31, 2006 (not including trade
payables, other account payables and accrued severance pay), of which $10.8
million is due in 2006 (not including $1.9 million short-term bank credit).
In
addition, we may incur additional indebtedness in the future. Accordingly,
we
are subject to the risks associated with significant indebtedness,
including:
· |
we
must dedicate a portion of our cash flows from operations to pay
principal
and interest and, as a result, we may have less funds available for
operations and other purposes;
|
· |
it
may be more difficult and expensive to obtain additional funds through
financings, if available at all;
|
· |
we
are more vulnerable to economic downturns and fluctuations in interest
rates, less able to withstand competitive pressures and less flexible
in
reacting to changes in our industry and general economic conditions;
and
|
· |
if
we default under any of our existing debt instruments, including
paying
the outstanding principal when due, and if our creditors demand payment
of
a portion or all of our indebtedness, we may not have sufficient
funds to
make such payments.
|
The
occurrence of any of these events could materially adversely affect our results
of operations and financial condition and adversely affect our stock
price.
The
agreements governing the terms of our debentures and notes contain numerous
affirmative and negative covenants that limit the discretion of our management
with respect to certain business matters and place restrictions on us, including
obligations on our part to preserve and maintain our assets and restrictions
on
our ability to incur or guarantee debt, to merge with or sell our assets to
another company, and to make significant capital expenditures without the
consent of the debenture holders. Our ability to comply with these and other
provisions of such agreements may be affected by changes in economic or business
conditions or other events beyond our control.
Failure
to comply with the terms of our indebtedness could result in a default that
could have material adverse consequences for us.
A
failure
to comply with the obligations contained in the agreements governing our
indebtedness could result in an event of default under such agreements which
could result in an acceleration of the debentures and notes and the acceleration
of debt under other instruments evidencing indebtedness that may contain
cross-acceleration or cross-default provisions. If the indebtedness under the
debentures, notes or other indebtedness were to be accelerated, there can be
no
assurance that our future cash flow or assets would be sufficient to repay
in
full such indebtedness.
We
may not generate sufficient cash flow to service all of our debt
obligations.
Our
ability to make payments on and to refinance our indebtedness and to fund our
operations depends on our ability to generate cash in the future. Our future
operating performance is subject to market conditions and business factors
that
are beyond our control. Consequently, we cannot assure you that we will generate
sufficient cash flow to pay the principal and interest on our debt. If our
cash
flows and capital resources are insufficient to allow us to make scheduled
payments on our debt, we may have to reduce or delay capital expenditures,
sell
assets, seek additional capital or restructure or refinance our debt. We cannot
assure you that the terms of our debt will allow for these alternative measures
or that such measures would satisfy our scheduled debt service obligations.
In
addition, in the event that we are required to dispose of material assets or
restructure or refinance our debt to meet our debt obligations, we cannot assure
you as to the terms of any such transaction or how quickly such transaction
could be completed. Our ability to refinance our indebtedness or obtain
additional financing will depend on, among other things:
· |
our
financial condition at the time;
|
· |
restrictions
in the agreements governing our other indebtedness;
and
|
· |
other
factors, including the condition of the financial markets and our
industry.
|
We
need significant amounts of capital to operate and grow our business and to
pay
our debt.
We
require substantial funds to operate our business, including to market our
products and develop and market new products and to pay our outstanding debt
as
it comes due. To the extent that we are unable to fully fund our operations,
including repaying our outstanding debt, through profitable sales of our
products and services, we will need to seek additional funding, including
through the issuance of equity or debt securities. In addition, based on our
internal forecasts, the assumptions described under “Liquidity and Capital
Resources” in
our
Management’s Discussion and Analysis of Financial Condition and Results of
Operations,
and
subject to the other risk factors described herein, we believe that our present
cash position and anticipated cash flows from operations, lines of credit and
anticipated additions to paid-in capital should be sufficient to satisfy our
current estimated cash requirements through the next twelve months. However,
in
the event our internal forecasts and other assumptions regarding our liquidity
prove to be incorrect, we may need to seek additional funding. There can be
no
assurance that we will obtain any such additional financing in a timely manner,
on acceptable terms, or at all. Moreover, the issuance by us of additional
debt
or equity is severely restricted by the terms of our existing indebtedness.
If
additional funds are raised by issuing equity securities or convertible debt
securities, stockholders may incur further dilution. If we incur additional
indebtedness, we may be subject to affirmative and negative covenants that
may
restrict our ability to operate or finance our business. If additional funding
is not secured, we will have to modify, reduce, defer or eliminate parts of
our
present and anticipated future commitments and/or programs.
The
payment by us of our secured convertible notes in stock or the conversion of
such notes by the holders could result in substantial numbers of additional
shares being issued, with the number of such shares increasing if and to the
extent our market price declines, diluting the ownership percentage of our
existing stockholders.
In
September 2005, we issued $17.5 million in secured convertible notes due March
31, 2008. The Notes are convertible at the option of the holders at a fixed
conversion price of $1.00. We will repay the principal amount of the notes
over
the next two and one-half years, with the principal amount being amortized
in
twelve payments payable at our option in cash and/or stock, by requiring the
holders to convert a portion of their Notes into shares of our common stock,
provided certain conditions are met. The failure to meet such conditions could
make us unable to pay our notes, causing us to default. If the price of our
common stock is above $1.00, the holders of our notes will presumably convert
their notes to stock when payments are due, or before, resulting in the issuance
of additional shares of our common stock.
