arotech10q-2007q1.htm
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|
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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, 2007 .
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)
|
|
(Former
address, if changed since last
report)
|
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90
days. Yes
x No
o
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: o Accelerated
filer: o Non-accelerated
filer: x
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange
Act). Yes
o
No
x
APPLICABLE
ONLY TO CORPORATE ISSUERS:
The
number of shares outstanding of the issuer’s common stock as of May 14, 2007 was
11,983,576.
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 (Unaudited):
|
|
Condensed Consolidated Balance Sheets at March 31, 2007 and December
31,
2006
|
3
|
Condensed Consolidated Statements of Operations for the Three Months
Ended
March 31, 2007 and 2006
|
5
|
Condensed Consolidated Statements of Cash Flows for the Three Months
Ended
March 31, 2007 and 2006
|
6
|
Notes to the Interim Condensed Consolidated Financial
Statements
|
8
|
Item
2 – Management’s Discussion and Analysis of Financial Condition and
Results of Operations
|
15
|
Item
3 – Quantitative and Qualitative Disclosures about Market
Risk
|
22
|
Item
4 – Controls and Procedures
|
22
|
PART
II - OTHER INFORMATION
|
|
Item
1 – Legal Proceedings
|
24
|
Item
1A – Risk Factors
|
24
|
Item
6 – Exhibits
|
42
|
SIGNATURES
|
43
|
ITEM
1.
|
FINANCIAL
STATEMENTS (UNAUDITED)
|
(U.S.
Dollars)
|
|
March
31, 2007
|
|
|
December
31, 2006
|
|
ASSETS
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
CURRENT
ASSETS:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
1.1,495,824
|
|
|
$ |
2,368,872
|
|
Restricted
collateral deposits and restricted held-to-maturity
securities
|
|
|
280,387
|
|
|
|
648,975
|
|
Escrow
receivable
|
|
|
1,479,826
|
|
|
|
1,479,826
|
|
Available-for-sale
marketable securities
|
|
|
42,341
|
|
|
|
41,166
|
|
Trade
receivables (net of allowance for doubtful accounts in the amount
of
$159,000 as of March 31, 2007 and December 31, 2006)
|
|
|
10,195,816
|
|
|
|
7,780,965
|
|
Unbilled
receivables
|
|
|
4,968,323
|
|
|
|
6,902,533
|
|
Other
accounts receivable and prepaid expenses
|
|
|
847,467
|
|
|
|
1,134,622
|
|
Inventories
|
|
|
7,753,484
|
|
|
|
7,851,820
|
|
Total
current assets
|
|
|
27,063,468
|
|
|
|
28,208,779
|
|
SEVERANCE
PAY FUND
|
|
|
2,359,726
|
|
|
|
2,246,457
|
|
OTHER
LONG-TERM RECEIVABLES
|
|
|
83,785
|
|
|
|
262,608
|
|
PROPERTY
AND EQUIPMENT, NET
|
|
|
4,662,964
|
|
|
|
3,740,593
|
|
INVESTMENT
IN AFFILIATED COMPANY
|
|
|
440,019
|
|
|
|
392,398
|
|
OTHER
INTANGIBLE ASSETS, NET
|
|
|
9,098,172
|
|
|
|
9,502,214
|
|
GOODWILL
|
|
|
30,715,225
|
|
|
|
30,715,225
|
|
|
|
$ |
74,423,359
|
|
|
$ |
75,068,274
|
|
The
accompanying notes are an integral part of the Condensed Consolidated
Financial
Statements.
CONDENSED
CONSOLIDATED BALANCE SHEETS
(U.S.
Dollars, except share data)
|
|
March
31, 2007
|
|
|
December
31, 2006
|
|
|
|
(Unaudited)
|
|
|
|
|
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
CURRENT
LIABILITIES:
|
|
|
|
|
|
|
Trade
payables
|
|
$ |
2.3,066,032
|
|
|
$ |
2,808,131
|
|
Other
accounts payable and accrued expenses
|
|
|
4,224,686
|
|
|
|
5,171,055
|
|
Current
portion of capitalized leases
|
|
|
55,263
|
|
|
|
55,263
|
|
Current
portion of promissory notes due to purchase of
subsidiaries
|
|
|
302,900
|
|
|
|
302,900
|
|
Short-term
bank loans and current portion of long-term loans
|
|
|
3,401,485
|
|
|
|
3,496,008
|
|
Deferred
revenues
|
|
|
982,471
|
|
|
|
1,321,311
|
|
Convertible
debenture
|
|
|
2,601,097
|
|
|
|
2,583,629
|
|
Total
current liabilities
|
|
|
14,633,934
|
|
|
|
15,738,297
|
|
Accrued
severance pay
|
|
|
4,239,862
|
|
|
|
4,039,049
|
|
Long-term
portion of loans
|
|
|
1,091,405
|
|
|
|
–
|
|
Long-term
portion of promissory notes due to purchase of
subsidiaries
|
|
|
75,725
|
|
|
|
151,450
|
|
Long-term
portion of capitalized leases
|
|
|
153,802
|
|
|
|
158,120
|
|
Total
long-term liabilities
|
|
|
5,560,794
|
|
|
|
4,348,619
|
|
MINORITY
INTEREST
|
|
|
82,176
|
|
|
|
21,520
|
|
SHAREHOLDERS’
EQUITY:
|
|
|
|
|
|
|
|
|
Share
capital –
|
|
|
|
|
|
|
|
|
Common
stock – $0.01 par value each;
|
|
|
|
|
|
|
|
|
Authorized:
250,000,000 shares as of March 31, 2007 and December 31, 2006; Issued:
12,023,242 shares as of March 31, 2007 and December 31, 2006; Outstanding:
11,983,576 shares as of March 31, 2007 and December 31,
2006
|
|
|
120,232
|
|
|
|
120,232
|
|
Preferred
shares – $0.01 par value each;
|
|
|
|
|
|
|
|
|
Authorized:
1,000,000 shares as of March 31, 2007 and December 31, 2006; No shares
issued and outstanding as of March 31, 2007 and December 31,
2006
|
|
|
–
|
|
|
|
–
|
|
Additional
paid-in capital
|
|
|
218,538,899
|
|
|
|
217,735,860
|
|
Accumulated
deficit
|
|
|
(160,264,365 |
) |
|
|
(158,566,123 |
) |
Treasury
stock, at cost (common stock – 39,666 shares as of March 31, 2007 and
December 31, 2006)
|
|
|
(3,537,106 |
) |
|
|
(3,537,106 |
) |
Notes
receivable from shareholders
|
|
|
(1,307,166 |
) |
|
|
(1,304,179 |
) |
Accumulated
other comprehensive loss
|
|
|
595,961
|
|
|
|
511,154
|
|
Total
shareholders’ equity
|
|
|
54,146,455
|
|
|
|
54,959,838
|
|
|
|
$ |
74,423,359
|
|
|
$ |
75,068,274
|
|
The
accompanying notes are an integral part of the Condensed Consolidated
Financial
Statements.
(U.S.
Dollars, except share data)
|
|
Three
months ended March 31,
|
|
|
|
2007
|
|
|
2006
|
|
Revenues
|
|
$ |
11,529,162
|
|
|
$ |
8,896,412
|
|
Cost
of revenues
|
|
|
7,403,223
|
|
|
|
6,652,752
|
|
Amortization
of intangible assets
|
|
|
339,960
|
|
|
|
510,692
|
|
Research
and development
|
|
|
498,085
|
|
|
|
304,612
|
|
Selling
and marketing
|
|
|
1,030,768
|
|
|
|
899,268
|
|
General
and administrative
|
|
|
3,724,290
|
|
|
|
3,102,536
|
|
Impairment
of goodwill and other intangible assets
|
|
|
–
|
|
|
|
204,059
|
|
Total
operating costs
|
|
|
12,996,326
|
|
|
|
11,673,919
|
|
Operating
loss
|
|
|
(1,467,164 |
) |
|
|
(2,777,507 |
) |
Other
income
|
|
|
11,944
|
|
|
|
17,506
|
|
Financial
expenses, net
|
|
|
(124,080 |
) |
|
|
(1,461,136 |
) |
Loss
before minority interest in loss (earnings) of subsidiaries, earnings
from
affiliated company and tax expenses
|
|
|
(1,579,300 |
) |
|
|
(4,221,137 |
) |
Income
tax expenses
|
|
|
(105,907 |
) |
|
|
(39,972 |
) |
Minority
interest in loss (earnings) of subsidiaries
|
|
|
(60,656 |
) |
|
|
9,189
|
|
Gain
from affiliated company
|
|
|
47,621
|
|
|
|
38,472
|
|
Net
loss
|
|
$ |
(1,698,242 |
) |
|
$ |
(4,213,448 |
) |
Deemed
dividend to certain shareholders
|
|
|
–
|
|
|
|
(317,207 |
) |
Net
loss attributable to common shareholders
|
|
$ |
(1,698,242 |
) |
|
$ |
(4,530,655 |
) |
Basic
and diluted net loss per share
|
|
$ |
(0.15 |
) |
|
$ |
(0.70 |
) |
Weighted
average number of shares used in computing basic and diluted net
loss per
share
|
|
|
11,219,131
|
|
|
|
6,480,162
|
|
The
accompanying notes are an integral part of the Condensed Consolidated
Financial
Statements.
|
|
Three
months ended March 31,
|
|
2007
|
|
2006
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
Net
loss for the period before deemed dividend to certain stockholders
of
common stock
|
|
$ |
(1,698,242 |
) |
|
$ |
(4,213,448 |
) |
Adjustments
required to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
613,110
|
|
|
|
380,078
|
|
Amortization
of intangible assets, capitalized software costs and impairment of
intangible assets
|
|
|
486,429
|
|
|
|
745,528
|
|
Amortization
relating to warrants issued to the holders of convertible debentures
and
beneficial conversion feature
|
|
|
22,593
|
|
|
|
483,609
|
|
Financial
expenses in connection with convertible debenture principal
repayment
|
|
|
–
|
|
|
|
506,960
|
|
Amortization
of deferred expenses related to convertible debenture
issuance
|
|
|
17,468
|
|
|
|
242,846
|
|
Remeasurement
of liability in connection with warrants granted
|
|
|
–
|
|
|
|
(35,270 |
) |
Stock
based compensation due to options and shares granted to
employees
|
|
|
791,996
|
|
|
|
230,941
|
|
Earnings
(loss) to minority
|
|
|
60,656
|
|
|
|
(9,189 |
) |
Share
in earnings of affiliated company
|
|
|
(47,621 |
) |
|
|
(38,472 |
) |
Liability
for employee rights upon retirement, net
|
|
|
87,145
|
|
|
|
115,997
|
|
Write-off
of inventory
|
|
|
–
|
|
|
|
70,577
|
|
Decrease in
deferred tax assets
|
|
|
13,002
|
|
|
|
7,564
|
|
Changes
in operating asset and liability items:
|
|
|
|
|
|
|
|
|
Capital
loss from sale of property and equipment
|
|
|
3,232
|
|
|
|
–
|
|
Decrease
(increase) in trade receivables and notes receivable
|
|
|
(2,238,114 |
) |
|
|
3,967,096
|
|
Decrease
(increase) in unbilled receivables
|
|
|
1,934,210
|
|
|
|
(87,515 |
) |
Decrease
(increase) in other accounts receivable and prepaid
expenses
|
|
|
262,556
|
|
|
|
(91,927 |
) |
Decrease
in inventories
|
|
|
103,701
|
|
|
|
146,995
|
|
Decrease
(increase) in trade payables
|
|
|
253,983
|
|
|
|
(2,893,400 |
) |
Decrease
(increase) in deferred revenues
|
|
|
(338,840 |
) |
|
|
519,418
|
|
Decrease
in accounts payable and accruals
|
|
|
(1,138,943 |
) |
|
|
(639,714 |
) |
Net
cash used in operating activities from continuing
operations
|
|
|
(811,679 |
) |
|
|
(591,326 |
) |
Net
cash used in operating activities from discontinuing
operations
|
|
|
–
|
|
|
|
(120,000 |
) |
Net
cash used in operating activities
|
|
|
(811,679 |
) |
|
|
(711,326 |
) |
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Purchase
of property and equipment
|
|
|
(1,535,555 |
) |
|
|
(128,132 |
) |
Increase
in capitalized research and development projects
|
|
|
–
|
|
|
|
(202,607 |
) |
Decrease
(increase) in restricted securities and deposits,
net
|
|
|
368,589
|
|
|
|
(2,864,139 |
) |
Net
cash used in investing activities
|
|
|
(1,166,966 |
) |
|
|
(3,194,878 |
) |
FORWARD
|
|
$ |
(1,978,645 |
) |
|
$ |
(3,906,204 |
) |
The
accompanying notes are an integral part of the Condensed Consolidated
Financial
Statements.