One-twelfth
of the principal amount of the Notes is payable on each of January 31, 2006,
March 31, 2006, May 31, 2006, July 31, 2006, September 30, 2006, November 30,
2006, May 31, 2007, July 31, 2007, September 30, 2007, November 30, 2007,
January 31, 2008, and March 31, 2008. We paid the January 31, 2006 and March
31,
2006 payments in stock by requiring the holders to convert a portion of their
Notes. Additionally, with the agreement of the holders of our Notes, we prepaid
the payments of September 30, 2007, November 30, 2007, January 31,
2008,
and
March
31, 2008, as well as a small portion of the payment due July 31, 2007, in stock
by requiring the holders to convert a portion of their Notes. In the event
we
continue to elect to make payments of principal on our convertible notes in
stock by requiring the holders to convert a portion of their Notes, either
because our cash position at the time makes it necessary or we otherwise deem
it
advisable, the price used to determine the number of shares to be issued on
conversion will be calculated using an 8% discount to the average trading price
of our common stock during 17 of the 20 consecutive trading days ending two
days
before the payment date. Accordingly, the lower the market price of our common
stock at the time at which we make payments of principal in stock, the greater
the number of shares we will be obliged to issue and the greater the dilution
to
our existing stockholders.
In
either
case, the issuance of the additional shares of our common stock could adversely
affect the market price of our common stock.
We
can
require the holder of our Notes to convert a portion of their Notes into shares
of our common stock at the time principal payments are due only if such shares
are registered for resale and certain other conditions are met. We do not have
shares of our stock registered for resale in order to continue requiring the
holders to convert a portion of their Notes. As a result, we have filed a
registration statement with the SEC to register for resale more shares of our
common stock in order to continue requiring conversion of our Notes upon
principal payment becoming due. Any delay in the registration process, including
through routine SEC review of our registration statement or other filings with
the SEC, could result in our having to pay scheduled principal repayments on
our
Notes in cash, which would negatively impact our cash position and, if we do
not
have sufficient cash to make such payments in cash, could cause us to default
on
our Notes.
We
have pledged a substantial portion of our assets to secure our borrowings.
Our
debentures and notes are secured by a substantial portion of our assets. If
we
default under the indebtedness secured by our assets, those assets would be
available to the secured creditors to satisfy our obligations to the secured
creditors, which could materially adversely affect our results of operations
and
financial condition and adversely affect our stock price.
Any
inability to continue to make use from time to time of our subsidiaries’ current
working capital lines of credit could have an adverse effect on our ability
to
do business.
From
time
to time our working capital needs are partially dependent on our subsidiaries’
lines of credit, which are themselves dependent upon our subsidiaries’ inventory
and receivables. In the event that we are unable to continue to make use of
our
subsidiaries’ lines of credit for working capital on economically feasible
terms, including because of any diminution in our subsidiaries’ inventory and
receivables, our business, operating results and financial condition could
be
adversely affected.
We
may not be successful in operating new businesses.
Prior
to
the acquisitions of IES and MDT in 2002 and the acquisitions of FAAC and Epsilor
in January 2004 and AoA in August 2004, our primary business was the marketing
and sale of products based on primary and refuelable Zinc-Air fuel cell
technology and advancements in battery technology for defense and security
products and other military applications, electric vehi-
cles
and
consumer electronics. As a result of our acquisitions, a substantial component
of our business is the marketing and sale of high-tech multimedia and
interactive training solutions and sophisticated
lightweight materials and advanced engineering processes used to armor vehicles.
These are relatively new businesses for us and our management group has limited
experience operating these types of businesses. Although we have retained our
acquired companies’ management personnel, we cannot assure that such personnel
will continue to work for us or that we will be successful in managing these
new
businesses. If we are unable to successfully operate these new businesses,
our
business, financial condition and results of operations could be materially
impaired.
Our
earnings will decline if we write off additional goodwill and other intangible
assets.
As
of
December 31, 2004, we had recorded goodwill of $39.7 million. On January 1,
2002, we adopted SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No.
142 requires goodwill to be tested for impairment on adoption of the Statement,
at least annually thereafter, and between annual tests in certain circumstances,
and written down when impaired, rather than being amortized as previous
accounting standards required. Goodwill is tested for impairment by comparing
the fair value of our reportable units with their carrying value. Fair value
is
determined using discounted cash flows. Significant estimates used in the
methodologies include estimates of future cash flows, future short-term and
long-term growth rates, weighted average cost of capital and estimates of market
multiples for the reportable units. We performed the required annual impairment
test of goodwill, based on our projections and using expected future discounted
operating cash flows. As of December 31, 2005, we identified in AoA an
impairment of goodwill in the amount of $11.8 million. As of March 31, 2006,
we
identified in AoA an additional impairment of goodwill in the amount of
$204,000.
Our
and
our subsidiaries’ long-lived assets and certain identifiable intangibles are
reviewed for impairment in accordance with Statement of Financial Accounting
Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived
Assets,” whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. Recoverability of the carrying amount
of assets to be held and used is measured by a comparison of the carrying amount
of the assets to the future undiscounted cash flows expected to be generated
by
the assets. If such assets are considered to be impaired, the impairment to
be
recognized is measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets. As of December 31, 2004, we identified
an
impairment of other intangible assets identified with the IES acquisition and,
as a result, we recorded an impairment loss in the amount of $320,000. As of
December 31, 2005, we identified an impairment of other intangible assets
identified with the AoA acquisition and, as a result, we recorded an impairment
loss in the amount of $499,000.
We
will
continue to assess the fair value of our goodwill annually or earlier if events
occur or circumstances change that would more likely than not reduce the fair
value of our goodwill below its carrying value. These events or circumstances
would include a significant change in business climate, including a significant,
sustained decline in an entity’s market value, legal factors, operating
performance indicators, competition, sale or disposition of a significant
portion of the business, or other factors. If we determine that significant
impairment has occurred, we
would
be
required to write off the impaired portion of goodwill. Impairment charges
could
have a material adverse effect on our financial condition and
results.