CONSOLIDATED
STATEMENT OF CASH FLOWS (UNAUDITED) (U.S. Dollars)
|
|
Three
months ended March 31,
|
|
|
|
2007
|
|
|
2006
|
|
FORWARD
|
|
$ |
(1,978,645 |
) |
|
$ |
(3,906,204 |
) |
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Decrease
in short-term credit from banks
|
|
|
(1,432 |
) |
|
|
(133,747 |
) |
Proceeds
from exercise of warrants
|
|
|
–
|
|
|
|
3,195,772
|
|
Proceeds
from exercise of options to employees and consultants
|
|
|
37,642
|
|
|
|
–
|
|
Increase
in long term debt
|
|
|
1,115,000
|
|
|
|
–
|
|
Repayment
of long-term loans
|
|
|
–
|
|
|
|
(9,906 |
) |
Net
cash provided by financing activities
|
|
|
1,151,210
|
|
|
|
3,052,119
|
|
DECREASE
IN CASH AND CASH EQUIVALENTS
|
|
|
(827,435 |
) |
|
|
(854,085 |
) |
CASH
ACCRETION (EROSION) DUE TO EXCHANGE RATE
DIFFERENCES
|
|
|
(45,613 |
) |
|
|
15,347
|
|
BALANCE
OF CASH AND CASH EQUIVALENTS AT THE BEGINNING OF THE
PERIOD
|
|
|
2,368,872
|
|
|
|
6,150,651
|
|
BALANCE
OF CASH AND CASH EQUIVALENTS AT THE END OF THE
PERIOD
|
|
$ |
1,495,824
|
|
|
$ |
5,311,913
|
|
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 Condensed 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 FAAC Corporation (“FAAC”), a wholly-owned
subsidiary based in Ann Arbor, Michigan, and FAAC’s 80%-owned United Kingdom
subsidiary FAAC Limited; IES Interactive Training, Inc. (“IES”), a wholly-owned
subsidiary based in Ann Arbor, Michigan; Electric Fuel Battery Corporation
(“EFB”), 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. (“Epsilor”), a wholly-owned subsidiary located in
Dimona, Israel; MDT Protective Industries, Ltd. (“MDT”), a majority-owned
subsidiary based in Lod, Israel; MDT Armor Corporation (“MDT Armor”), a
majority-owned subsidiary based in Auburn, Alabama; and Armour of America,
Incorporated (“AoA”), a wholly-owned subsidiary based in Auburn,
Alabama.
b. Basis
of presentation:
The
accompanying interim condensed 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, 2007, its operating
results for the three-month periods ended March 31, 2007 and 2006 and its cash
flow for the three-month periods ended March 31, 2007 and 2006.
The
results of operations for the three months ended March 31, 2007 are not
necessarily indicative of results that may be expected for any other interim
period or for the full fiscal year ending December 31, 2007.
The
balance sheet at December 31, 2006 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 condensed 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, 2006.
c. Accounting
for stock-based compensation:
For
the
three months ended March 31, 2007 and 2006 the compensation expense recorded
related to stock options and restricted shares was $791,996 and $230,941,
respectively, of which $53,812 and $47,665, respectively, was for stock options
and $738,184 and $183,276, respectively, was for restricted shares. 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, 2007
was $1,684,674, of which $230,981 was for stock options and
$1,453,693 was for restricted shares. The weighted average period over which
this compensation cost is expected to be recognized is approximately 16
months.
Income
tax expense was not impacted since the Company is in a net operating loss
position and does not record income tax expense.
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.
There
were no new options or restricted stock issued in the first quarter and no
options were exercised in the first quarter.
d. Reclassification:
Certain
comparative data in these financial statements have been reclassified to conform
with the current year’s presentation.
e. Reverse
split:
The
Company’s shareholders approved a one-for-fourteen reverse stock split of the
Company’s common stock on June 19, 2006, which was effected on June 21, 2006. As
a result of the reverse stock split, every fourteen shares of Arotech common
stock were combined into one share of common stock; any fractional shares
created by the reverse stock split were eliminated. The reverse stock split
affected all of Arotech’s common stock, stock options, warrants and convertible
debt outstanding immediately prior to the effective date of the reverse stock
split. All shares of common stock, options, warrants, option and warrant
exercise prices, convertible debt conversion prices and per share data included
in these financial statements for all periods prior to June 21, 2006 presented
have been retroactively adjusted to reflect this one-for-fourteen reverse
split.
f. Anti-dilutive
shares for EPS calculation
All
outstanding stock options, non-vested restricted stock and warrants have been
excluded from the calculation of the diluted net loss per common share because
all such securities are anti-dilutive for the periods presented. The total
weighted average number of shares related to the outstanding options, restricted
stock and warrants excluded from the calculations of diluted net loss per share
was 1,871,826.
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,
2007, the Company did not adjust the inventory. Inventories are composed of
the
following:
|
March
31, 2007
|
|
December
31, 2006
|
|
(Unaudited)
|
|
|
Raw
and packaging materials
|
$ |
5,808,506
|
|
$ |
4,556,250
|
Work-in-progress
|
|
1,838,212
|
|
|
3,186,843
|
Finished
goods
|
|
106,766
|
|
|
108,727
|
|
$ |
7,753,484
|
|
$ |
7,851,820
|
NOTE
3: IMPACT
OF RECENTLY ISSUED ACCOUNTING STANDARDS
Effective
January 1, 2007, the first day of fiscal 2007, the Company adopted SFAS No.
155,
“Accounting for Certain Hybrid Financial Instruments,” to simplify the
accounting for certain hybrid instruments. The adoption of this statement did
not have a material effect on the consolidated financial condition or results
of
operations as the Company had no hybrid instruments to which SFAS No. 155
applies.
Effective
January 1, 2007, the first day of fiscal 2007, the Company adopted SFAS No.
156,
“Accounting for Servicing of Financial Assets,” which addresses the recognition
and measurement of separately recognized servicing assets and liabilities.
The
adoption of this statement did not have a material effect on the consolidated
financial condition or results of operations.
Effective
January 1, 2007, the first day of fiscal 2007, the Company adopted FASB
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” which
clarifies the accounting for uncertainty in income taxes recognized in the
Company's financial statements in accordance with FAS 109, “Accounting for
Income Taxes.” The interpretation prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement
of
a tax position taken or expected to be taken in a tax return. See Note 6 below
for additional information, including the effects of adoption on the Company’s
consolidated financial condition or results of operations.
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,”(“SFAS
No. 157”) which establishes a common definition for “fair value” to be applied
to generally accepted accounting principles in the United States. It provides
guidance requiring use of fair value, establishes a framework for measuring
fair
value, and expands disclosure about such fair value measurements. SFAS No.
157
is effective for fiscal years beginning after November 15, 2007. The Company
is
currently assessing the impact of SFAS No. 157 on the Company’s financial
statements.
In
December 2006, the FASB issued FASB Staff Position (FSP) Emerging Issues Task
Force (EITF) No. 00-19-2, “Accounting for Registration Payment Arrangements,”
which requires an issuer to account for a contingent obligation to transfer
consideration under a registration payment arrangement in accordance with FASB
Statement No. 5, “Accounting for Contingencies,” and FASB Interpretation No. 14,
“Reasonable Estimation of the Amount of Loss.” Registration payment arrangements
are frequently entered into in connection with issuance of unregistered
financial instruments, such as equity shares or warrants. A registration payment
arrangement contingently obligates the issuer to make future payments or
otherwise transfer consideration to another party if the issuer fails to file
a
registration statement with the SEC for the resale of specified
financial
instruments or fails to have the registration statement declared effective
within a specific period. The FSP requires issuers to make certain disclosures
for each registration payment arrangement or group of similar arrangements.
The
FSP is effective immediately for registration payment arrangements and financial
instruments entered into or modified after the FSP’s issuance date. For
previously issued registration payment arrangements and financial instruments
subject to those arrangements, the FSP is effective for financial statements
issued for fiscal years beginning after December 15, 2006. To the extent that
the Company enters into financing arrangements in the future that include
registration payment arrangements, the future application of this FSP may have
a
material effect on our financial condition and results of
operations.
In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities,” (“SFAS No. 159”) which permits
entities to choose to measure many financial instruments and certain other
items
at fair value. The objective is to improve financial reporting by
providing entities with the opportunity to mitigate volatility in reported
earnings caused by measuring related assets and liabilities differently without
having to apply complex hedge accounting provisions. SFAS No. 159 applies
to all entities and is effective for fiscal years beginning after November
15,
2007. The Company is currently assessing the impact of SFAS No. 159 on the
Company’s financial statements.
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
total assets for the three months ended March 31, 2007 and 2006:
|
|
Simulation
and Training
|
|
Battery
and
Power
Systems
|
|
Armor
|
|
All
Others
|
|
Total
|
Three
months ended March 31, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
from outside customers
|
|
$ |
4,216,008
|
|
|
$ |
2,539,132
|
|
|
$ |
4,774,022
|
|
|
$ |
–
|
|
|
$ |
11,529,162
|
|
Depreciation,
amortization and impairment expenses (1)
|
|
|
(398,876 |
) |
|
|
(237,920 |
) |
|
|
(188,960 |
) |
|
|
(59,302 |
) |
|
|
(885,058 |
) |
Direct
expenses (2)
|
|
|
(3,210,791 |
) |
|
|
(2,621,243 |
) |
|
|
(3,925,755 |
) |
|
|
(2,460,477 |
) |
|
|
(12,218,266 |
) |
Segment
income (loss)
|
|
$ |
606,341
|
|
|
$ |
(320,031 |
) |
|
$ |
659,307
|
|
|
$ |
(2,519,779 |
) |
|
|
(1,574,162 |
) |
Financial
expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(124,080 |
) |
Loss
from continuing operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
(1,698,242 |
) |
Segment
assets (3),
(4)
|
|
$ |
42,851,260
|
|
|
$ |
18,369,473
|
|
|
$ |
10,801,573
|
|
|
$ |
2,401,053
|
|
|
$ |
74,423,359
|
|
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
expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,461,136 |
) |
Loss
from continuing operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
(4,213,448 |
) |
Segment
assets (3),
(4)
|
|
$ |
44,005,859
|
|
|
$ |
16,299,877
|
|
|
$ |
8,932,609
|
|
|
$ |
12,371,120
|
|
|
$ |
81,609,464
|
|
(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 all assets.
|
(4)
|
Out
of those amounts, goodwill in our Simulation and Training, Battery
and
Power Systems and Armor Divisions stood at $24,235,419, $5,413,210
and
$1,066,596, respectively, as of March 31, 2007 and $23,605,069, $4,902,639
and $973,352, respectively, as of March 31,
2006.
|
NOTE
5:
|
CONVERTIBLE
DEBENTURES, DETACHABLE WARRANTS AND LONG TERM
DEBT
|
|
a.
|
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 (“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 Company’s 8% secured convertible
debentures due September 30, 2006, since terminated) and in the assets of FAAC
Incorporated (junior to a bank that extends to FAAC Incorporated a $6 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, 2007, the principal amount of $2.6 million remained outstanding under
these convertible notes.
The
Notes
are convertible at the investors’ option at a fixed conversion price of $14.00.
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.
In
connection with these convertible notes, the Company will recognize financial
expenses of $422,034 with respect to assigning fair value 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.
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.
During
the three months ended March 31, 2007, the Company recorded an expense of
approximately $17,000, 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.
|
b.
|
Mortgage
Note, Auburn, Alabama:
|
In
March
2007, the Company purchased 16,700 square feet of space in Auburn, Alabama
for
approximately $1.1 million pursuant to a seller-financed secured purchase money
mortgage. Half the mortgage is payable over ten years in equal monthly
installments based on a 20-year amortization of the full principal amount,
and
the remaining half is payable at the end of ten years in a balloon
payment. The note requires a payment (principal and interest) of approximately
$9,300 per month at an interest rate of 8% per annum. The balance of this note
is shown in the short and long term sections of the balance sheet.
NOTE
6: INCOME
TAXES
As
highlighted in Note 3 above, the Company adopted the provisions of FIN 48 on
January 1, 2007. As a result of the implementation of FIN 48, the Company did
not record a liability for unrecognized tax positions. The adoption of FIN
48
did not impact our financial condition, results of operations or cash flows.
At
December 31, 2006, we had net deferred tax assets of $39.5 million. The deferred
tax assets are primarily composed of federal, state and foreign tax net
operating loss (“NOL”) carryforwards. Due to uncertainties surrounding our
ability to generate future taxable income to realize these assets, a full
valuation has been established to offset our net deferred tax asset.
Additionally, the future utilization of our NOL carryforwards to offset future
taxable income may be subject to a substantial annual limitation as a result
of
ownership changes that may have occurred previously or that could occur in
the
future. We have not yet determined whether such an ownership change has
occurred. However, the Company plans to complete a Section 382 analysis
regarding the limitation of the net operating losses. When this project
is
completed,
the Company plans to update the unrecognized tax benefits under FIN 48.
Therefore, the Company expects that the unrecognized tax benefits may change
within 12 months of this reporting date. At this time, the Company cannot
estimate how much the unrecognized tax benefits may change. Any carryforwards
that will expire prior to utilization as a result of such limitations will
be
removed from deferred tax assets with a corresponding reduction of the valuation
allowance. Due to the existence of the valuation allowance, future changes
in
our unrecognized tax benefits will not impact our effective tax
rate.