Failure
to comply with the earnout provisions of our acquisition agreements could have
material adverse consequences for us.
A
failure
to comply with the obligations contained in our acquisition agreements to make
the earnout payments required under such agreements as ultimately determined
in
arbitration or litigation could result in actions for damages, a possible right
of rescission on the part of the sellers, and the acceleration of debt under
instruments evidencing indebtedness that may contain cross-acceleration or
cross-default provisions. If we are unable to raise capital in order to pay
the
earnout provisions of our acquisition agreements, there can be no assurance
that
our future cash flow or assets would be sufficient to pay such
obligations.
In
this
connection, we note that we have received preliminary indications that there
may
be a dispute regarding the amount that we owe the former shareholders of FAAC
Incorporated in respect of their earnout for 2005. Pursuant to the purchase
agreement and a side letter, we are obligated to pay the former shareholders
of
FAAC an amount equal to “the net income realized by FAAC Incorporated from the
Stryker Driver Simulator Program with the U.S. Army.” Subsequently, the U.S.
Army added additional programs, all of which it classified generally as the
“Common Driver Training Program” (CDT). The former shareholders of FAAC have
indicated their belief that the 2005 earnout is due on the entire CDT program,
which would equal to an additional amount of $3.5 million. We have taken the
position that the 2005 earnout is due only on the Stryker part of the CDT
program, relying on the specific language of the side letter, and that we
therefore owe an additional amount of only $604,000. If this issue is ultimately
decided in favor of the former shareholders of FAAC, the need to pay additional
earnout sums to them could have a material adverse effect on our cash flows
and
financial condition.
We
may consider acquisitions in the future to grow our business, and such activity
could subject us to various risks.
We
may
consider acquiring companies that will complement our existing operations or
provide us with an entry into markets we do not currently serve. Growth through
acquisitions involves substantial risks, including the risk of improper
valuation of the acquired business and the risk of inadequate integration.
There
can be no assurance that suitable acquisition candidates will be available,
that
we will be able to acquire or manage profitably such additional companies or
that future acquisitions will produce returns that justify our investments
in
such companies. In addition, we may compete for acquisition and expansion
opportunities with companies that have significantly greater resources than
we
do. Furthermore, acquisitions could disrupt our ongoing business, distract
the
attention of our senior officers, increase our expenses, make it difficult
to
maintain our operational standards, controls and procedures and subject us
to
contingent and latent risks that are different, in nature and magnitude, than
the risks we currently face.
We
may
finance future acquisitions with cash from operations or additional debt or
equity financings. There can be no assurance that we will be able to generate
internal cash or obtain financing from external sources or that, if available,
such financing will be on terms acceptable to us. The issuance of additional
common stock to finance acquisitions may result in substantial di-
lution
to
our stockholders. Any debt financing may significantly increase our leverage
and
may involve restrictive covenants which limit our operations.
We
may not successfully integrate our prior
acquisitions.
In
light
of our acquisitions of IES, MDT, FAAC, Epsilor and AoA, our success will depend
in part on our ability to manage the combined operations of these companies
and
to integrate the operations and personnel of these companies along with our
other subsidiaries and divisions into a single organizational structure, and
to
replace those subsidiary managers who have left or may in the future leave
our
employ. There can be no assurance that we will be able to effectively integrate
the operations of our subsidiaries and divisions and our acquired businesses
into a single organizational structure. Integration of these operations could
also place additional pressures on our management as well as on our key
technical resources. The failure to successfully manage this integration could
have an adverse material effect on us.
If
we are
successful in acquiring additional businesses, we may experience a period of
rapid growth that could place significant additional demands on, and require
us
to expand, our management, resources and management information systems. Our
failure to manage any such rapid growth effectively could have a material
adverse effect on our financial condition, results of operations and cash
flows.
If
we are unable to manage our growth, our operating results will be
impaired.
As
a
result of our acquisitions, we are currently experiencing a period of
significant growth and development activity which has placed a significant
strain on our personnel and resources. Our activity has resulted in increased
levels of responsibility for both existing and new management personnel. Many
of
our management personnel have had limited or no experience in managing growing
companies. We have sought to manage our current and anticipated growth through
the recruitment of additional management and technical personnel and the
implementation of internal systems and controls. However, our failure to manage
growth effectively could adversely affect our results of
operations.
A
significant portion of our business is dependent on government contracts and
reduction or reallocation of defense or law enforcement spending could reduce
our revenues.
Many
of
the customers of IES, FAAC and AoA to date have been in the public sector of
the
U.S., including the federal, state and local governments, and in the public
sectors of a number of other countries, and most of MDT’s customers have been in
the public sector in Israel, in particular the Ministry of Defense.
Additionally, all of EFB’s sales to date of battery products for the military
and defense sectors have been in the public sector in the United States. A
significant decrease in the overall level or allocation of defense or law
enforcement spending in the U.S. or other countries could reduce our revenues
and have a material adverse effect on our future results of operations and
financial condition.
Sales
to
public sector customers are subject to a multiplicity of detailed regulatory
requirements and public policies as well as to changes in training and
purchasing priorities. Contracts with public sector customers may be conditioned
upon the continuing availability of public funds, which in turn depends upon
lengthy and complex budgetary procedures, and may be sub-
ject
to
certain pricing constraints. Moreover, U.S. government contracts and those
of
many international government customers may generally be terminated for a
variety of factors when it is in the best interests of the government and
contractors may be suspended or debarred for misconduct at the discretion of
the
government. There can be no assurance that these factors or others unique to
government contracts or the loss or suspension of necessary regulatory licenses
will not reduce our revenues and have a material adverse effect on our future
results of operations and financial condition.