At
least three years of the Company’s federal returns are still open for
examination, so it is possible that the amount of this liability could change
in
future accounting periods.
The
Company files income tax returns, including returns for its subsidiaries, with
federal, state, local and foreign jurisdictions. The Company is no longer
subject to IRS examination for periods prior to 2002, although carryforward
losses that were generated prior to 2002 may still be adjusted by the IRS if
they are used in a future period. Additionally, the Company is no longer subject
to examination in Israel for periods prior to 2002.
Interest
and penalties, when accrued, relating to income tax liabilities are included
in
income tax expense. As of March 31, 2007, the Company had not accrued any
interest or penalties relating to income taxes.
ITEM
2.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
|
This
report contains forward-looking statements made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. These
statements involve inherent risks and uncertainties. When used in this
discussion, the words “believes,” “anticipated,” “expects,” “estimates” and
similar expressions are intended to identify such forward-looking statements.
Such statements are subject to certain risks and uncertainties. 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 product names mentioned may
be
trademarks or registered trademarks of their respective holders. Unless the
context requires otherwise, all references to us refer collectively to Arotech
Corporation and its subsidiaries.
We
make available through our internet website free of charge our annual report
on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K,
amendments to such reports and other filings made by us with the SEC, as soon
as
practicable after we electronically file 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 Ann Arbor, Michigan, 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 Auburn, Alabama, which manufactures 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 cells, 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”).
|
Overview
of Results of Operations
We
incurred significant operating losses for the years ended December 31, 2005
and
2006 and for the first three months of 2007. 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.
In
2005
our net loss increased to $23.9 million on revenues of $49.0 million from $9.0
million on revenues of $50.0 million in 2004. About half of the 2005 loss was
the result of impairments during 2005 of goodwill and other intangible assets
in
connection with our AoA subsidiary; the remainder of the increase in net loss
was attributable to the factors cited below. In 2006, our net loss decreased
to
$15.6 million on revenues of $43.1 million. In the first three months of 2007
we
had a net loss of $1.7 million on revenues of $11.5 million, compared to the first three months
of
2006, when we had a net loss of $4.2 million on revenues of $8.9 million.
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
2007. 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
an
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 $339,000 during
the first three months of 2007.
Issuances
of Restricted Shares, Options and Warrants
During
2006, 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 $738,000 during
the
first three months of 2007.
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 $54,000 during the first three months of 2007.
Overview
of Operating Performance and Backlog
Overall,
our net loss before minority interest earnings, earnings from affiliated company
and tax expenses for the three months ended March 31, 2007 was $1.6 million
on
revenues of $11.5 million, compared to a net loss of $4.2 million on revenues
of
$8.9 million during the three months ended March 31, 2006. As of March 31,
2007,
our overall backlog totaled $40.3 million.
In
our
Simulation and Training Division, revenues decreased from approximately $4.9
million in the first three months of 2006 to $4.2 million in the first three
months of 2007. As of March 31, 2007, our backlog for our Simulation and
Training Division totaled $11.5 million.
In
our
Battery and Power Systems Division, revenues increased from approximately $2.0
million in the first three months of 2006 to approximately $2.5 million in
the
first three months of 2007. As of March 31, 2007, our backlog for our Battery
and Power Systems Division totaled $10.0 million.
In
our
Armor Division, revenues increased from $1.9 million during the first three
months of 2006 to $4.8 million during the first three months of 2007. As of
March 31, 2007, our backlog for our Armor Division totaled $18.8
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
are 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.
Results
of Operations
Three
months ended March 31, 2007 compared to the three months ended March 31,
2006.
Revenues.
During the three months ended March 31, 2007, we (through our
subsidiaries) recognized revenues as follows:
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Ø
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IES
and FAAC recognized revenues from the sale of interactive use-of-force
training systems simulators, and from the provision of maintenance
services in connection with such
systems.
|
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Ø
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MDT,
MDT Armor and AoA recognized revenues from payments under vehicle
armoring
contracts, for service and repair of armored vehicles, and on sale
of
armoring products.
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Ø
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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.
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Ø
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EFL
recognized revenues from the sale of water-activated battery (WAB)
lifejacket lights.
|
Revenues
for the three months ended March 31, 2007 totaled $11.5 million, compared to
$8.9 million in the comparable period in 2006, an increase of
$2.6 million, or 29.6%. In the first quarter of 2007, revenues were
$4.2 million for the Simulation and Training Division (compared to $4.9 million
in the first quarter of 2006, a decrease of $721,000, or
14.6%); $2.5 million for the Battery and Power Systems Division (compared to
$2.0 million in the first quarter of 2006, an increase of
$497,000, or 24.3%, due primarily to increased sales of Epsilor and EFB); and
$4.8 million for the Armor Division (compared to $1.9 million in the first
quarter of 2006, an increase of $2.9 million,
or 148.9%, due primarily to increased revenues from MDT
and MDT Armor, mostly in respect of orders for the “David” Armored
Vehicle).
Cost
of revenues. Cost of revenues totaled $7.4
million during the first quarter of 2007, compared to $6.7 million in the first
quarter of 2006, an increase of $750,000, or
11.3%, due primarily to production of a new product in our
Armor Division and the decrease in margins due to change in the mix of products
and customers in 2007 in comparison to 2006.
Direct
expenses for our three divisions during the first quarter of 2007 were $3.2
million for the Simulation and Training Division (compared to $4.2 million
in
the first quarter of 2006, a decrease of $1.0 million, or
23.5%, due primarily to decreased sales of FAAC); $2.6
million for the Battery and Power Systems Division (compared to $2.2 million
in
the first quarter of 2006, an increase of $470,000, or
21.8%, due primarily to increased revenues; and $3.9 million for the Armor
Division (compared to $2.4 million in the first quarter of
2006, an increase of $1.5 million, or
66.6%, due primarily to production of the “David” Armored
Vehicle.)
Amortization
of intangible assets. Amortization of intangible
assets totaled $340,000 in the first quarter of 2007, compared to $511,000
in
the first quarter of 2006, a decrease of $171,000, or 33.4%, due primarily
to a
decrease in amortization of intangible assets related to our subsidiary
AoA.
Research
and development expenses. Research and
development expenses for the first quarter of 2007 were $498,000, compared
to
$305,000 during the first quarter of 2006, an increase of $193,000, or 63.5%.
This increase was primarily attributable to increases in expenses
at
Epsilor
and EFL for design improvements and at FAAC for expenses associated with the
improvements to the Company’s simulator products.
Selling
and marketing expenses. Selling and marketing
expenses for the first quarter of 2007 were $1.0 million, compared to $899,000
the first quarter of 2006, an increase of $132,000, or 14.6%. This increase
was
primarily attributable to the overall increase in revenues and their associated
sales and marketing expenses.