Our
U.S. government contracts may be terminated at any time and may contain other
unfavorable provisions.
The
U.S.
government typically can terminate or modify any of its contracts with us either
for its convenience or if we default by failing to perform under the terms
of
the applicable contract. A termination arising out of our default could expose
us to liability and have a material adverse effect on our ability to re-compete
for future contracts and orders. Our U.S. government contracts contain
provisions that allow the U.S. government to unilaterally suspend us from
receiving new contracts pending resolution of alleged violations of procurement
laws or regulations, reduce the value of existing contracts, issue modifications
to a contract and control and potentially prohibit the export of our products,
services and associated materials.
Government
agencies routinely audit government contracts. These agencies review a
contractor's performance on its contract, pricing practices, cost structure
and
compliance with applicable laws, regulations and standards. If we are audited,
we will not be reimbursed for any costs found to be improperly allocated to
a
specific contract, while we would be required to refund any improper costs
for
which we had already been reimbursed. Therefore, an audit could result in a
substantial adjustment to our revenues. If a government audit uncovers improper
or illegal activities, we may be subject to civil and criminal penalties and
administrative sanctions, including termination of contracts, forfeitures of
profits, suspension of payments, fines and suspension or debarment from doing
business with United States government agencies. We could suffer serious
reputational harm if allegations of impropriety were made against us. A
governmental determination of impropriety or illegality, or an allegation of
impropriety, could have a material adverse effect on our business, financial
condition or results of operations.
We
may be liable for penalties under a variety of procurement rules and
regulations, and changes in government regulations could adversely impact our
revenues, operating expenses and profitability.
Our
defense and commercial businesses must comply with and are affected by various
government regulations that impact our operating costs, profit margins and
our
internal organization and operation of our businesses. Among the most
significant regulations are the following:
· |
the
U.S. Federal Acquisition Regulations, which regulate the formation,
administration and performance of government contracts;
|
· |
the
U.S. Truth in Negotiations Act, which requires certification and
disclosure of all cost and pricing data in connection with contract
negotiations; and
|
· |
the
U.S. Cost Accounting Standards, which impose accounting requirements
that
govern our right to reimbursement under certain cost-based government
contracts.
|
These
regulations affect how we and our customers do business and, in some instances,
impose added costs on our businesses. Any changes in applicable laws could
adversely affect the financial performance of the business affected by the
changed regulations. With respect to U.S. government contracts, any failure
to
comply with applicable laws could result in contract termination, price or
fee
reductions or suspension or debarment from contracting with the U.S.
government.
Our
operating margins may decline under our fixed-price contracts if we fail to
estimate accurately the time and resources necessary to satisfy our
obligations.
Some
of
our contracts are fixed-price contracts under which we bear the risk of any
cost
overruns. Our profits are adversely affected if our costs under these contracts
exceed the assumptions that we used in bidding for the contract. Often, we
are
required to fix the price for a contract before we finalize the project
specifications, which increases the risk that we will mis-price these contracts.
The complexity of many of our engagements makes accurately estimating our time
and resources more difficult. In the event we fail to estimate our time and
resources accurately, our expenses will increase and our profitability, if
any,
under such contracts will decrease.
If
we are unable to retain our contracts with the U.S. government and subcontracts
under U.S. government prime contracts in the competitive rebidding process,
our
revenues may suffer.
Upon
expiration of a U.S. government contract or subcontract under a U.S. government
prime contract, if the government customer requires further services of the
type
provided in the contract, there is frequently a competitive rebidding process.
We cannot guarantee that we, or if we are a subcontractor that the prime
contractor, will win any particular bid, or that we will be able to replace
business lost upon expiration or completion of a contract. Further, all U.S.
government contracts are subject to protest by competitors. The termination
of
several of our significant contracts or nonrenewal of several of our significant
contracts, could result in significant revenue shortfalls.
The
loss of, or a significant reduction in, U.S. military business would have a
material adverse effect on us.
U.S.
military contracts account for a significant portion of our business. The U.S.
military funds these contracts in annual increments. These contracts require
subsequent authorization and appropriation that may not occur or that may be
greater than or less than the total amount of the contract. Changes in the
U.S.
military’s budget, spending allocations and the timing of such spending could
adversely affect our ability to receive future contracts. None of our contracts
with the U.S. military has a minimum purchase commitment, and the U.S. military
generally has the right to cancel its contracts unilaterally without prior
notice. We manufacture for the U.S. aircraft and land vehicle armor systems,
protective equipment for military personnel and other technologies used to
protect soldiers in a variety of life-threatening or catastrophic situations,
and batteries for communications devices. The loss of, or a significant
reduction in, U.S. military business
for
our
aircraft and land vehicle armor systems, other protective equipment, or
batteries could have a material adverse effect on our business, financial
condition, results of operations and liquidity.
A
reduction of U.S. force levels in Iraq may affect our results of operations.
Since
the
invasion of Iraq by the U.S. and other forces in March 2003, we have received
orders from the U.S. military for armoring of vehicles and military batteries.
These orders are the result, in substantial part, of the particular combat
situations encountered by the U.S. military in Iraq. We cannot be certain to
what degree the U.S. military would continue placing orders for our products
if
the U.S. military were to reduce its force levels or withdraw completely from
Iraq. A significant reduction in orders from the U.S. military could have a
material adverse effect on our business, financial condition, results of
operations and liquidity.
There
are limited sources for some of our raw materials, which may significantly
curtail our manufacturing operations.
The
raw
materials that we use in manufacturing our armor products include
Kevlar®,
a
patented product of E.I. du Pont de Nemours Co., Inc. We purchase Kevlar in
the
form of woven cloth from various independent weaving companies. In the event
Du
Pont and/or these independent weaving companies were to cease, for any reason,
to produce or sell Kevlar to us, we might be unable to replace it with a
material of like weight and strength, or at all. Thus, if our supply of Kevlar
were materially reduced or cut off or if there were a material increase in
the
price of Kevlar, our manufacturing operations could be adversely affected and
our costs increased, and our business, financial condition and results of
operations could be materially adversely affected.
Some
of the components of our products pose potential safety risks which could create
potential liability exposure for us.
Some
of
the components of our products contain elements that are known to pose potential
safety risks. In addition to these risks, there can be no assurance that
accidents in our facilities will not occur. Any accident, whether occasioned
by
the use of all or any part of our products or technology or by our manufacturing
operations, could adversely affect commercial acceptance of our products and
could result in significant production delays or claims for damages resulting
from injuries. Any of these occurrences would materially adversely affect our
operations and financial condition. In the event that our products, including
the products manufactured by MDT and AoA, fail to perform as specified, users
of
these products may assert claims for substantial amounts. These claims could
have a materially adverse effect on our financial condition and results of
operations. There is no assurance that the amount of the general product
liability insurance that we maintain will be sufficient to cover potential
claims or that the present amount of insurance can be maintained at the present
level of cost, or at all.
Our
fields of business are highly competitive.
The
competition to develop defense and security products and electric vehicle
battery systems, and to obtain funding for the development of these products,
is, and is expected to remain, intense.
Our
defense and security products compete with other manufacturers of specialized
training systems, including Firearms Training Systems, Inc., a producer of
interactive simulation systems designed to provide training in the handling and
use of small and supporting arms. In addition, we compete with manufacturers
and
developers of armor for cars and vans, including O’Gara-Hess & Eisenhardt, a
division of Armor Holdings, Inc.
Our
battery technology competes with other battery technologies, as well as other
Zinc-Air technologies. The competition in this area of our business consists
of
development stage companies, major international companies and consortia of
such
companies, including battery manufacturers, automobile manufacturers, energy
production and transportation companies, consumer goods companies and defense
contractors.
Various
battery technologies are being considered for use in electric vehicles and
defense and safety products by other manufacturers and developers, including
the
following: lead-acid, nickel-cadmium, nickel-iron, nickel-zinc, nickel-metal
hydride, sodium-sulfur, sodium-nickel chloride, zinc-bromine, lithium-ion,
lithium-polymer, lithium-iron sulfide, primary lithium, rechargeable alkaline
and Zinc-Air.
Many
of
our competitors have financial, technical, marketing, sales, manufacturing,
distribution and other resources significantly greater than ours. If we are
unable to compete successfully in each of our operating areas, especially in
the
defense and security products area of our business, our business and results
of
operations could be materially adversely affected.
Our
business is dependent on proprietary rights that may be difficult to protect
and
could affect our ability to compete effectively.
Our
ability to compete effectively will depend on our ability to maintain the
proprietary nature of our technology and manufacturing processes through a
combination of patent and trade secret protection, non-disclosure agreements
and
licensing arrangements.
Litigation,
or participation in administrative proceedings, may be necessary to protect
our
proprietary rights. This type of litigation can be costly and time consuming
and
could divert company resources and management attention to defend our rights,
and this could harm us even if we were to be successful in the litigation.
In
the absence of patent protection, and despite our reliance upon our proprietary
confidential information, our competitors may be able to use innovations similar
to those used by us to design and manufacture products directly competitive
with
our products. In addition, no assurance can be given that others will not obtain
patents that we will need to license or design around. To the extent any of
our
products are covered by third-party patents, we could need to acquire a license
under such patents to develop and market our products.
Despite
our efforts to safeguard and maintain our proprietary rights, we may not be
successful in doing so. In addition, competition is intense, and there can
be no
assurance that our competitors will not independently develop or patent
technologies that are substantially equivalent or superior to our technology.
In
the event of patent litigation, we cannot assure you that a court would
determine that we were the first creator of inventions covered by our issued
patents or pending patent applications or that we were the first to file patent
applications for those inven-
tions.
If
existing or future third-party patents containing broad claims were upheld
by
the courts or if we were found to infringe third-party patents, we may not
be
able to obtain the required licenses from the holders of such patents on
acceptable terms, if at all. Failure to obtain these licenses could cause delays
in the introduction of our products or necessitate costly attempts to design
around such patents, or could foreclose the development, manufacture or sale
of
our products. We could also incur substantial costs in defending ourselves
in
patent infringement suits brought by others and in prosecuting patent
infringement suits against infringers.
We
also
rely on trade secrets and proprietary know-how that we seek to protect, in
part,
through non-disclosure and confidentiality agreements with our customers,
employees, consultants, and entities with which we maintain strategic
relationships. We cannot assure you that these agreements will not be breached,
that we would have adequate remedies for any breach or that our trade secrets
will not otherwise become known or be independently developed by
competitors.
We
are dependent on key personnel and our business would suffer if we fail to
retain them.
We
are
highly dependent on the president of our FAAC subsidiary and the general
managers of our MDT and Epsilor subsidiaries, and the loss of the services
of
one or more of these persons could adversely affect us. We are especially
dependent on the services of our Chairman and Chief Executive Officer, Robert
S.
Ehrlich, and our President and Chief Operating Officer, Steven Esses. The loss
of either Mr. Ehrlich or Mr. Esses could have a material adverse effect on
us.
We are party to an employment agreement with Mr. Ehrlich, which agreement
expires at the end of 2007, and an employment agreement with Mr. Esses, which
agreement expires at the end of 2006. We do not have key-man life insurance
on
either Mr. Ehrlich or Mr. Esses.