General
and administrative expenses. General and
administrative expenses for the first quarter of 2007 were $3.7 million compared
to $3.1 million in the first quarter of 2006, an increase of $622,000, or 20.0%.
This increase was primarily attributable to stock compensation expense incurred
in respect of restricted shares granted to the executive officers of the
Company.
Financial
expenses, net. Financial expenses totaled
approximately $124,000 in the first quarter of 2007 compared to $1.5 million
in
the first quarter of 2006, a decrease of $1.3 million, or 91.5%. The difference
was due primarily to decreased interest related to our convertible notes that
were issued in March 31, 2006 as a result of payments of principal during 2006,
and financial expenses in 2006 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 that did not occur in the first three months
of 2007.
Income
taxes. We and certain of our subsidiaries
incurred net operating losses during the three months ended March 31, 2007
and
accordingly, no provision for income taxes was recorded. With respect
to some of our subsidiaries that operated at a net profit during 2007, we were
able to offset federal taxes against our accumulated loss carry forward. We
recorded a total of $106,000 in tax expense in the first quarter of 2007,
compared to $40,000 in tax expense in the first quarter of 2006, mainly
concerning state taxes.
Impairment
of goodwill and other intangible assets. 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. We performed the required annual impairment
test of goodwill, based on our management’s projections and using expected
future discounted operating cash flows. We did not identify any impairment
of
goodwill during the first quarter of 2007. In the corresponding period of 2006,
we identified in AoA an impairment of goodwill in the amount of
$204,000.
Net
loss. Due to the factors cited above, net loss decreased from $4.2
million in 2006 to $1.7 million in 2007, a decrease of $2.5 million, or 59.7%.
(Net loss attributable to common stockholders was $4.5 million in 2006, due
to a
deemed dividend that was recorded in the amount of $317,000 in 2006 due to
the
repricing of existing warrants and the issuance of new warrants.)
Liquidity
and Capital Resources
As
of
March 31, 2007, we had $1.5 million in cash, $280,000 in restricted collateral
securities and restricted held-to-maturity securities due within one year,
$1.5
million in an escrow receivable, and $42,000 in available-for-sale marketable
securities, as compared to December 31, 2006, when we had $2.4 million in cash,
$649,000 in restricted collateral securities and restricted held-to-maturity
securities due within one year, $1.5 million in an escrow receivable and $41,000
in available-for-sale marketable securities.
We
used
available funds in the three months ended March 31, 2007 primarily for sales
and
marketing, continued research and development expenditures, and other working
capital needs. We increased our investment in fixed assets (including the
purchase of two buildings in Alabama) during the three months ended March 31,
2007 by $1.5 million over the investment as at December 31, 2006. Our net fixed
assets amounted to $4.7 million at quarter end.
Net
cash
used in operating activities from continuing operations for the three months
ended March 31, 2007 and 2006 was $812,000 and $591,000, respectively, an
increase of $221,000. This increase in cash used was primarily the result of
changes in working capital.
Net
cash
used in investing activities for the three months ended March 31, 2007 and
2006
was $1.2 million and $3.2 million, a decrease of $2.0 million. This decrease
was
primarily the result of the change in restricted securities and
deposits.
Net
cash
provided by financing activities for the three months ended March 31, 2007
and
2005 was $1.2 million and $3.1 million, respectively. This decrease was
primarily the result of warrant exercises in February, March and April of 2006
that had no equivalent in 2007.
As
of
March 31, 2007, 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
$6.0
million in bank and certificated debt outstanding, $2.6 million of which was
convertible debt, and approximately $3.4 million in short-term
debt.
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 remainder of the year. This
belief 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 and
in Item 1A of our Annual Report on Form 10-K for the year ended December 31,
2006, as amended, including without limitation (i) that we will be able to
refinance, restructure or convert to equity our $2.6 million in convertible
notes that is due in 2007 (which does not include $3.4 million short-term bank
credit), (ii) 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 (iii) 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 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.
ITEM
3.
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QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.
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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 2007. 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. dollars, and a substantial portion of our costs are incurred in U.S.
dollars. Therefore, our functional currency is the U.S. dollar.
While
we
conduct our business primarily in U.S. dollars, some of our agreements are
denominated in foreign currencies, and we occasionally hedge part of the risk
of
a devaluation of the U.S dollar, which could have an adverse effect on the
revenues that we incur in foreign currencies. We do not hold or issue derivative
financial instruments for trading or speculative purposes
ITEM
4.
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CONTROLS
AND PROCEDURES.
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Evaluation
of Disclosure Controls and Procedures
As
of
March 31, 2007, 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.
Based
on
their evaluations, our principal executive officer and principal financial
officer were able to conclude that our disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act
of 1934) were effective as of March 31, 2007 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.
Changes
in Internal Controls Over Financial Reporting
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
Class
Action Litigation
We
have
learned that on March 23, 2007, a purported class action complaint (the
“Complaint”) was apparently filed in the United States District Court for the
Eastern District of Michigan against us and certain of our officers and
directors. The Complaint seeks class status on behalf of all persons who
purchased our securities between March 31, 2005 and November 14, 2005 (the
“Period”) and alleges violations by us and certain of our officers and directors
of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the
“Exchange Act”) and Rule 10b-5 thereunder, primarily related to our acquisition
of Armour of America in 2005 and certain public statements made by us with
respect to our business and prospects during the Period. The Complaint also
alleges that we did not have adequate systems of internal operational or
financial controls, and that our financial statements and reports were not
prepared in accordance with GAAP and SEC rules. The Complaint seeks an
unspecified amount of damages. Two similar cases were apparently filed in the
United States District Court for the Eastern District of New York in May
2007.
Although
the ultimate outcome of this matter cannot be determined with certainty, we
believe that the allegations stated in the Complaint are without merit and
we
and our officers and directors named in the Complaint intend to defend ourselves
vigorously against such allegations.
AoA
Arbitration
On
March
20, 2007, we filed a Demand for Arbitration with the American Arbitration
Association against the person from whom we purchased our Armor of America
subsidiary (the “Seller”). In our demand, we seek the return of $3 million, plus
interest, held in escrow by the Seller in connection with his sale of AoA to
us
in 2004. The parties had agreed in 2004 that the Seller would be entitled to
all
or part of the $3 million if AoA achieved certain levels of sales to certain
customers by December 31, 2006. As of December 31, 2006, AoA had not achieved
sales sufficient to entitle the Seller to the $3 million. In our demand, we
seek
the return of the escrowed funds.