Payment
of severance or retirement benefits earlier than anticipated could strain our
cash flow.
Our
Chairman and Chief Executive Officer, Robert S. Ehrlich, and our President
and
Chief Operating Officer, Steven Esses, both have employment agreements that
provide for substantial severance payments and retirement benefits. We are
required to fund a certain portion of these payments according to a
predetermined schedule. Should Mr. Ehrlich or Mr. Esses leave our employ under
circumstances entitling them to severance or retirement benefits, or become
disabled or die, before we have funded these payments, the need to pay these
severance or retirement benefits ahead of their anticipated schedule could
put a
strain on our cash flow and have a material adverse effect on our financial
condition.
There
are risks involved with the international nature of our
business.
A
significant portion of our sales are made to customers located outside the
U.S.,
primarily in Europe and Asia. In 2005, 2004 and 2003, without taking account
of
revenues derived from discontinued operations, 21%, 19% and 42%, respectively,
of our revenues, were derived from sales to customers located outside the U.S.
We expect that our international customers will continue to account for a
substantial portion of our revenues in the near future. Sales to international
customers may be subject to political and economic risks, including political
instability, currency controls, exchange rate fluctuations, foreign taxes,
longer payment cycles and changes in import/export regulations and tariff rates.
In addition, various forms of protectionist trade legisla-
tion
have
been and in the future may be proposed in the U.S. and certain other countries.
Any resulting changes in current tariff structures or other trade and monetary
policies could adversely affect our sales to international
customers.
Our
management has determined that we have material weaknesses in our internal
controls. If we fail to achieve and maintain effective internal controls in
accordance with Section 404 of the Sarbanes-Oxley Act, we may not be able to
accurately report our financial results.
Section
404 of the Sarbanes-Oxley Act of 2002 requires us to include an internal control
report of management in our Annual Report on Form 10-K. Our management
acknowledges its responsibility for internal controls over financial reporting
and seeks to continually improve those controls. In addition, in order to
achieve compliance with Section 404 within the prescribed period, we have been
engaged in a process to document and evaluate our internal controls over
financial reporting. In this regard, management has dedicated internal
resources, engaged outside consultants and adopted a work plan to (i) assess
and
document the adequacy of internal control over financial reporting, (ii) take
steps to improve control processes where appropriate, (iii) validate through
testing that controls are functioning as documented and (iv) implement a
continuous reporting and improvement process for internal control over financial
reporting. We believe our process for documenting, evaluating and monitoring
our
internal control over financial reporting is consistent with the objectives
of
Section 404 of Sarbanes-Oxley.
Our
evaluation so far has identified a material weakness under standards established
by the Public Company Accounting Oversight Board (PCAOB) related to our FAAC
subsidiary. A material weakness is a condition in which the design or operation
of one or more of the internal control components does not reduce to a
relatively low level the risk that misstatements caused by error or fraud in
amounts that would be material in relation to the financial statements being
audited may occur and not be detected within a timely period by employees in
the
normal course of performing their assigned functions. Our management had not
yet
completed its assessment of the effectiveness of our internal control over
financial reporting as of December 31, 2005. However, based on their evaluation
procedures performed to date, management has concluded that internal controls
over financial reporting were ineffective as of December 31, 2005. Because
we
had not yet completed our assessment of the effectiveness of our internal
control over financial reporting, our independent auditors have disclaimed
any
opinion on our internal controls, as stated in their report which is included
in
our most recent annual report on Form 10-K.
As
a
public company, we will have significant requirements for enhanced financial
reporting and internal controls. The process of designing and implementing
effective internal controls is a continuous effort that requires us to
anticipate and react to changes in our business and the economic and regulatory
environments and to expend significant resources to maintain a system of
internal controls that is adequate to satisfy our reporting obligations as
a
public company. We cannot assure you that the measures we have taken or will
take to remediate any material weaknesses or that we will implement and maintain
adequate controls over our financial processes and reporting in the future
as we
continue our rapid growth. If we are unable to establish appropriate internal
financial reporting controls and procedures, it could cause us to fail to meet
our reporting obligations, result in material misstatements in our financial
statements, harm our
operating
results, cause investors to lose confidence in our reported financial
information and have a negative effect on the market price for shares of our
common stock.
Investors
should not purchase our common stock with the expectation of receiving cash
dividends.
We
currently intend to retain any future earnings for funding growth and, as a
result, do not expect to pay any cash dividends in the foreseeable
future.
Market-Related
Risks
The
price of our common stock is volatile.
The
market price of our common stock has been volatile in the past and may change
rapidly in the future. The following factors, among others, may cause
significant volatility in our stock price:
· |
announcements
by us, our competitors or our
customers;
|
· |
the
introduction of new or enhanced products and services by us or our
competitors;
|
· |
changes
in the perceived ability to commercialize our technology compared
to that
of our competitors;
|
· |
rumors
relating to our competitors or us;
|
· |
actual
or anticipated fluctuations in our operating results;
|
· |
the
issuance of our securities, including warrants, in connection with
financings and acquisitions; and
|
· |
general
market or economic conditions.
|
One
of
the continued listing standards for our stock on the Nasdaq Stock Market (both
the Nasdaq National Market, on which our stock is currently listed, and the
Nasdaq Capital Market (formerly known as the Nasdaq SmallCap Market)) is the
maintenance of a $1.00 bid price. Our stock price is currently below $1.00,
and
has been so since August 15, 2005. On March 28, 2006, we received a Nasdaq
Staff
Determination indicating that we were not in compliance with the minimum bid
price requirement for continued listing set forth in Marketplace Rule 4450(a)
and that our securities are, therefore, subject to delisting from the Nasdaq
National Market at the opening of business on April 6, 2006. The letter also
stated that we may request a review of the Staff Determination to a Nasdaq
Listing Qualifications Panel. We have requested a review of the Staff
Determination by a Nasdaq Listing Qualifications Panel. The request for review
has stayed the delisting of our stock from the Nasdaq National Market pending
the Panel’s decision.
Another
continued listing standard for our stock on the Nasdaq Stock Market is our
being
current with our filing and other obligations under the Securities and Exchange
Act of 1934, including our filing a complete annual report on Form 10-K. In
our
Annual Report on Form 10-K that we
timely
filed with the Securities and Exchange Commission on March 31, 2006, we noted,
in presenting management’s conclusions that our internal controls were not
effective as of December 31, 2005, that management had not yet completed its
assessment of the effectiveness of our internal control over financial
reporting. Nasdaq and the SEC have concluded that the Form 10-K that we filed
was therefore deficient.
We
have
requested from Nasdaq additional time to complete our assessment of the
effectiveness of our internal control over financial reporting and to file
an
amendment to our Form 10-K to bring us back into compliance. This matter was
included in the appeal that we requested before the Nasdaq Listing
Qualifications Panel.
If
our
common stock were to be delisted from the Nasdaq National Market, we might
apply
to be listed on the Nasdaq Capital Market if we then met the initial listing
standards of the Nasdaq Capital Market (other than the $1.00 minimum bid
standard). If we were to move to the Nasdaq Capital Market, current Nasdaq
regulations would give us the opportunity to obtain an additional 180-day grace
period (until September 22, 2006) if we meet certain net income, stockholders’
equity or market capitalization criteria; if at the end of that period we had
not yet achieved compliance with the minimum bid price rule, we would be subject
to delisting from the Nasdaq Capital Market. Although we would have the
opportunity to appeal any potential delisting, there can be no assurances that
this appeal would be resolved favorably. As a result, there can be no assurance
that our common stock will remain listed on the Nasdaq Stock
Market.
While
our
stock would continue to trade on the over-the-counter bulletin board following
any delisting from the Nasdaq, any such delisting of our common stock could
have
an adverse effect on the market price of, and the efficiency of the trading
market for, our common stock. Trading volume of over-the-counter bulletin board
stocks has been historically lower and more volatile than stocks traded on
an
exchange or the Nasdaq Stock Market. As a result, holders of our securities
could find it more difficult to sell their securities. Also, if in the future
we
were to determine that we need to seek additional equity capital, it could
have
an adverse effect on our ability to raise capital in the public equity
markets.
In
addition, if we fail to maintain Nasdaq listing for our securities, and no
other
exclusion from the definition of a “penny stock” under the Securities Exchange
Act of 1934, as amended, is available, then any broker engaging in a transaction
in our securities would be required to provide any customer with a risk
disclosure document, disclosure of market quotations, if any, disclosure of
the
compensation of the broker-dealer and its salesperson in the transaction and
monthly account statements showing the market values of our securities held
in
the customer’s account. The bid and offer quotation and compensation information
must be provided prior to effecting the transaction and must be contained on
the
customer’s confirmation. If brokers become subject to the “penny stock” rules
when engaging in transactions in our securities, they would become less willing
to engage in transactions, thereby making it more difficult for our stockholders
to dispose of their shares.
Additionally,
delisting from the Nasdaq Stock Market would constitute an event of default
under our debentures due in September 2006, which could result in acceleration
of debt under other instruments evidencing other indebtedness that may contain
cross-acceleration or cross-
default
provisions, even if the delisting were not an event of default under those
other
instruments.
A
substantial number of our shares are available for sale in the public market
and
sales of those shares could adversely affect our stock
price.
Sales
of
a substantial number of shares of common stock into the public market, or the
perception that those sales could occur, could adversely affect our stock price
or could impair our ability to obtain capital through an offering of equity
securities. As of April 30, 2006, we had 118,567,381 shares of common stock
issued and outstanding. Of these shares, most are freely transferable without
restriction under the Securities Act of 1933 or pursuant to effective resale
registration statements, and a substantial portion of the remaining shares
may
be sold subject to the volume restrictions, manner-of-sale provisions and other
conditions of Rule 144 under the Securities Act of 1933.
Exercise
of our warrants, options and convertible debt could adversely affect our stock
price and will be dilutive.
As
of
April 30, 2006, there were outstanding warrants to purchase a total of
15,798,860 shares of our common stock at a weighted average exercise price
of
$1.14 per share, options to purchase a total of 8,622,235 shares of our common
stock at a weighted average exercise price of $0.79 per share, of which
8,301,171 were vested, at a weighted average exercise price of $0.76 per share,
and outstanding debentures and notes convertible into a total of 11,590,727
shares of our common stock at a weighted average conversion price of $1.12
per
share. Holders of our options, warrants and convertible debt will probably
exercise or convert them only at a time when the price of our common stock
is
higher than their respective exercise or conversion prices. Accordingly, we
may
be required to issue shares of our common stock at a price substantially lower
than the market price of our stock. This could adversely affect our stock price.
In addition, if and when these shares are issued, the percentage of our common
stock that existing stockholders own will be diluted.
Our
certificate of incorporation and bylaws and Delaware law contain provisions
that
could discourage a takeover.