The
Seller has asserted counterclaims against us in the arbitration, alleging (i)
that he is entitled to keep the $3 million, (ii) that he is entitled to an
additional $3 million in post-sale earnouts, and (iii) that he is entitled
to
$70,000 in compensation (plus interest and statutory penalties) wrongfully
withheld by us when we constructively terminated his employment. We believe
that
the Seller’s counterclaims are without merit, and will pursue our own claims,
and contest the Seller’s counterclaims, vigorously.
The
following factors, among others, which may contain changes from risk factors
as
previously disclosed in our Form 10-K for the year ended December 31, 2006,
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, 2007, we had an accumulated deficit of
approximately $160.5 million. In an effort to reduce operating expenses and
maximize available resources, we have consolidated certain of our subsidiaries,
shifted personnel and reassigned 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.
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” below, 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 which is payable during 2007. 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.
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
$6.0 million principal amount as of March 31, 2007 (not including trade
payables, other accounts
payable
and accrued severance pay), of which $2.6 million is in respect of our
convertible notes due in 2007 and $3.5 million is bank working capital lines
of
credit. In addition, we may incur additional indebtedness in the future.
Accordingly, we are subject to the risks associated with significant
indebtedness, including:
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·
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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;
|
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·
|
it
may be more difficult and expensive to obtain additional funds through
financings, if available at all;
|
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·
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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
|
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·
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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 notes that mature during 2007 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 note 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 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 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:
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·
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our
financial condition at the time;
|
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·
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restrictions
in the agreements governing our other indebtedness;
and
|
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·
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other
factors, including the condition of the financial markets and our
industry.
|
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 $14.00. The principal amount of the notes was payable over
a
period of 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 were 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 $14.00, 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 was 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 (deferred by agreement to June 30, 2007), July 31, 2007,
September 30, 2007, November 30, 2007, January 31, 2008, and March 31, 2008.
We
paid all of the January 31, 2006, March 31, 2006, May 31, 2006, July 31, 2006
and September 30, 2006, and most of the November 30, 2006 and January 31, 2007,
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, leaving only
the
payments of May 31, 2007 (deferred by agreement to June 30, 2007) and most
of
the payment of July 31, 2007 remaining, which represents approximately $2.6
million of outstanding principal under the 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. If our stock
price were to decline, we might 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. As a result, we would need to file an
additional 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
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 our acquired
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 battery technology
and advancements in battery technology for defense and security products and
other military applications, electric vehicles and consumer electronics. As
a
result of our acquisitions, a substantial component of our business is the
marketing and sale of 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 December 31, 2006,
we identified in AoA an additional impairment of goodwill in the amount of
$316,000.
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.
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 dilution to
our
stockholders. Any debt financing may significantly increase our leverage and
may
involve restrictive covenants which limit our operations.
We
may not successfully integrate our 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 have experienced 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
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 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 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, 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 inventions. If existing or future third-party patents
containing broad claims were upheld by the courts or if we were found to
infringe third-party patents, we may not be able to obtain the required licenses
from the holders of such patents on acceptable terms, if at all. Failure to
obtain these licenses could cause delays in the introduction of our products
or
necessitate costly attempts to design around such patents, or could foreclose
the development, manufacture or sale of our products. We could also incur
substantial costs in defending ourselves in patent infringement suits brought
by
others and in prosecuting patent infringement suits against
infringers.
We
also
rely on trade secrets and proprietary know-how that we seek to protect, in
part,
through non-disclosure and confidentiality agreements with our customers,
employees, consultants, and entities with which we maintain strategic
relationships. We cannot assure you that these agreements will not be breached,
that we would have adequate remedies for any breach or that our trade secrets
will not otherwise become known or be independently developed by
competitors.
We
are dependent on key personnel and our business would suffer if we fail to
retain them.
We
are
highly dependent on the 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 2009, and an employment agreement with Mr. Esses, which
agreement expires at the end of 2008. 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 2006, 2005 and 2004, without taking account
of
revenues derived from discontinued operations, 25%, 21% and 19%, respectively,
of our revenues, were derived from sales to customers located outside the U.S.
We expect that our international customers will continue to account for a
substantial portion of our revenues in the near future. Sales to international
customers may be subject to political and economic risks, including political
instability, currency controls, exchange rate fluctuations, foreign taxes,
longer payment cycles and changes in import/export regulations and tariff rates.
In addition, various forms of protectionist trade legislation have been and
in
the future may be proposed in the U.S. and certain other countries. Any
resulting changes in current tariff structures or other trade and monetary
policies could adversely affect our sales to international customers. See also “Israel-Related
Risks,” below.
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.
Risks
Related to Government Contracts
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 subject to certain pricing
constraints. Moreover, U.S. government contracts and those of many international
government customers may generally be terminated for a variety of factors when
it is in the best interests of the government and contractors may be suspended
or debarred for misconduct at the discretion of the government. There can be
no
assurance that these factors or others unique to government contracts or the
loss or suspension of necessary regulatory licenses will not reduce our revenues
and have a material adverse effect on our future results of operations and
financial condition.
Our
U.S. government contracts may be terminated at any time and may contain other
unfavorable provisions.
The
U.S.
government typically can terminate or modify any of its contracts with us either
for its convenience or if we default by failing to perform under the terms
of
the applicable contract. A termination arising out of our default could expose
us to liability and have a material adverse effect on our ability to re-compete
for future contracts and orders. Our U.S. government contracts contain
provisions that allow the U.S. government to unilaterally suspend us from
receiving new contracts pending resolution of alleged violations of procurement
laws or regulations, reduce the value of existing contracts, issue modifications
to a contract and control and potentially prohibit the export of our products,
services and associated materials.
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:
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the
U.S. Federal Acquisition Regulations, which regulate the formation,
administration and performance of government
contracts;
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the
U.S. Truth in Negotiations Act, which requires certification and
disclosure of all cost and pricing data in connection with contract
negotiations; and
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the
U.S. Cost Accounting Standards, which impose accounting requirements
that
govern our right to reimbursement under certain cost-based government
contracts.
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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 termin-
ation,
price or fee reductions or suspension or debarment from contracting with the
U.S. government.
We
may not be able to receive or retain
the necessary licenses or authorizations required for us to export or re-export
our products, technical data or services, or to transfer technology from foreign
sources (including our own subsidiaries) and to work collaboratively with
them.Denials of such
licenses and authorizations could have a material adverse effect on our business
and results of operations.
U.S.
regulations concerning export
controls require us to screen potential customers, destinations, and technology
to ensure that sensitive equipment, technology and services are not exported
in
violation of U.S. policy or diverted to improper uses or
users.