Provisions
of our amended and restated certificate of incorporation may have the effect
of
making it more difficult for a third party to acquire, or of discouraging a
third party from attempting to acquire, control of us. These provisions could
limit the price that certain investors might be willing to pay in the future
for
shares of our common stock. These provisions:
· |
divide
our board of directors into three classes serving staggered three-year
terms;
|
· |
only
permit removal of directors by stockholders “for cause,” and require the
affirmative vote of at least 85% of the outstanding common stock
to so
remove; and
|
· |
allow
us to issue preferred stock without any vote or further action by
the
stockholders.
|
The
classification system of electing directors and the removal provision may tend
to discourage a third-party from making a tender offer or otherwise attempting
to obtain control of us and may maintain the incumbency of our board of
directors, as the classification of the board of directors increases the
difficulty of replacing a majority of the directors. These provisions may have
the effect of deferring hostile takeovers, delaying changes in our control
or
management, or may make it more difficult for stockholders to take certain
corporate actions. The amendment of any of these provisions would require
approval by holders of at least 85% of the outstanding common
stock.
Israel-Related
Risks
A
significant portion of our operations takes place in Israel, and we could be
adversely affected by the economic, political and military conditions in that
region.
The
offices and facilities of three of our subsidiaries, EFL, MDT and Epsilor,
are
located in Israel (in Beit Shemesh, Lod and Dimona, respectively, all of which
are within Israel’s pre-1967 borders). Most of our senior management is located
at EFL’s facilities. Although we expect that most of our sales will be made to
customers outside Israel, we are nonetheless directly affected by economic,
political and military conditions in that country. Accordingly, any major
hostilities involving Israel or the interruption or curtailment of trade between
Israel and its present trading partners could have a material adverse effect
on
our operations. Since the establishment of the State of Israel in 1948, a number
of armed conflicts have taken place between Israel and its Arab neighbors and
a
state of hostility, varying in degree and intensity, has led to security and
economic problems for Israel.
Historically,
Arab states have boycotted any direct trade with Israel and to varying degrees
have imposed a secondary boycott on any company carrying on trade with or doing
business in Israel. Although in October 1994, the states comprising the Gulf
Cooperation Council (Saudi Arabia, the United Arab Emirates, Kuwait, Dubai,
Bahrain and Oman) announced that they would no longer adhere to the secondary
boycott against Israel, and Israel has entered into certain agreements with
Egypt, Jordan, the Palestine Liberation Organization and the Palestinian
Authority, Israel has not entered into any peace arrangement with Syria or
Lebanon. Moreover, since September 2000, there has been a significant
deterioration in Israel’s relationship with the Palestinian Authority, and a
significant increase in terror and violence. Israel recently withdrew
unilaterally from the Gaza Strip and certain areas in northern Samaria. It
is
unclear what the long-term effects of such disengagement plan will be. Efforts
to resolve the problem have failed to result in an agreeable solution.
The
election of representatives of the Hamas movement to a majority of seats in
the
Palestinian Legislative Council may create additional unrest and uncertainty.
There can be no assurance that the recent relative calm will continue.
Continued
hostilities between the Palestinian community and Israel and any failure to
settle the conflict may have a material adverse effect on our business and
us.
Moreover, the current political and security situation in the region has already
had an adverse effect on the economy of Israel, which in turn may have an
adverse effect on us.
Service
of process and enforcement of civil liabilities on us and our officers may
be
difficult to obtain.
We
are
organized under the laws of the State of Delaware and will be subject to service
of process in the United States. However, approximately 22% of our assets are
located outside the
United
States. In addition, two of our directors and most of our executive officers
are
residents of Israel and a portion of the assets of such directors and executive
officers are located outside the United States.
There
is
doubt as to the enforceability of civil liabilities under the Securities Act
of
1933, as amended, and the Securities Exchange Act of 1934, as amended, in
original actions instituted in Israel. As a result, it may not be possible
for
investors to enforce or effect service of process upon these directors and
executive officers or to judgments of U.S. courts predicated upon the civil
liability provisions of U.S. laws against our assets, as well as the assets
of
these directors and executive officers. In addition, awards of punitive damages
in actions brought in the U.S. or elsewhere may be unenforceable in
Israel.
Exchange
rate fluctuations between the U.S. dollar and the Israeli NIS may negatively
affect our earnings.
Although
a substantial majority of our revenues and a substantial portion of our expenses
are denominated in U.S. dollars, a portion of our costs, including personnel
and
facilities-related expenses, is incurred in New Israeli Shekels (NIS). Inflation
in Israel will have the effect of increasing the dollar cost of our operations
in Israel, unless it is offset on a timely basis by a devaluation of the NIS
relative to the dollar. In 2005, the inflation adjusted NIS depreciated against
the dollar.
Some
of our agreements are governed by Israeli law.
Israeli
law governs some of our agreements, such as our lease agreements on our
subsidiaries’ premises in Israel, and the agreements pursuant to which we
purchased IES, MDT and Epsilor. While Israeli law differs in certain respects
from American law, we do not believe that these differences materially adversely
affect our rights or remedies under these agreements.
The
following documents are filed as exhibits to this report:
Exhibit
Number
|
|
Description
|
31.1
|
|
Certification
of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
31.2
|
|
Certification
of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
32.1
|
|
Certification
of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
|
32.2
|
|
Certification
of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
Dated: May
15,
2006
|
AROTECH
CORPORATION |
|
By:
|
/s/
Robert S. Ehrlich
|
|
|
Name:
|
Robert
S. Ehrlich
|
|
|
Title:
|
Chairman
and CEO
|
|
|
|
(Principal
Executive Officer)
|
|
By:
|
/s/
Thomas J. Paup
|
|
|
Name:
|
Thomas
J. Paup
|
|
|
Title:
|
Vice
President - Finance and CFO
|
|
|
|
(Principal
Financial Officer)
|
Exhibit
Number
|
|
Description
|
31.1
|
|
Certification
of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
31.2
|
|
Certification
of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
32.1
|
|
Certification
of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
|
32.2
|
|
Certification
of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
|