In
order
for us to export certain products, technical data or services, we are required
to obtain licenses from the U.S. government, often on a
transaction-by-transaction basis. These licenses are generally required for
the
export of the military versions of our products and technical data and for
defense services. We cannot be sure of our ability to obtain the U.S. government
licenses or other approvals required to export our products, technical data
and
services for sales to foreign governments, foreign commercial customers or
foreign destinations.
In
addition, in order for us to obtain certain technical know-how from foreign
vendors and to collaborate on improvements on such technology with foreign
vendors, including at times our own foreign subsidiaries, we may need to obtain
U.S. government approval for such collaboration through manufacturing license
or
technical assistance agreements approved by U.S. government export control
agencies.
The
U.S.
government has the right, without notice, to revoke or suspend export licenses
and authorizations for reasons of foreign policy, issues over which we have
no
control.
Failure
to receive required licenses or
authorizations would hinder our ability to export our products, data and
services and to use some advanced technology from foreign sources. This could
have a material adverse effect on our business, results of operations and
financial condition.
Our
failure to comply with export control rules could have a material adverse effect
on our business.
Our
failure to comply with these rules could expose us to significant criminal
or
civil enforcement action by the U.S. government, and a conviction could result
in denial of export privileges, as well as contractual suspension or debarment
under U.S. government contracts, either of which could have a material adverse
effect on our business, results of operations and financial
condition.
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 assump-
tions
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.
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:
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announcements
by us, our competitors or our
customers;
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the
introduction of new or enhanced products and services by us or our
competitors;
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changes
in the perceived ability to commercialize our technology compared
to that
of our competitors;
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rumors
relating to our competitors or us;
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actual
or anticipated fluctuations in our operating
results;
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the
issuance of our securities, including warrants, in connection with
financings and acquisitions; and
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general
market or economic conditions.
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If
our shares were to be delisted, our stock price might decline further and we
might be unable to raise additional capital.
One
of
the continued listing standards for our stock on the Nasdaq Stock Market (both
the Nasdaq Global Market (formerly known as 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 was below $1.00 between August 15, 2005 and June 20, 2006;
however, on June 21, 2006, we effected a one-for-fourteen reverse stock split,
which brought the bid price of our common stock back over $1.00. If our bid
price were to go and remain below $1.00 for 30 consecutive business days, Nasdaq
could notify us of our failure to meet the continued listing standards, after
which we would have 180 calendar days to correct such failure or be delisted
from the Nasdaq Global Market. In addition, we may be unable to satisfy the
other continued listing requirements.
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 Global
Market. If our common stock were to be delisted from the Nasdaq Global 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 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.
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 March 31, 2007, we had 11,983,576 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
March 31, 2007, there were outstanding warrants to purchase a total of 674,707
shares of our common stock at a weighted average exercise price of $13.27 per
share, options to purchase a total of 1,535,829 shares of our common stock
at a weighted average exercise price of $8.33 per share, of which 535,097 were
vested, at a weighted average exercise price of $8.38 per share, and outstanding
notes convertible into a total of 185,793 shares of our common stock at a
weighted average conversion price of $14.00 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:
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·
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divide
our board of directors into three classes serving staggered three-year
terms;
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|
·
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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
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|
·
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allow
us to issue preferred stock without any vote or further action by
the
stockholders.
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The
classification system of electing directors and the removal provision may tend
to discourage a third-party from making a tender offer or otherwise attempting
to obtain control of us and may maintain the incumbency of our board of
directors, as the classification of the board of directors increases the
difficulty of replacing a majority of the directors. These provisions may have
the effect of deferring hostile takeovers, delaying changes in our control
or
management, or may make it more difficult for stockholders to take certain
corporate actions. The amendment of any of these provisions would require
approval by holders of at least 85% of the outstanding common
stock.
Israel-Related
Risks
A
significant portion of our operations takes place in Israel, and we could be
adversely affected by the economic, political and military conditions in that
region.
The
offices and facilities of three of our subsidiaries, EFL, MDT and Epsilor,
are
located in Israel (in Beit Shemesh, Lod and Dimona, respectively, all of which
are within Israel’s pre-1967 borders). Most of our senior management is located
at EFL’s facilities. Although we expect that most of our sales will be made to
customers outside Israel, we are nonetheless directly affected by economic,
political and military conditions in that country. Accordingly, any major
hostilities involving Israel or the interruption or curtailment of trade between
Israel and its present trading partners could have a material adverse effect
on
our operations. Since the establishment of the State of Israel in 1948, a number
of armed conflicts have taken place between Israel and its Arab neighbors and
a
state of hostility, varying in degree and intensity, has led to security and
economic problems for Israel.
Historically,
Arab states have boycotted any direct trade with Israel and to varying degrees
have imposed a secondary boycott on any company carrying on trade with or doing
business in Israel. Although in October 1994, the states comprising the Gulf
Cooperation Council (Saudi Arabia, the United Arab Emirates, Kuwait, Dubai,
Bahrain and Oman) announced that they would no longer adhere to the secondary
boycott against Israel, and Israel has entered into certain agreements with
Egypt, Jordan, the Palestine Liberation Organization and the Palestinian
Authority, Israel has not entered into any peace arrangement with Syria or
Lebanon. Moreover, since September 2000, there has been a significant
deterioration in Israel’s relationship with the Palestinian Authority, and a
significant increase in terror and violence. Efforts to resolve the problem
have
failed to result in an agreeable solution. Israel withdrew unilaterally from
the
Gaza Strip and certain areas in northern Samaria in 2005. It is unclear what
the
long-term effects of such disengagement plan will be. The election of
representatives of the Hamas movement to a majority of seats in the Palestinian
Legislative Council has created additional unrest and uncertainty.
In
July
and August of 2006, Israel was involved in a full-scale armed conflict with
Hezbollah, a Lebanese Islamist Shiite militia group and political party, in
southern Lebanon, which involved missile strikes against civilian targets in
northern Israel that resulted in economic losses. On August 14, 2006, a
ceasefire was declared relating to that armed conflict, although it is uncertain
whether or not the ceasefire will continue to hold.
Continued
hostilities between Israel and its neighbors and any failure to settle the
conflict could 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 13% 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 2006 and in the first three months of 2007, the
inflation adjusted NIS appreciated 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
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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
17, 2007
|
AROTECH
CORPORATION
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|
By:
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/s/
Robert S. Ehrlich
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|
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Name:
|
Robert
S. Ehrlich
|
|
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Title:
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Chairman
and CEO
|
|
|
|
(Principal
Executive Officer)
|
|
By:
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/s/
Thomas J. Paup
|
|
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Name:
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Thomas
J. Paup
|
|
|
Title:
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Vice
President – Finance and CFO
|
|
|
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(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
|